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 holdings in fraudulent as well as non fraudulent firms, even if they do not hold stocks in fraudulent firms. Within a state, households with more lifetime experience of corporate fraud hold less equity. Following the exogenous increase in fraud revelation due to Arthur Andersen's demise, states with more Arthur Andersen clients experience a larger decrease in stock market participation. We provide evidence that the documented effect is likely to reflect a loss of trust in the stock market. This article is protected by copyright. All rights reserved. 1 JEL classification: G30, D12, D14 6 channels through which fraud revelation may affect stock market participation. Section IV provides evidence on the relevance of trust. Section V concludes and discusses implications of the results for corporate finance.

The impact of corporate fraud on director‐interlocked firms: Evidence from bank loans

“…In addition to corporate governance propagation, the literature has documented other potential mechanisms through which the negative impacts of fraud may transfer from the fraudulent firms to other firms. For instance, firms may suffer if they are in the same industries as the fraudulent firms (Gleason, Jenkins, & Johnson, ; Goldman, Peyer, & Stefanescu, ; Yuan & Zhang, ) or if they are located near the fraudulent firms (Giannetti & Wang, ; Parsons et al., ). To ensure that our main results are not driven by these other factors, we estimate two more sets of regressions.…”

Social Capital and Stock Market Participation via Technologies: The Role of Households’ Risk Attitude and Cognitive Ability

“…This conjecture is supported by several proposed explanations in the literature contemplating the role of participation costs in solving this puzzle [17,[20][21][22][23][24][25][26]. Moreover, scholars also reflected on behavioral approaches such as risk attitude [15,[27][28][29][30][31][32][33]; cognitive ability of households such as financial awareness [34], financial literacy [35], and IQ [36]; and sociological aspects including social interaction [5,8,12], trust [7,11] and shared vision [6,9,10,13]. This study reflects on the articles, considering risk attitude, cognitive ability, and sociological factors to explain the puzzle in stock market participation from the recommended journals in finance such as the Journal of Finance, Journal of Financial Economics, Review of Financial Studies, and Review of Finance.…”

“…For instance, Guiso et al [7], Georgarakos and Pasini [8], and Balloch et al [11] considered trust to explain the limited participation while Georgarakos and Inderst [51] studied the impact of trust on professional financial advice to explain stock market participation. Kumar et al [29] considered the risk attitude and the role of trust in investment decision while Giannetti and Wang [15] provided evidence that the risk attitude on household stock market participation is due to a loss of trust in the stock market. This notion is also motivated from the previous studies about risk aversion [27], uncertainty dispersion [28], and loss aversion [32].…”

“…The studies of Cao et al [28], Kumar [55], Gormley et al [31], Kumar et al [29], Bonaparte et al [33], and Giannetti and Wang [15] established a clear influence of risk attitude in explaining stock market participation. This factor can give a clear understanding of the relationship between social interaction and the investment participation by identifying the risk aversion and risk taking of households.…”

“…Stock market participation is the ownership of shares in a company or property, and the purchase of shares through options or by allowing partial ownership in exchange for financing [14]. Giannetti and Wang [15] also defined stock market participation as household ownership of any shares in publicly held corporations, mutual funds, or investment trusts, in each year.…”