Financial Fraud, Investor Sentiment And Peer Firms’ Overinvestment

Information disclosure in financial report not only affects policymakers’ recognition of investment opportunities, but also changes the degree of information asymmetry among managers, shareholders and creditors. Thus, the quality of financial report may have significances on company’s investment behavior. Plenty of studies have confirmed that false report will interfere with the normal policy decision of corporates’ investment, making them investment efficiency decline, which, however, is not limited to internal of false company. Because of the externality of accounting information, other companies, especially those within the same and competitive industry of fraud company, are likely to be misled by optimistic market signals released by fraudulent report, resulting in overinvestment and inefficiency of the whole industry. Based on the above logic, this paper empirically examines the effects of financial fraud on peer companies’ investment behaviors and its consequences.Firstly, based on related research on financial fraud, accounting information externalities and overinvestment, this paper analyzed the theoretical relationship between financial fraud and peer companies’ overinvestment, found out investor sentiment that the key factor largely affects the relationship and demonstrated the specific mechanism of investor sentiment. Then, focusing on the most common way that is inflated revenues of financial fraud, the article selected 11 representative fraud companies and the corresponding 203 peer companies and 330 control group companies as research sample and established empirical models reflecting the relationship among financial fraud, investor sentiment and peer companies’ overinvestment. The results show that, peer companies significantly increase their investment in view of wrong information after fraud company reveals exaggerated performance in its financial report, and the more revenue that fraud company inflates, the more overinvestment that peer companies have. At the meanwhile, when the investor sentiment is higher, the preference of peer companies’ overinvestment is more obvious. In addition, the effect of financial fraud and investor sentiment on peer companies’ investment is greater. Ultimately, the article also analyzed the impact of financial fraud on peer firms’ investment behaviors by comparing their investment efficiency before and after fraud. The empirical results show that, compared with the previous occurrence of fraud, peer companies have additional investment on account of being misled by false information of fraud company and the investment efficiency drops significantly.