The Value of Political Ties and Market Credibility: Evidence from Corporate Scandals in China


HKUST IEMS Academic Seminar

Corporate scandals can be devastating. They not only cause huge losses of market value to firms but also can trigger panic and market instability, thus attracting great attention from investors and regulators. In China, corporate scandals have different levels of negative impact on firms’ value, depending on the nature of the scandal, as discovered by Prof. Mingyi Hung, Department of Accounting, HKUST, in her research on corporate scandals in Chinese firms. At a HKUST IEMS Academic Seminar, she talked about how political scandals trigger worse market reactions than market scandals.

Characteristics-adjusted abnormal returns (CSARs) for different types of scandals

The finding comes from an analysis of 212 enforcement actions against corporate misconduct by Chinese courts and securities regulators from 1997-2005. Prof. Hung and co- authors categorized scandals into political scandals, market scandals and mixed scandals, depending on whether the scandal is primarily associated with the destruction of political ties, market credibility, or both. Out of the 212 cases, they identified 26 political scandals such as managers bribing government officials or stealing from the state through tax evasion, 91 market scandals such as financial misrepresentation and managers misappropriating firm assets through embezzlement or kickbacks, and 95 mixed scandals, such as embezzlement by managers of state- owned enterprises (SOEs). They then employ an event study methodology to test how the market reacts to these different types of corporate scandals, as measured by the firms’ cumulative abnormal returns (CARs), calculated as stock returns minus returns of the market index during a certain event window. The results suggest the value of a firm’s political ties is greater than a firm’s market credibility. They also found that compared to market scandals, political and mixed scandals are more likely to lead to greater departure of political and affiliated directors and larger decreases in loans from state-owned banks.

The finding contributes to a better understanding of contracting arrangements of firms in different institutional settings. Compared to prior research mainly on market-based economies such as the U.S., Prof Hung’s study reveals the value of political ties and market credibility in a relationship-based economy that has institutional characteristics similar to other emerging economies.

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