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Financial Misrepresentation and Its

Impact on Rivals
Eitan Goldman, Urs Peyer, and Irina Stefanescu
This paper examines how the announcement of an accusation of fraudulent financial misrepresentation affects industry rivals of the accused firm. Consistent with the importance of the industry
competition effect, we find that rivals in less competitive industries benefit from the event. However, in competitive industries, the information spillover effect dominates the competition effect,
resulting in negative returns to rival shareholders following the event. The spillover effect increases in importance with the severity of the accusation and is more important for opaque rivals
and for rivals that had positive stock price reactions to past positive earnings surprises of the
accused firm.

Recent interest surrounding the revelations of corporate financial misrepresentation has centered on the firms accused of such activities. Palmrose, Richardson, and Scholz (2004), Karpoff,
Lee, and Martin (2008a, b), and Gande and Lewis (2009) document significant declines in shareholder value around the first revelation of accusations of financial misrepresentation and earnings
restatements. While the shareholders of a firm accused of financial misrepresentation suffer significant financial loss, this disclosure may hold economic implications for other related firms
as well. The main goal of this paper is to investigate how the value of rival firms is affected
by such revelations. For example, the following is a quote from a March 2002 Associated Press
report concerning the exposure of wrongdoing at Global Crossing Corporation:
Global Crossings sudden implosion has done more than sting shareholders, creditors and
employees. Its burdened the suffering telecom industry with new worries about solvency and
accounting irregularities while prompting some investors to flee the sector. Global Crossing
was a wake-up call for a lot of people that didnt realize how bad the telecom sector had
become, . . . .
An accusation of financial misrepresentation in one firm may have negative implications for
shareholders of rival firms. Therefore, one hypothesis supposes that information contained in an
accusation of financial misrepresentation at one firm affects the information used to value rival
firms (the information spillover hypothesis). Another hypothesis posits that rival firms benefit
from the accusation of financial misrepresentation of a firm, possibly by attracting its customers
(the industry competition hypothesis). As a result, it is not obvious a priori that an accusation

Eitan Goldman is an Associate Professor of Finance and FedEx Faculty Fellow at Indiana University, Bloomington, IN
47405. Urs Peyer is an Associate Professor of Finance at INSEAD, Fontainebleau, France, 77305. Irina Stefanescu is an
Assistant Professor of Finance at Indiana University, Bloomington, IN 47405.
We would like to thank Bill Christie (editor), an anonymous referee, David Denis, Nishant Dass, Mattias Kahl, Jorg
Rocholl, Anil Shivdasani, Greg Udell, Xiaoyun Yu, and seminar participants at the University of North Carolina, Indiana
University, the EFA 2006 meetings in Zurich, the FMA Europe 2007 meetings in Barcelona, the FMA 2007 meetings in
Orlando, the Indiana-Notre Dame-Purdue Finance Symposium 2007, and the Frank Batten Young Scholars Conference
2008 for helpful comments and discussions.
Financial Management Winter 2012 pages 915 - 945

Financial Management r Winter 2012

916

Figure 1. CAR Rival Dispersion by Herfindahl Deciles

-1.5

-1

-.5

.5

1.5

The cumulative abnormal returns (CAR) of the rival firms are illustrated by Herfindahl deciles. CAR
rival is computed as the market-adjusted cumulative return over the three days around the announcement
of the accusation of financial misrepresentation of a competitor. The market return is the CRSP valueweighted index. Rivals are selected using the historical four-digit SIC in Compustat. The Herfindahl index
is computed based on sales of companies listed in Compustat. Herfindahl deciles are formed based on
one Herfindahl index per four-digit SIC industry. The lowest Herfindahl decile corresponds to the most
competitive industries.

10

Herfindahl deciles

of financial misrepresentation is detrimental to all rival firms. This study aims to measure the
importance of these two hypotheses in the context of financial misrepresentation deemed to have
the deliberate intent of fraud.
We begin our analysis with a sample of 1,001 enforcement actions for financial misrepresentations from April 1976 to January 2010, an extended version of the sample used in Karpoff
et al. (2008a, b).1 We restrict this sample to the subgroup of actions that are flagged by Karpoff
et al. (2008a, b) for fraud charges. Our final sample (after several additional restrictions due to
data availability) includes 444 enforcement actions. For these 444 cases, we find that firm value
declines by 19.7%, on average, in the three days around the enforcement action begin date. In the
same time period, we find that rival firm values decline by 0.54%, on average.2
Although the average drop in rival value suggests that the information spillover effect dominates the industry competition effect, this average number hides significant variation at the
industry and intraindustry level. Figure 1 illustrates the distribution of rival cumulative abnormal
announcement returns (CAR) for the three-day window around the event. Rival firms are grouped
by industry concentration deciles based on the Herfindahl Index. This figure reports a significant
variation in rival CAR within each group. For all rivals, the variability in CAR is 0.091. The
within-industry variation is 0.087, while the across-industry variation is only 0.0029. We explore
1

We thank Karpoff, Lee, and Martin for providing us with an updated version of their data.

A rival firm is defined based on historical four-digit SIC codes, extracted from Compustat.

