The Financial Implications of Corporate Fraud

46 Pages Posted: 14 Mar 2012 Last revised: 15 Nov 2012

See all articles by Chen Lin

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

Frank M. Song

The University of Hong Kong - School of Economics and Finance

Zengyuan Sun

Xiamen University - Institute for Financial and Accounting Studies

Date Written: November 1, 2012

Abstract

This paper explores the financial implications of corporate fraud by examining the impact of corporate fraud on fraudulent firms’ external financing cost and corporate cash holdings. Using a sample consist of 184 fraudulent firms that experience material litigation in securities class action, we find that firms’ cost of debt significantly increases associated with corporate fraud incident. In line with the costly external financing evidence, fraudulent firms accumulate more cash to keep liquidity and avoid underinvestment issues. Consistent with the precautionary motive argument, the value of cash increases after corporate fraud. In addition, corporate fraud contributes to financial constrains in the sense that fraudulent firms display a positive cash flow sensitivity of cash after corporate fraud. Our result indicates that corporate fraud can have a real impact on corporate outcomes by affecting the external financing cost and internal cash holdings.

Keywords: Corporate fraud, Cash, Costly external finance

JEL Classification: G32, K22

Suggested Citation

Lin, Chen and Song, Frank M. and Sun, Zengyuan, The Financial Implications of Corporate Fraud (November 1, 2012). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2020958 or http://dx.doi.org/10.2139/ssrn.2020958

Chen Lin (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Frank M. Song

The University of Hong Kong - School of Economics and Finance ( email )

8th Floor Kennedy Town Centre
23 Belcher's Street
Kennedy Town
Hong Kong

Zengyuan Sun

Xiamen University - Institute for Financial and Accounting Studies ( email )

Xiamen, Fujian 361005
China

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