Corporate Scandals and Household Stock Market Participation

Abstract

We show that after the revelation of corporate fraud in a state, household stock market participation in that state decreases. Households decrease their holdings in fraudulent as well as non-fraudulent firms, even if they did not hold stocks in fraudulent firms. Within a state, households with more lifetime experience of corporate fraud hold less equity. Furthermore, following the arguably exogenous increase in fraud revelation due to the Arthur Andersen’s demise, a one-standard-deviation increase in fraud revelation due to the presence of Arthur Andersen’s clients increases the probability that a household exits the stock market by 7 percentage points. We provide evidence that the negative effect of fraud revelation on stock market participation is likely to be due to a loss of trust in the stock market.

Keywords: corporate securities fraud, corporate scandal, household stock market participation, local bias

JEL Classification: G30, D12, D14