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

917

both sources of variation, industry- and firm-level, to determine which rival firms react more
positively (negatively) to the event.
To guide our empirical analysis, we develop a set of implications based on the idea that the
relative magnitude of the competition effect and the information spillover effect depend upon
specific firm and industry characteristics. We then test these implications by analyzing the crosssectional variation in rival firms abnormal returns around the event date.
We find that rivals in less competitive industries experience higher CAR around the event. CAR
is also higher for rivals of accused firms that have both large sales and are in the least competitive
industries. These results are consistent with the industry competition hypothesis, which predicts
that rivals of a troubled firm may gain value by attracting clients of the accused firm.
We construct a rival-level proxy for the level of competition with the accused firm (this proxy
measures the stock price reactions of the rival to the earnings announcements by the accused
firm, prior to the event). We find that this variable is negatively correlated with rival CAR. A
rival that experienced stock price drops when the accused firm reported higher than expected
earnings in the past, now experiences an increase in value on the event date. We interpret these
results as consistent with the industry competition hypothesis. For example, when WorldCom
manipulated its cost numbers, it reported earnings growth that was difficult for its main rival,
AT&T, to match.3 The market believed, at the time, that AT&T was losing the fight against
WorldCom. Once WorldComs false earnings statements were exposed, the market realized that
AT&T was actually doing well in holding off its competitors.
In addition, we find that rival CARs are lower when the CAR of the accused firm is more
negative, consistent with the information spillover hypothesis. This effect, however, is reversed for
rivals in the least competitive industries, which is further indication that the industry competition
effect dominates the information spillover effect in concentrated industries.
Finally, we find that rival CARs are more negative for rivals that exhibit higher levels of
opacity (as measured, for example, through bid-ask spreads, intangibles-to-asset ratios, and analyst
forecast dispersion). When the market has less information about a rival firm, it assumes that
the lowered earnings reported by the accused firm also reflect lowered earnings for rival firms.
Hence, these rivals see a larger drop in value following the event date.
To highlight the economic impact of industry competition versus information spillover effects,
we form two subsamples of firms that are predicted to be more affected by either the industry
competition effect or by the information spillover effect. For the subsample of firms predicted
to be most affected by the industry competition effect (rivals in the least competitive industries,
rivals of large accused firms with very negative event date CARs, least opaque rivals, and most
opaque accused firms), we find that the average three-day CAR is 3.2%. For the subsample of
rival firms predicted to be most affected by the information spillover effect (rivals in the most
competitive industries, large accused firms with very negative CARs, most opaque rivals, and
least opaque accused firms), we find that the average three-day CAR is 1.5%.
In summary, our findings indicate the importance of both the competition and information
spillover effects in determining rival firm response to financial misrepresentation. The results
highlight the firm- and industry-level characteristics that distinguish firms who are more sensitive
to the information spillover effect from firms that are more sensitive to the industry competition
The New York Times article Trying to Catch Worldcoms Mirage (6/30/2002) reflects this idea: . . . AT&Ts shares
had been hammered by investors concerned about the companys cable strategy and because Wall Street did not believe
that AT&Ts core operations were being run as well as, say, WorldComs and Several top executives said last week that
competing against WorldCom for the attention of investors and Wall Street analysts in recent years was essentially like
running track against an athlete who is later discovered to be using steroids.

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Financial Management r Winter 2012

effect. Thus, this paper provides a more complete picture of the overall impact that cases of
fraudulent financial misrepresentation have had on investors, extending recent work by Karpoff
et al. (2008a) and Gande and Lewis (2009) that focus on the value loss to shareholders of the
accused firm.4
This paper relates to two strands of literature. One strand analyzes the importance of information
spillover and industry competition effects, while the second focuses on financial misrepresentation. The first strand of literature primarily focuses on analyzing the abnormal returns of portfolios
of rival companies following various events.5 Most closely related to our paper are Lang and Stulz
(1992) who investigate the impact of bankruptcy on rivals, Laux, Starks, and Yoon (1998) who
analyze rival reactions to dividend revisions, and Gleason, Jenkins, and Johnson (2008) who
investigate the effect of earnings restatements on industry rivals. Lang and Stulz (1992) find that
rival returns are negative, on average, following a bankruptcy event in their industry; however, for
a portfolio of rivals in highly concentrated industries with low leverage, the returns are positive.6
Laux et al. (1998) find that firm-level characteristics are important in explaining cross-sectional
variation in rival reaction to dividend revisions beyond industry-level (or portfolio-level) characteristics. Gleason et al. (2008) find that nonrestating firms that have the same external auditor
also incur a stock price drop if one of their competitors in the same industry restates earnings.
Finally, Chen, Ho, and Shih (2007) find that rivals react negatively when other firms announce
corporate capital investments.
The second stream of related literature investigates the effects of financial misrepresentation.
Palmrose et al. (2004) document an average abnormal announcement return of 9% in response
to restatements of annual or quarterly financial statements. Karpoff et al. (2008a) find an average
loss in market value of 38% when news of financial misconduct breaks. They indicate that a
significant part of the loss relates to reputation costs, costs that are not explained by future direct
penalties levied on the firm. Gande and Lewis (2009) find a significant drop in share price of
4.5% upon the announcement of shareholder-initiated class action lawsuits. All three studies
suggest that firms caught in or accused of financial misrepresentation, fraud, or misstatements
typically experience a substantial drop in firm value.

