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Does the External Monitoring Effect of Financial Analysts Deter Corporate Fraud in China?

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Abstract

We examine whether analyst coverage influences corporate fraud in China. The fraud triangle specifies three main factors, i.e. opportunity, incentive, and rationalization. On the one hand, analysts may reduce the fraud opportunity factor through external monitoring aimed at discouraging managerial misconduct, which can moderate agency problems. On the other hand, analysts may increase the fraud incentive factor by pressurizing managers to achieve short-term performance targets, which can exacerbate agency problem. In either case, the potential influence of analysts on the fraud rationalization factor may be more pronounced among firms that are more dependent on the capital market for corporate finance. Using a sample of Chinese listed firms, we show a negative association between corporate fraud propensity and analyst coverage, and that this effect is more pronounced among non-state-owned enterprises, which are more reliant on the stock market for external funding. These findings suggest that analyst coverage contributes to corporate fraud deterrence in emerging economies characterized by weak investor protection. The main policy implication is that further development of the analyst profession in emerging economies may benefit investors and strengthen business ethics.

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Notes

  1. We gratefully appreciate the two reviewers for suggesting these additional tests, which enhance the robustness of our main findings.

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Acknowledgements

We thank Lei Zhang, Wei Diao and Jiaqi Wu for their excellent research assistance.

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Authors and Affiliations

  1. School of Public Finance and Economics, Southwestern University of Finance and Economics, Chengdu, China

    Jiandong Chen

  2. Schulich School of Business, York University, Toronto, Canada

    Douglas Cumming

  3. University of Edinburgh Business School, Edinburgh, UK

    Wenxuan Hou

  4. Manchester Business School, The University of Manchester, Manchester, UK

    Edward Lee

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  1. Jiandong Chen
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  2. Douglas Cumming
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  3. Wenxuan Hou
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Correspondence to Douglas Cumming.

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Chen, J., Cumming, D., Hou, W. et al. Does the External Monitoring Effect of Financial Analysts Deter Corporate Fraud in China?. J Bus Ethics 134, 727–742 (2016). https://doi.org/10.1007/s10551-014-2393-3

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