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Do Financial Markets Discipline Corporate Maleficence by Driving Down Stock Prices ?

Do Financial Markets Discipline Corporate Maleficence by Driving Down Stock Prices ?. Tackling Money Laundering Conference Utrecht, 2-3 November 2007. Peter-Jan Engelen Utrecht University, the Netherlands p.engelen@econ.uu.nl. Background of the project.

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Do Financial Markets Discipline Corporate Maleficence by Driving Down Stock Prices ?

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  1. Do Financial Markets Discipline Corporate Maleficence by Driving Down Stock Prices? Tackling Money Laundering Conference Utrecht, 2-3 November 2007 Peter-Jan Engelen Utrecht University, the Netherlands p.engelen@econ.uu.nl

  2. Background of the project • Relationship between discovery of illegal corporate behaviour and stock prices • Do shareholders punish companies by driving down stock prices? • Is there any price for corporate maleficence? • Disciplinary role • Magnitude of penalty

  3. Background of the project – cont’d • Event study methodology • Campbell, Lo and MacKinlay (1997), Chap.4 • MacKinlay (JEL, 1997) • McWilliams and Siegel (AMJ, 1997) • Armitage (JES, 1995) • Two exploratory studies • Low countries • Sample of 5 European countries

  4. Methodology • Event study • AAREaggregate of individual abnormal stock returns aligned in event time • Calculating individual ARs:

  5. Benchmark expected return models • Market-adjusted model • Market model • Dimson model for thin trading correction

  6. Test statistics • Traditional t-test of Brown and Warner (1985)

  7. Test statistics – cont’d • Potential problems • Event-induced variance • Variance during event window exceeds variance over estimation period • Thin trading • Non-normal return distribution • Traditional test statistics might be misspecified • Non-parametric tests do not depend on assumptions about probability distribution of returns

  8. Exploratory study 1

  9. Sample description • Preliminary study • The Low Countries (B, NL) • Listed on Euronext Brussels or Amsterdam • 1994-2003 • Public announcement of 57 cases of corporate malconduct • Leading financial newspapers (FD, FET)

  10. Scope • Impact of different types of illegal behaviour • Insider trading, corruption, tax fraud, accounting fraud, miscellaneous • Impact of company versus individual level • Impact of phase • Rumour • Formal investigation (police, judicial) • Impact of direct versus indirect effect • Bottom line (direct) • Reputation (indirect)

  11. Hypotheses • Hyp.1 – Stock prices of listed firm show a negative abnormal return upon the announcement of the corporate malconduct • Hyp.2 – A value-impact corporate malconduct exhibits a larger negative abnormal return of stock returns than a maleficence with only an impact on the trust of shareholders • Hyp.3 – Corporate malconduct at the firm level has a larger negative abnormal return than at the individual level • Hyp.4 – The further corporate maleficence is along the formal investigation procedure, the larger the abnormal negative return

  12. Empirical results – Total sample (Madj)

  13. Empirical results – subsamples • Corruption • Only day 0 sign. at 5% level using MM (-1.77%) • Other days no significant ARs • Tax fraud • Sign. at 5% level at day 0(-0.99%) • Sign. at 1% level at day [+1](-3.55%) (-4.54%) • Insider trading • Not sign. at day 0 (-0.66%) • Sign. at 1% level at day [-1](-2.13%)

  14. Empirical results – subsamples • Accounting fraud • Sign. AR at day [-2] at 1% level (-10.40%) • Miscellaneous • Sign. AR at day 0 at 1% level (-1.20%)

  15. Empirical results – subsamples • Stadium • No price reaction for rumours • Sign. neg. AR for court phase • Firm vs. individual level • No difference • Bottom-line vs. trust • Higher impact for bottom-line events

  16. Exploratory study 2

  17. Sample description • Public announcement of 239 cases of corporate malconduct • Leading financial newspapers • 1995-2005 • Five countries • Belgium, France, Germany, the Netherlands, UK • Five types of corporate malconduct • Insider trading, tax and accounting fraud, bribery, price fixing and market power abuse, miscellaneous

  18. Sample description – cont’d

  19. Empirical results (Madj)

  20. Empirical results (Madj) – cont’d

  21. Further research • Larger sample with richer taxonomy of corporate malconduct • Cross-country (five countries) – cultural differences • Differences in types across countries • Differences pre and post Enron (mental framing) or other time-effects • Interpretation and consequences of the results for business ethics

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