4
Research on corporate fraud takes many different perspectives. Karpoff, Lee, and Vendrzyk (1999) study firms indicted
for procurement fraud in government contracts. Goldman and Slezak (2006) theoretically analyze optimal executive
compensation and its effect on fraud, while Burns and Kedia (2006) and Bergstresser and Philippon (2006) empirically
demonstrate that earnings management and financial misreporting are motivated by stock-based compensation. Johnson,
Ryan, and Tian (2009) confirm a positive association between stock-based compensation and the fraudulent manipulation
of accounting statements, while Erickson, Hanlon, and Maydew (2006) argue that there is no such link. Miller (2006),
Dyck, Morse, and Zingales (2009), and Yu and Yu (2011) examine various aspects relating to fraud detection. Finally,
Gande and Lewis (2009) find that firms facing shareholder class action lawsuits suffer a loss in value before their actual
indictment.
5
Eckbo (1983), Eckbo and Wier (1985), and Shahrur (2005) examine the impact of mergers on industry rivals. Olsen
and Dietrich (1985) look at retail sales announcements. Docking, Hirschey, and Jones (1997) examine bank loan loss
announcements. Laux et al. (1998) study rival stock price reactions to dividend revisions. Slovin, Sushka, and Poloncheck
(1999) examine competitive effects and contagion at commercial banks. Bittlingmayer and Hazlett (2000) look at
the impact of antitrust rulings against Microsoft. Chen, Ho, and Ik (2005) investigate rival responses to new product
announcements. Hung-Chia, Reed, and Rocholl (2010) consider rival responses to the announcement of an IPO by a
large entrant. Zhang (2010) examines the effect on industry competitors when firms emerge from bankruptcy. Akhigbe,
Borde, and Whyte (2000) find positive information spillover effects for rivals of M&A targets at the time of the takeover
announcement.
6
It is also possible that fraud can have an effect on firms along the supply chain. While we do not study such firms,
Hertzel et al. (2008) look at the impact of bankruptcy on firms along the supply chain and Shahrur (2005) studies the
effects of horizontal mergers on customers and suppliers.

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We add to these two strands of the literature in the following ways. First, our analysis documents
the simultaneous importance of both the competition and the information spillover effects. While
Lang and Stulz (1992) report some aspects of these effects in the case of bankruptcy announcements, we document their importance in the context of intentional financial misrepresentation. In
fact, Gleason et al. (2008) suggest that investigating competitive effects from accounting-related
issues is an avenue for future research.7
Additionally, our study adds to the literature on the competitive and the information spillover
effects by analyzing the importance of firm-level characteristics in addition to industry-level
ones. This is another way in which we extend the analysis of such studies as Lang and Stulz
(1992) and Laux et al. (1998).
Thus, we explore the impact on rivals when accused of financial misrepresentation and conduct
the analysis on a firm-level basis. This analysis explores the more subtle aspects of the information
spillover and competition effects in the context of intentional financial misrepresentation.
The rest of this paper is organized as follows. In Section I, we derive the main empirical
implications, which are then tested in Section II. Section III provides several robustness tests,
while Section IV sets forth our conclusions.

I. Hypotheses and Implications


We hypothesize that the public announcement of an investigation of financial reporting violations that are deemed to be fraudulent will have two effects on the stock prices of rival
firms. The industry competition hypothesis suggests that a rival firm will benefit from the
investigation in the form of reduced competition from the investigated firm. This implies a
positive abnormal stock return following the announcement. The information spillover hypothesis suggests that a rival firm suffers from the announcement since it reveals information that
the rival firms value may also be inflated. This implies a negative abnormal stock return following the announcement. The potential existence of these two effects leads to the following
implications:
Implication 1: The industry competition hypothesis predicts that greater industry competition
is associated with lower (more negative) abnormal returns to the industry rivals of the
investigated firm. The information spillover hypothesis predicts that the level of industry
competition will have no bearing on the abnormal returns of rival firms.
In more competitive industries, firms are less able to extract surplus from consumers. In such
industries, a loss of one competitor will have a smaller impact on the profits of rival firms. One
empirical proxy for measuring industry competition is the Herfindahl Index calculated based
on sales of firms in the same four-digit SIC code. A higher index number represents a less
competitive industry. Another empirical proxy is the Parrino (1997) Homogeneity Index that
measures the similarity of firms within industries.
Implication 2: The industry competition hypothesis predicts that an event that is more
detrimental to the accused firm will be associated with higher (more positive) rival abnormal
returns. In contrast, the information spillover hypothesis predicts that an event that is more
7
Several other studies focus on the event of earnings announcements and earnings restatements that are closer to the
type of event we describe, but that are not detrimental to the firms ability to continue in business and to compete in the
market. These studies include, for example, Han and Wild (1990), Pownall and Waymire (1989), and Ramnath (2002).

