Stock market reaction to regulatory investigation announcements

Xi Wu and Junsheng Zhang

China Journal of Accounting Studies, 2014, vol. 2, issue 1, 37-52

Abstract: Prior event studies have examined investor wealth losses due to corporate misconduct in China’s capital markets, using the regulator’s formal sanction announcement as the relevant event. However, an important and earlier event (namely, the regulatory investigation announcement) has been overlooked. We find that the market reaction is a decrease of 2% around the sanction event (which is consistent with prior literature), while it reaches a decrease of about 6% around the investigation event, suggesting that focusing on the sanction event alone will substantially underestimate investors’ wealth losses. In exploring the cross-sectional variations of investor reaction to the investigation announcement event, we find that a larger magnitude of prior-year earnings management is significantly associated with more negative abnormal returns, which suggests that investors may use prior financial reporting quality in making decisions when faced with insufficient information. The implication of our evidence for civil lawsuits against corporate misrepresentation in China is also discussed.

Date: 2014
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DOI: 10.1080/21697221.2014.891069

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