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

Tat-kei Lai (), Adrian C.H. Lei and Frank Song ()

Journal of Business Finance & Accounting, 2019, vol. 46, issue 1-2, 32-67

Abstract: We examine the impact of corporate fraud committed by one firm (the “fraudulent firm”) on other firms with interlocking directors (the “interlocked firms”), focusing on the debtholder side. We argue that the revelation of a fraudulent firm's fraud can damage the reputation of the interlocked firms because corporate governance can propagate via director interlocks. Empirically, we find that the interlocked firms' cost of debt is higher and the loan covenants become stricter after the fraud cases of the fraudulent firms are revealed. Consistent with the corporate governance propagation explanation, our results are weaker (stronger) for interlocked firms that have better (worse) pre‐event corporate governance standards. Our findings suggest that corporate fraud of fraudulent firms can affect other firms through director‐interlocks beyond shareholder value.

Date: 2019
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