Corporate fraud and information asymmetry in emerging markets. Case of firms subject to enforcement actions in Malaysia
DOI | https://doi.org/10.1108/JFC-11-2017-0107 |
Pages | 95-112 |
Date | 07 January 2019 |
Published date | 07 January 2019 |
Author | Abdul Ghafoor,Rozaimah Zainudin,Nurul Shahnaz Mahdzan |
Subject Matter | Accounting & Finance,Financial risk/company failure,Financial crime |
Corporate fraud and information
asymmetry in emerging markets
Case of firms subject to enforcement
actions in Malaysia
Abdul Ghafoor
University of Malaya Faculty of Business and Accountancy,
Kuala Lumpur, Malaysia, and
Rozaimah Zainudin and Nurul Shahnaz Mahdzan
Finance and Banking Department, University of Malaya Faculty of Business and
Accountancy, Kuala Lumpur, Malaysia
Abstract
Purpose –The purpose of this study is to examine changesin firms’level of information asymmetry in
emerging market of Malaysia for the period of 2000-2016. Specifically, the study focuses on changes in the
quoted spreadand quoted depth following the fraud announcement.
Design/methodology/approach –The study uses a unique set of fraud sample using enforcement
action releases(EARs) identified from the Security Commission of Malaysia and Bursa Malaysia. To estimate
the result, the authors use event study methodology,OLS regression and simultaneous model on a set of 67
fraudulentfirms.
Findings –The results of event study, OLS regression and simultaneous equation models suggest that
information asymmetry increases on fraud discovery. The authors also use the analysis on subsamples
classified by the type of regulator (who issued the enforcement release) and type of fraud committed.
However, the authorsfind no evidence of a difference in information asymmetry across thesegroups. Overall,
the results support the reputational view of fraud that it damages the firms’reputation and increases
uncertaintyin the capital market.
Research limitations/implications –These findings providevaluable insights into understanding the
information asymmetry around fraud announcements, especially for Malaysia, where the majority of the
public-listedcompanies are family-controlled and under significant statecontrol. The results of this study call
for the activerole that regulators can play to achieve a transparentand liquid capital market.
Practical implications –The research has practical implications.Specifically, for Malaysia, fraud is the
primary area for National Results Areas (NKRA) in the Government Transformation Program (GTP).
Therefore, for regulatorsand policymakers to ensure a liquid and transparentcapital market, identifying the
factors that elicit the fraudulent behavior and improving the related governance mechanism are necessary
steps to preventthe fraudulent practices.
Social implications –Due to increased informationasymmetry on fraud announcements, the demand for
equity decreasesthat may affect not only the fraudulent firms but also results in negative externality for non-
fraudulentfirms, thus impairing their ability to fundequity.
Originality/value –A significant majority of studies have focused on corporate frauds in developed
countries such as the USA that is characterizedby dispersed ownership system and a strong capital market.
One of the vocal critics of the agency theory is that it neglects the socialand institutional framework within
which companies operate. In emergingmarkets, such as Malaysia, the published academic papers on fraud
and information asymmetry are very limited. As emerging markets practice different cultures, corporate
JEL classification –M480, D4, K4, K20, G140
Corporate
fraud
95
Journalof Financial Crime
Vol.26 No. 1, 2019
pp. 95-112
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-11-2017-0107
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1359-0790.htm
governance mechanisms and market regulations, the study is significant to investigate the behavior of
investorsin such markets.
Keywords Malaysia, Information asymmetry, Fraud, Enforcement action releases (EARs)
Paper type Research paper
1. Introduction
A corporate fraud revelation is an unscheduled event in the capital market that is likely to
influence information asymmetry. The scope of most of the fraud literature surrounds the
adverse consequences of fraud on shareholders’wealth in terms of stock returns (Armour
et al.,2010;Karpoff et al., 2008;Murphy et al.,2009;Palmrose et al.,2004). Majority of these
studies find that fraud announcement has a negative effect on shareholders’wealth. However,
we argue that the price reaction analysis may not provide a complete picture because a change
in price subsumes the effects of the whole market and reflects the average investor’srevisionof
the assessment of the distribution of future returns. In comparison to stock returns, the effect of
fraud announcement is expected to be more pronounced in information asymmetry based on
the reputational hypothesis of Karpoff and Lott (1993) which suggests that fraud discovery
damages the firm’s reputation and results in higher uncertainty. In such an environment of
uncertainty, investors hesitate to invest in the capital market and increase their required rate of
return. In return, the information asymmetry affects the firms’value through stock returns and
thecostofcapital(Armstrong et al., 2011;Easley et al.,2002).
The literature provides competing arguments about the effect of fraud on subsequent
information asymmetry. On the one hand, the reputational hypothesis of Karpoff and Lott
(1993) argues that fraud discovery damages the firm’s reputation and results in higher
uncertainty. In such an environment of uncertainty, investors hesitate to invest in the capital
market and increase their required rate of return[1]. Based on these arguments, one may expect
an increase in information asymmetry following the fraud news. On the other hand, there are
also arguments that support the idea that fraud revelation decreases information asymmetry.
For example, Karpoff et al. (2008) argue that fraud discovery conveys private information to the
market about firm’s prospects, and hence reduces uncertainty about future cash flows of the
fraudulent firm. After the fraud event, the direct penalties and strict monitoring imposed by
regulatory bodies, such as the security commission (SC) assure investors that the firm will not
commit such act again, hence reducing information asymmetry[2].
In this study, we empirically examine the effect of fraud revelation on information
asymmetry in the Malaysian capitalmarket. We believe that this study is the first of its kind
to examine the effect of fraud announcements on information asymmetry in the emerging
market. The study contributes to fraud literature in several meaningful ways. First, this
study provides the first direct evidence on fraud–information asymmetry relationship in
emerging market, thus linking corporate ethics and market microstructure literature. As
Verrecchia (2001) suggests, given their low information environments, emerging markets
provide a unique setting to investigate the impacts of institutional characteristics on
changes related to information.Second, we examine information asymmetry within various
groups (i.e. based on fraud types and regulatory bodies), as well across the groups to
observe any change in the information asymmetry. Finally, we contribute to the fraud
literature by using a model that capturesthe simultaneous nature of the spreads and depths
in reaction to fraud news.
The remainder of this paper is organized as follows. Section 2 describes the reasons to
use Malaysia as our study setting. Section 3 describes the literature review. Section 4
discusses the data and sample. Section5 is the conclusion of the paper.
JFC
26,1
96
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