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Financial Management r Winter 2012

detrimental to the accused firm will be associated with lower (more negative) rival abnormal
returns.
When the (negative) magnitude of the event is large, the resulting impact on the rival will
be large, as well. If the competition effect dominates, then the benefit to a rival firm will be
magnified if the event has severe implications for the accused firm. If the information spillover
effect dominates, then the cost to the rival firm and the drop in its value will be magnified with the
severity of the event. Implication 2 is a test of which of the two effects is stronger. One empirical
proxy for the importance of the event is the CAR of the accused firm around the event date. A
second measure of the importance of the event to rivals is the revenues of the accused firm. An
additional measure of the importance of the event to a rival is the earnings response coefficient
(ERC). This variable is a rival-specific measure. The ERC measures the rivals average stock
market reaction to the accused firms earnings announcements in the years preceding the event.
Implication 3: The industry competition hypothesis predicts that greater opacity in a rival
firm has no bearing on its abnormal returns. The information spillover hypothesis predicts
that greater rival opacity is associated with lower (more negative) rival abnormal returns.
The market uses information generated by the event to update its estimate of each rivals market
value. For more opaque rivals and for rivals whose valuation is more uncertain (e.g., rivals with
more growth opportunities), the market will put more weight on new (negative) information.
Some measures of firm-level opaqueness include rival bid-ask spreads, the proportion of assets
that are intangible, and rival-analyst forecast dispersion.
Implication 4: The industry competition hypothesis predicts that greater opacity in an accused
firm has no bearing on rival abnormal returns. The information spillover hypothesis predicts
that greater opacity in an accused firm is associated with higher (less negative) rival abnormal
returns.
When the accused firm is opaque, the announcement will tend to have a smaller impact on
rivals. The assumption here is that information about an accused firm that is more opaque is less
likely to be used in updating rival firm value. Table I summarizes the four implications.

II. Data and Empirical Results


In this section, we describe our data, formulate tests, and discuss the empirical results.
A. Data
Sample selection begins with a comprehensive list of hand-collected Securities and Exchange
Commission (SEC) and Department of Justice (DOJ) enforcement actions for financial misrepresentation from April 1976-January 2010 (1,001 events).8 We impose several filters on these
8
The data are from the Karpoff et al. (2008a, b) database, which has been graciously provided to us by the authors (KLM
database hereafter). It consists of all enforcement actions initiated by the SEC and DOJ from April 1976 to January
2010 for violation of one or more of three provisions of the Securities and Exchange Act of 1934, as amended by the
Foreign Corrupt Practices Act of 1977: 1) 15 U.S.C. 78m(b)(2)(A) that requires firms to keep and maintain books and
records that accurately reflect all transactions; 2) 15 U.S.C. 78m(b)(2)(B), which requires firms to devise and maintain
a system of internal accounting controls; and 3) 15 U.S.C. 78m(b)(5), which establishes that no person shall knowingly
circumvent or knowingly fail to implement a system of internal accounting controls or knowingly falsify any book, record,
or account.

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

921

Table I. Implications
The table summarizes the implications of the industry competition and information spillover hypotheses.
The first column also lists proxies used to test the implications. Columns 2 and 3 report the expected sign
of the relation between the proxy and the cumulative abnormal return (CAR) of the rival firm.
Industry Competition
Hypothesis

Information Spillover
Hypothesis

Imp1: Product Market Competition

Lower competition, higher (more


No effect
positive) CAR
Herfindahl index
+
0
Parrino Homogeneity index
+
0
Imp2: Importance of Event
Higher (more positive) reaction More negative reaction of rivals
of rivals especially in
(lower announcement returns)
concentrated industries
Announcement return of accused firm

Sales of accused firm


+
+
Earnings Response Coefficient

Imp3: Opacity of Rival Firm


No effect
More negative reaction of rivals
(lower announcement returns)
Bid-ask spread
0

MB
0

Intangibles/ assets
0

Analyst forecast dispersion


0

Imp4: Opacity of Accused Firm


No effect
Less negative reaction of rivals
(higher announcement returns)
Bid-ask spread
0
+
MB
0
+
Intangibles/assets
0
+
Analyst forecast dispersion
0
+

data. First, we restrict the sample to firms with a Compustat and CRSP identifier (848 remaining
observations). Additionally, we consider only actions that include charges of fraud under the
1933 Securities Act or the 1934 Securities Exchange Act (646 observations remaining). Therefore, we focus on charges for intentional financial misrepresentation rather than charges for
accidental accounting or auditing errors. Finally, we require that all firms have return data around
the enforcement begin date (hereafter the event date), reported sales in Compustat for the two
years preceding the event date, and have a historical SIC code (reported since 1987). Following
Karpoff et al. (2008a, b), an enforcement action is defined as the full chain of public releases
that relate to a specific company where books are suspect. Most enforcement actions originate
from public announcements (e.g., self-disclosures, restatements, management departures) or from
investigations initiated by other agencies (e.g., Department of Defense, Environmental Protection
Agency). These restrictions leave a final sample of 444 events.
Table II presents the distribution of these events by industry. We follow Lang and Stulz (1992)
in identifying industry rivals of the accused firm based on historical four-digit SIC codes. For
the purpose of describing the sample, however, we present the industry distribution based on
two-digit SIC codes. Panel A of Table II reports that the sample of accused firms spans a large
number of industries and varies significantly in terms of reported sales. A large portion of the
accused firms (65%) are in manufacturing and services. Panel B of Table II presents the average
number of rivals for each industry across all events. This table also describes the minimum,

Financial Management r Winter 2012

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Table II. Distribution of the Sample by Industry


