Spillover Effect of Fraud Allegations and Investor Sentiment

Abstract

This paper examines the spillover effect of the news about fraud allegedly committed by Chinese reverse merger companies (CRMs). These CRMs recently became public through reverse mergers with U.S. shell companies rather than through traditional IPOs. A number of these CRMs had allegations brought against them for fraudulent reporting or activities. Once the regulators and the public became alarmed by the frequency of alleged-fraud revelations, the stock prices of the offending as well as other companies were hammered. In particular, other CRMs and U.S.-listed Chinese IPOs experienced strong negative spillover effects. The intensity of the effect differed according to short selling activities, suggesting that short sellers played an important role in the spillover effect. Since non-Chinese (U.S. and other foreign) RMs have escaped the wrath of investors, the stock market reaction appears to be based on the country of origin rather than the method of going public.