Reputational Penalties for Different Types of Corporate Scandals in China

This study investigates reputational penalties for two main types of corporate scandals in China: accounting scandal vs. corruption. Compared with U.S. firms that experienced an average of 41% drop in firm value if accounting scandal was disclosed, I find that accounting scandals are less destructive to firm value in a relationship-based economy such as China. However, while pure accounting scandals are relatively innocuous in China, I find that corruption charges against the firms' senior executives have serious consequences. I explore several explanations for such difference in market reaction to the two types of scandals, including political network effect, accounting write-off effect, corporate governance effect, incentive effect, and executive turnover effect. My empirical evidence provides consistent support to the political relationship explanation which indicates that the damaged social and political networks and the ability to contract caused by the corruption charges would have a more negative impact on firms' operations and performances. Although my results do not fully eliminate all the other alternative explanations, they are likely to be a less important reason for the stronger reputation penalties for corruption charges than accounting scandals in China.