Panel A presents the number of accused firms in our sample per two-digit SIC and by size deciles. Size
deciles are created based on sales using all firms in Compustat by year and historical two-digits SIC codes.
Panel B reports the average (median, minimum, and maximum) number of rivals per event in a given
two-digit SIC. There are a total of 28,907 rival firms in our sample.
Panel A. Distribution of Firm Accused of Financial Misrepresentation (Event Firms)
2-digit SIC
Bracket
0109
1014
1517
2039
4049
5051
5259
6067
7089

Industry

Sized Based Deciles


1

Mining
1
Construction
Manufacturing
13
3
Transportationa
Wholesale trade
1
Retail trade
2
Finance, Insurance 1
Services
6
Others
Total
27

1
17
6
2
5
2
14

1
1
22
5
4
4
5
9

2
17
4
2
2
3
12

1
16
5
1
3
7

3
1
18
4
4
8
6
10

47

51

42

33

54

7
1
24
1
1
8
5
1
41

Total
8

10

1
2
12
5
4
4
6
13

27
1
2
4
9
19

16
7
1
3
2
11

47

62

40

7
8
182
36
25
34
45
106
1
444

Panel B. Distribution of Rivals


2-Digit SIC
Bracket
0109
1014
1517
2039
4049
5051
5259
6067
7089
a

Industry
Mean
Mining
Construction
Manufacturing
Transportationa
Wholesale trade
Retail trade
Finance, Insurance
Services
Others

58
13
38
25
13
23
101
141
13

No. Rivals per Event


Median
Min
20
12
23
20
10
15
31
77
13

4
1
1
2
2
2
2
1
13

Max
156
21
171
91
43
100
469
397
13

Includes communications and utilities.

maximum, and median number of rival firms. The maximum number of rivals varies from 13 in
the less competitive industries to 469 in the most competitive ones.
Table III presents the distribution over time for our sample of accused firms. The number of
accused firms varies from 3 in 2008 to a high of 59 in 2002 (following the collapse of Enron).
The average number of accused firms per year is 21.
B. Variables
The dependent variable in our analysis is the rival firm three-day abnormal stock return
following the announcement of an accusation of fraudulent financial misrepresentation by a
competitor. We calculate the cumulative abnormal return (CAR) by taking the difference between
the firms stock return and the value-weighted CRSP index (Brown and Warner, 1985).
To test Implication 1, the effect of the level of product market competition on rival CAR, we
compute the Herfindahl Index to measure the competitiveness of the industry. The Herfindahl

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

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Table III. Distribution of Accusations of Financial Misrepresentation by Year


The table reports the number of accused firms (events) by year. The year refers to the year of the enforcement
start date. There are a total of 444 events in our sample.
Year

No. Firms (Events)

Year

No. Firms (Events)

1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999

12
9
9
16
22
18
28
16
13
20
25
18

2000
2001
2002
2003
2004
2005
2006
2007
2008

36
36
59
22
20
24
31
7
3

Total

444

Figure 2. Cumulative Return for Firms Accused of Financial Misrepresentation


The average cumulative abnormal return (CAR) of the accused firms are shown from Day 5 to Day +5,
where Day 0 is the enforcement begin date (the event date or announcement date). The sample consists
of 444 firms accused of financial misrepresentation where the accusation includes charges of fraud under
the 1933 Securities Act or the 1934 Securities Exchange Act. CAR is computed as the market-adjusted
cumulative return. The market return is the CRSP value-weighted index.

Index is calculated based on sales of firms in the same historical four-digit SIC code using
all firms in Compustat. A higher index number represents a less competitive industry. We also
compute the Herfindahl Index based on segment sales. This index is calculated based on sales of
the firms largest business segment. Firms not identified in the segment-level files are considered
single segment firms and are assigned that firms primary four-digit SIC code.

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Financial Management r Winter 2012

To measure industry homogeneity, we compute a homogeneity index as suggested by Parrino


(1997). This proxy measures the partial correlation between monthly common stock returns and
an industry equal-weighted index. A higher value for this index is associated with a higher degree
of product homogeneity within the industry.
We use the accused firms CAR and sales, as well as the ERC between each accused firm and
its rivals, as proxies for the importance of the event. Firm sales are extracted from Compustat.
We compute the CAR for the accused firm as the difference between the firms return and the
value-weighted CRSP index using a three-day window around the event. The ERC is derived
by computing the stock price reaction of each rival to past announcements of earnings surprises
of the accused firm. For this purpose, we employ the method used in the accounting literature
in Foster (1981) and Freeman and Tse (1992), among others, which investigate intraindustry
information transfers.9
The ERC is calculated based on quarterly information about earnings surprises of the accused firm during the three-year period preceding the event. We use the following regression
specification:
CARi jt = ai j + bi j UE jt + eit ,
where CARijt is the cumulative abnormal return of rival i for the five days around the earnings
announcement of accused firm j in quarter t, and UEjt is the unexpected earnings announcement
(earnings surprise) of accused firm j calculated in quarter t. The earnings surprise, UEjt , is
computed as the difference between the analyst consensus quarterly earnings estimate and the
realized earnings as reported in IBES. The slope coefficient, bij , is the ERC estimated for each
rival i of accused firm j.
This variable conveys information about the extent to which rival firm i competes with accused
firm j. A positive ERC indicates that, on average, past positive earnings surprises of the accused
firm led to positive stock returns at the rival firm (low competition). A negative ERC implies
that, on average, past positive earnings surprises of the accused firm led to negative stock returns
to the rival (high competition). To test Implication 2, we use the property that a higher absolute
value of ERC indicates a higher importance of the event for the rival firm.
Implications 3 and 4 require proxies for the opaqueness of the rival, as well as for the accused
firms. To measure firm opaqueness we compute: 1) the quoted bid-ask spread, 2) the market-tobook ratio (MB) as the ratio between total debt plus market value of equity and book assets, 3) the
ratio of intangibles to total assets, and 4) analyst fiscal year-end earnings per share (EPS) forecast
dispersion six months prior to the event. In all regressions, we include as control variables, book
leverage, computed as the book value of long-term debt divided by the book value of assets, and
sales of the rival.

