Local Institutions, Audit Quality, and Financial Scandals of US-Listed Foreign Firms

47 Pages Posted: 5 May 2013 Last revised: 22 Jan 2015

See all articles by Lei Chen

Lei Chen

Southwestern University of Finance and Economics (SWUFE)

Date Written: July 1, 2014

Abstract

Using data on shareholder-initiated class action lawsuits in the US, I investigate the corporate scandals of US-listed foreign firms. The shareholders of scandal firms suffer considerable loss in both the short term and the long term. I document that firms domiciled in countries with weak institutions are more likely to be embroiled corporate scandals, but such a relation can be moderated by the presence of Big 4 auditors. Investors automatically adjust for undiscovered misconduct when valuing the stocks of non-scandal firms (i.e. the spillover effect). Investors rely on the audit quality to form their expectations about the severity of undiscovered misconduct, and thus impose less negative spillovers on firms with Big 4 auditors, especially when the firms are from countries with weak institutions. Taken together, my results suggest that listing on US exchanges does not fully compensate for weak local institutions; voluntarily bonding to a more stringent audit process has an incremental effect on protecting shareholder interests and enhances the confidence of investors in firms’ financial integrity.

Keywords: corporate scandals, US-listed foreign firms, the bonding theory, class action lawsuits, spillover effect, Big 4 auditors

JEL Classification: G3

Suggested Citation

Chen, Lei, Local Institutions, Audit Quality, and Financial Scandals of US-Listed Foreign Firms (July 1, 2014). Journal of Business Ethics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2260910 or http://dx.doi.org/10.2139/ssrn.2260910

Lei Chen (Contact Author)

Southwestern University of Finance and Economics (SWUFE) ( email )

55 Guanghuacun St,
Chengdu, Sichuan 610074
China

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