Bank Monitoring and Corporate Fraud: Evidence from a Natural Experiment

We find that financial misreporting in China is less likely if a firm’s province is more financially developed, if its largest shareholder holds more shares, or if the firm is in a government-supported industry, and more likely if the firm is connected to the market regulator. Many conventional Western governance mechanisms do not affect the incidence of misreporting. Natural experiments using two recent reforms support causal effects of financial development and blockholdings on misreporting. We also find that financial development reduces the frequency of tunneling and insider trading, but ownership structure has differing effects on these two types of fraud.