C. Results
Before analyzing the cross-sectional determinants of the stock price response of rival firms
to the announcement of an accusation of financial misrepresentation, we first examine several
univariate statistics.
9
This is slightly different from the standard ERC used in the literature that focuses on the firms own ERC (e.g., Collins
and Kothari, 1989; Kothari and Sloan, 1992).

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

925

1. Univariate Analysis
Figure 2 and Table IV confirm that accused firms typically suffer a negative CAR of 19.7%
in the period 1 to +1 days surrounding the event date. As the figure indicates, the event date is
preceded by a significant negative stock return suggesting that there is some information leakage
prior to the event date. For this reason, we use a three-day window (1,+1) in the multivariate
analysis.
In Table IV Panel A, we see that accused firms have average (median) sales of $1,885 ($132)
million in the year prior to the event, and an average (median) market share of 5% (0.7%). On
average, the accused firms are followed by eight analysts with an EPS forecast dispersion of 0.87.
In Panel B of Table IV, we report statistics for rival firms. There are a maximum of 28,907 rivals
in our sample. This number varies in our multivariate analysis depending upon the availability of
rival information on multiple dimensions. We reach the smallest number of rivals (6,845) when
we require information on the ERC.
Average rival CAR in the three-day window around the event date is 0.54%. Thus, generally,
across all events and all rivals, the information spillover effect dominates the competition effect.
However, there is great variability in these CARs with a maximum of 27.11% and a minimum
of 25.57%. Rival firms have average (median) sales of $652 ($64) million in the year preceding
the event, which is smaller than the sales of the accused firms. Rivals have an average of 3.8
analysts who follow them with an average EPS forecast dispersion of 0.15. Finally, average ERC
is 0.01 suggesting that positive (negative) earnings surprises at the accused firm have led, in the
past, to negative (positive) abnormal returns for rivals. More importantly, to test Implication 2,
there is substantial variation in ERC with a standard deviation of 3.89.

2. OLS Regressions
To test the implications, we begin with an OLS regression analysis with rival firm CAR as
the dependent variable. This approach allows us to test the cross-sectional predictions based
on rival-level characteristics, while simultaneously controlling for event-level variables, such as
the CAR of the accused firm, which have the same value within events. Standard errors are
heteroskedasticity-robust and corrected for clustering at the event level. In the robustness tests
below, we find the inferences to be qualitatively the same when we run between effects regressions
where each observation represents the average of the variable within an event. Thus, inferences
about event-level variables in the rival-level OLS regressions are consistent with inferences from
the event-level regressions.
Results from the OLS regressions are presented in Table V, Panels A and B. In all of these
regressions, the dependent variable is the three-day rival CAR around the event.
A. Testing Implication 1: Product Market Competition
In Table V, Panel A, Model 1, we find a positive association between the Herfindahl Index
and rival CAR. This is consistent with the competition hypothesis, which predicts that lower
industry competition is associated with higher rival abnormal returns (Implication 1). In Model 2,
we compute the Herfindahl Index based on segment sales and once again find a positive association between the Herfindahl Index and rival CAR. In Model 3, we determine that the Parrino
Homogeneity Index is significantly positively correlated with rival CAR. Thus, rivals in industries
that are more homogenous experience higher (more positive) abnormal returns around the event.

Financial Management r Winter 2012

926

Table IV. Sample Characteristics: Accused Firms and Their Rivals


This table reports summary statistics for the sample of firms accused of financial misrepresentation (Panel A)
and for their rivals (Panel B). Mean (MEAN), median (MEDIAN), standard deviation (STD), minimum
(MIN), maximum (MAX), and the number of observations (N) of each variable are presented. The cumulative
abnormal return (CAR) is the sum of the market-adjusted return using the CRSP value-weighted index as
a benchmark over the bracketed window (in days). SALES is from Compustat measured at the fiscal yearend prior to the enforcement begin date. MK SHARE is computed as sales of the rival or accused firm
(AF) divided by the sum of sales of all firms in Compustat in the same historical four-digit SIC. The BID
ASK SPREAD is calculated as (closing ask-closing bid) divided by closing midpoint. For each firm, we
average the bid ask spread over one year based on daily spreads. The market-to-book ratio (MB) is (total
debt + market value of equity) divided by book value of assets. INTANGIBLES is the ratio of intangibles
to total assets. FORECAST DISP is the analyst earnings forecast dispersion based in IBES. More than
one analyst with an earnings forecast is required. We use the fiscal year-end earnings forecast closest, but
prior to the enforcement begin date. HERFINDAHL is based on sales in Compustat and is computed by
historical four-digit SIC codes. The PARRINO INDEX is based on Parrino (1997) and computed as the
partial correlation between monthly common stock returns and an industry equally weighted index. A larger
index value is associated with a higher degree of product homogeneity with the industry. The DURABLE
INDUSTRY dummy is equal to one if the four-digit SIC industry is classified as delivering durable goods
according to the definition of Yogo (2006). Panel B also provides the earnings response coefficient (ERC)
and leverage of the rival. ERC is computed based on a regression estimating the sensitivity of the rivals
abnormal announcement return to the accused firms earnings surprises during the three years prior to the
enforcement begin date using quarterly earnings surprise data from IBES. Book leverage (BLEV ) is the
ratio of long-term debt divided by the book value of assets. With the exception of the cumulative abnormal
return (CAR), all variables are calculated for the year preceding the event date.
Panel A. Accused Firms (AF)

