Can judicial independence restrain corporate fraud? Empirical evidence from Chinese A-share listed firms

Abstract

This study investigates whether judicial independence can restrain corporate fraud. We take a unique personnel and financial reform in China’s local courts, which shifts the power of financial management and local judge appointment from municipal governments to the provincial level, as a natural experiment. This reform significantly strengthens the judicial independence of the local courts. Collecting data from Chinese A-share listed firms from 2011 to 2021 for empirical analysis, we find that this staggered judicial independence reform significantly restrains corporate fraud. Our mechanism analysis suggests that the judicial independence reform restrains corporate fraud by breaking local judicial protectionism, improving corporate governance, and relaxing financial constraints. This effect is more pronounced for state-owned enterprises, firms with political connections, and firms in poor legal environments. Overall, our research provides new evidence on how judicial independence restrains firm fraud, which provides important policy implications.