The Spillover Effect of Fraud Allegations Against Chinese Reverse Mergers
55 Pages Posted: 12 Jan 2015
Date Written: January 5, 2015
We examine the spillover effect of fraud allegations against Chinese companies that became public through reverse mergers (CRMs) instead of IPOs. Both short sellers and regulators took active interests in the frauds allegedly perpetrated by CRMs. Once the public became alarmed by the frequency of these alleged-fraud revelations, the stock prices of both the offending and non-offending Chinese companies (both CRMs and IPOs) tumbled. The intensity of this negative spillover effect increased with short selling activities, suggesting that short sellers played an important role. Since US-listed, non-Chinese RMs have escaped the wrath of investors, the market reaction appears to be based on the country of origin rather than the method of going public. The wide-spread spillover effect on seemingly non-fraudulent companies indicates a serious credibility gap for Chinese companies in general, calling for coordinated actions by the Chinese and US regulators to restore investors’ confidence.
Keywords: reverse merger, short selling, spillover effects
JEL Classification: G14, G18, K22, M41
Suggested Citation: Suggested Citation