CAR (1,+1)
CAR (2,+1)
CAR (2,+0)
CAR (1,0)
CAR (0,0)
SALES AF ($mil)
MK SHARE AF
BID ASK SPREAD AF
MB AF
INTANGIBLES AF
FORECAST DISP AF
HERFINDAHL
PARRINO INDEX
DURABLE INDUSTRY

CAR (1,+1)
CAR (2,+1)
CAR (2,+0)
CAR (1,0)
CAR (0,0)
SALES Rival ($mil)
MK SHARE Rival
ERC
BID ASK SPREAD Rival
MB Rival
INTANGIBLES Rival
FORECAST DISP Rival
BLEV Rival

Mean

Median

STD

Min

Max

19.70%
20.32%
18.77%
18.15%
17.56%
1,885
0.055
2.65%
2.837
0.141
0.867
0.183
0.514
0.478

11.68%
12.49%
11.68%
10.62%
10.25%
132
0.007
1.38%
1.731
0.066
0.020
0.142
0.489
0.000

24.87%
28.27%
25.61%
21.94%
19.65%
9,011
0.127
4.51%
4.511
0.186
11.940
0.148
0.110
0.501

101.42%
104.56%
90.64%
84.45%
70.10%
0.000
0.000
0.00%
0.721
0.000
0.000
0.018
0.363
0.000

16.35%
21.96%
13.57%
14.46%
10.09%
51,056
0.725
16.07%
16.790
0.811
4.590
0.647
0.710
1.000

444
444
444
444
432
444
444
408
431
385
267
444
444
157

0.54%
0.66%
0.47%
0.35%
0.23%
652
0.01
0.01
2.83%
3.06
0.09
0.15
0.21

Panel B. Rival Firms


0.57%
9.08%
0.68%
10.39%
0.61%
9.26%
0.48%
7.75%
0.27%
5.82%
64
3,908
0.00
0.04
0.02
3.89
1.70%
3.78%
1.75
4.61
0.02
0.15
0.02
1.51
0.08
1.95

25.57%
28.62%
24.90%
20.77%
15.27%
0.001
0.00
11.08
0.05%
0.53
0.00
0.00
0.09

27.11%
30.77%
27.11%
22.72%
17.26%
12,023
0.20
13.17
17.12%
22.09
0.69
2.05
1.59

28,906
28,907
28,907
28,906
28,903
28,888
28,888
6,845
28,354
28,066
24,876
14,077
28,686

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

927

Table V. Multivariate Analysis


The table reports the OLS estimation results with the rival firm market adjusted return (CAR) cumulated
over the three days around the enforcement begin date [1,+1] as the dependent variable. Variables are
either computed for the rival or the accused firm (AF). HERFINDAHL is based on sales in Compustat and
is computed by historical four-digit SIC codes. HIGH HERF is a dummy equal to one if the rival firm is
in an industry in the tenth decile of the Herfindahl industry distribution in a given year (most concentrated
industries). HERFINDAHL SEGMENTS is based on sales reported in the Compustat segment database. The
PARRINO INDEX is based on Parrino (1997) and computed as the partial correlation between monthly
common stock returns and an industry equally weighted index. A larger index value is associated with a
higher degree of product homogeneity with the industry. The DURABLE INDUSTRY dummy is equal to
one if the four-digit SIC industry is classified as delivering durable goods according to the definition of
Yogo (2006). SALES is from Compustat measured at the fiscal year end prior to the enforcement begin date.
BLEV is the ratio of long-term debt divided by book value of assets. ERC is computed based on a regression
estimating the sensitivity of the rivals abnormal announcement return to the accused firms earnings surprises
during the three years prior to the enforcement begin date using quarterly earnings surprise data from IBES.
The BID ASK SPREAD is calculated as (closing ask-closing bid) divided by closing midpoint. For each
firm we average the bid ask spread over one year based on daily spreads. The market-to-book ratio (MB)
is (total debt + market value of equity) divided by book value of assets. INTANGIBLES is the ratio of
intangibles to total assets. FORECAST DISP is the analyst earnings forecast dispersion based in IBES. More
than one analyst is required with an earnings forecast. We use the fiscal year-end earnings forecast closest,
but prior to the enforcement begin date. With the exception of the cumulative abnormal return (CAR), all
variables are calculated for the year preceding the event date. p Values, based on standard errors that are
heteroskedasticity robust and clustered at the event level, are reported in parentheses below the coefficient
estimates. F-statistics of each model are reported including its p value.
Panel A. Alternative Proxies for the Competitive Effect
Dependent Variable

