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Are investors always compensated for information risk? Evidence from Chinese reverse-merger firms

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Abstract

Using a data sample of 93 Chinese reverse-merger (CRM) firms listed in the U.S. over the period from 2000 to 2011, we find supporting evidence of poorer financial reporting quality exhibited by CRM firms relative to their respective US counterparts. Our main result indicates that while poor financial reporting quality induces information risk/asymmetry, higher (lower) information risk fails to be associated with higher (lower) expected returns. In contrast with prior studies that document information risk as non-diversifiable and a priced risk factor, the value relevance of the CRM firms’ financial reporting quality, in terms of information asymmetry-based premiums, is found to be remote.

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Notes

  1. Muddy Waters, LLC freely publishes investment research, which focuses on business fraud, accounting fraud, and fundamental problems. They have issued several reports uncovering the possibility of fraud committed by US-listed Chinese reverse-merger firms since 2010. For instance, Muddy Waters issued strong sell recommendations against Oriental Paper, Inc. on Jun 28, 2012, Rino International Corp. on Nov 10, 2010, China MediaExpress Holdings on Feb 3, 2011, and Duoyuan Global Water Inc. on Apr 4, 2011, etc. Those reports are all accessible at Muddy Waters’ official website, http://www.muddywatersresearch.com/research/.

  2. The central role of financial reporting quality in the firms’ information environment is demonstrated by Healy and Palepu (2001).

  3. The sample of U.S. IPO firms is identified as the U.S. firms that go public during our sample period.

  4. Bloomberg reports a list of Chinese reverse-merger firms that are currently traded on the Nasdaq OTC Market, NYSE and AMEX. We have retrieved the list that was published in June 2011. Any firm that has been delisted from the above equity market has been removed from the list. The details can be found on the website: http://www.bloomberg.com/news/2011-06-22/table-of-chinese-reverse-merger-firms-listed-on-u-s-stock-exchanges.html.

  5. Following the literature, the 11-month period extends from m − 1 to m − 12, because previous studies find that there is a short-term reversal of returns during the period from m − 1 to m + 0.

  6. When calculating average monthly returns for each size/BM/momentum quintile, we exclude CRM, CADR, and US IPO firms.

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Authors and Affiliations

  1. National Chengchi University, Taipei, Taiwan

    Yenn-Ru Chen & Mi-Hsiu Chiang

  2. Hong Kong Polytechnic University, Kowloon, Hong Kong

    Chia-Hsiang Weng

Authors
  1. Yenn-Ru Chen
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  2. Mi-Hsiu Chiang
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  3. Chia-Hsiang Weng
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Correspondence to Mi-Hsiu Chiang.

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Chen, YR., Chiang, MH. & Weng, CH. Are investors always compensated for information risk? Evidence from Chinese reverse-merger firms. Rev Quant Finan Acc 52, 159–196 (2019). https://doi.org/10.1007/s11156-018-0706-9

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  • DOI: https://doi.org/10.1007/s11156-018-0706-9

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