Product Market Implications of Corporate Accounting Fraud: Evidence from Scanner Data

Description

Corporate accounting fraud refers to the phenomenon that the financial statements of listed companies are intentionally manipulated, and material damages are caused to investors. This topic is not only of interest to academic researchers, but also to investors, the press, and policymakers.Despite numerous existing studies, there is limited empirical evidence on the impact of corporate accounting fraud on the product market. As demonstrated theoretically by Sadka (2006), if the manager manipulates the books to make her firm appear more efficient than real, the market will expect such an efficient firm to charge a lower price and/or produce a higher quantity. Therefore, to avoid detection of the accounting fraud, the fraud firm needs to adjust its product market behaviors to be consistent with the misreported financial statement. This argument is consistent with the earlier accounting scandal of WorldCom, which aggressively lowered prices during the fraud period. A more recent example is Luckin Coffee, which dramatically reduced product prices by providing substantial discount or free products and increased the market share, at the same timeof its accounting fraud.Furthermore, a firm's fraudulent accounting practices will also have spillover effects on the product market behaviors of its peer firms (Sadka 2006). When the firm aggressively prices down or produces more of its products, it could significantly put a downward pressure on the peer firms' pricing and production decisions and lower the profitability. Therefore, because of lower equilibrium price or markup, the industry as a whole will underperform.Our project studies the product market implications of firms' fraudulent accounting practices, and we will examine the direct effect on the fraudulent firms as well as the spillover effect on the peer firms. A significant empirical challenge facing researchers is that information on product market is limited. Our proposed research is made possible by combining a recently available dataset on product prices for a wide range of consumer nondurable goods sold at diverse geographic locations around the United States.Our paper contributes to the literature on corporate accounting fraud (Amiram et al. 2018). Understanding the implications to the product market is critical to draw a holistic view of the effects of corporate accounting fraud. Given the lack of empirical research on the effect of corporate accounting fraud on the product market, our work will complement existing evidence on the costs of accounting frauds, which focuses on the financial markets to equity and debt holders.