The Spillover Effects of Accounting Scandals in Business Groups

Abstract

We show that the revelation of an accounting scandal in a member firm induces stock price declines among other member firms in the same business group. Additional evidence suggests that the spillover effects of accounting scandals are amplified when peer member firms exhibit wider deviation between the ultimate controller’s voting rights and cash flow rights, demonstrate worse accounting transparency, participate more intensively in related party transactions, and appoint more connected audit partners. Further, we find that the spillover effects subside when the peer member firms engage Big Four auditors. We also document that peer member firms that are later identified as committing accounting fraud suffer sharper stock price declines around the revelation of the initial accounting scandal in the business group. Collectively, our evidence implies that an accounting scandal at a member firm destroys the market values of peer member firms by triggering investors’ concerns about accounting fraud risk for these firms.

Keywords: Business groups, accounting scandals, spillover effects, agency conflicts.

JEL Classification: G30, M41, M43