CAR Rival [1,+1]


(1)

Imp1: Product Market Competition


HERFINDAHL

(2)

(3)

0.023
(0.04)

HERFINDAHL SEGMENTS

SALES AF
SALES AF HIGH HERF
Control Variables
SALES RIVAL
BLEV RIVAL

(6)

0.058
(0.04)

0.022
(0.06)

0.020
(0.10)

0.016
(0.00)

0.039
(0.04)

DURABLE INDUSTRY

CAR AF HIGH HERF

(5)

0.015
(0.06)

PARRINO INDEX

Imp2: Importance of Event


CAR AF

(4)

0.008
(0.08)
0.015
(0.01)

0.019
(0.00)

0.015
(0.01)

0.012
(0.30)

0.000

0.000
(0.89)

0.000

0.002

(0.91)

(0.59)

(0.49)

0.016
(0.00)
0.057
(0.00)
0.000
(0.87)

0.002
(0.01)
0.002
(0.14)

0.003
(0.02)
0.002
(0.22)

0.003
(0.01)
0.002
(0.13)

0.004
(0.04)
0.004
(0.20)

0.002
(0.01)
0.002
(0.14)

0.000

(0.89)
0.095
(0.06)
0.002
(0.01)
0.002
(0.14)
(Continued)

Financial Management r Winter 2012

928

Table V. Multivariate Analysis (Continued)


Panel A. Alternative Proxies for the Competitive Effect
Dependent Variable

Constant
Events
Observations
R2
Adj. R2
F-stat
Prob > F

CAR Rival [1,+1]


(1)

(2)

(3)

(4)

(5)

(6)

0.002
(0.48)
428
27,655
0.010
0.0051
3.62
0.0033

0.001
(0.69)
428
27,655
0.00
0.0047
3.533
0.0038

0.017
(0.06)
428
27,655
0.01
0.0060
3.918
0.0017

0.009
(0.15)
157
5,287
0.020
0.0179
2.69
0.0165

0.001
(0.61)
428
27,655
0.010
0.0057
5.60
0.0000

0.001
(0.72)
428
27,655
0.010
0.0056
4.09
0.0005

Panel B. Alternative Proxies for Rival and Accused Firm Opaqueness


Dependent Variable

Imp1: Product Market Competition


HERFINDAHL
Imp2: Importance of Event
CAR AF
ERC

CAR Rival [1,+1]


(7)

(8)

(9)

(10)

(11)

0.023
(0.12)

0.018
(0.10)

0.020
(0.08)

0.033
(0.01)

0.003
(0.87)

0.008
(0.47)
0.001
(0.05)

0.015
(0.01)

0.014
(0.01)

0.015
(0.02)

0.022
(0.01)

Imp3: Opacity of Rival Firm


BID ASK SPREAD
RIVAL

0.064
(0.07)
0.000
(0.07)

MB RIVAL

0.019
(0.03)

INTANGIBLES RIVAL

0.000

FORECAST DISP
RIVAL

(0.78)
Imp4: Opacity of Accused Firm
BID ASK SPREAD AF

0.023
(0.62)
0.000
(0.94)

MB AF

0.002
(0.83)

INTANGIBLES AF
FORECAST DISP AF
Control Variables
SALES AF

0.001
(0.00)
0.000
(0.82)

0.000
(0.90)

0.001
(0.51)

0.000
(0.99)

0.001
(0.22)
(Continued)

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

929

Table V. Multivariate Analysis (Continued)


Panel B. Alternative Proxies for Rival and Accused Firm Opaqueness
Dependent Variable

SALES RIVAL
BLEV RIVAL
Constant
Events
Observations
R2
Adj. R2
F-stat
Prob > F

CAR Rival [1,+1]


(7)

(8)

(9)

(10)

(11)

0.004
(0.07)
0.002
(0.16)
0.003
(0.44)
139
6,603
0.010
0.0083
1.98
0.0728

0.002
(0.06)
0.001
(0.39)
0.003
(0.30)
392
26,841
0.000
0.005
2.36
0.0229

0.002
(0.03)
0.002
(0.16)
0.001
(0.83)
416
26,505
0.000
0.004
2.31
0.0252

0.002
(0.01)
0.002
(0.32)
0.001
(0.84)
369
19,856
0.010
0.008
3.32
0.0020

0.002
(0.19)
0.000
(0.94)
0.001
(0.80)
242
10,675
0.010
0.006
12.05
0.0000

This finding is consistent with the industry competition hypothesis, which predicts that rivals in
industries with more homogenous products find it easier to acquire the customers of the accused
firm or that customers find it easier to switch suppliers (Implication 1).
To further test whether customers care about financial misrepresentation, a prediction of the
competition hypothesis, we follow the approach of Titman (1984) who finds that firms with
customers who care about the firms long-term survival because of switching costs (e.g., truck
manufacturing) should have low leverage to reduce the chance of financial distress. Thus, we
expect that customers are more likely to select a rival firm rather than the accused firm in industries
that sell durable goods. We use the definition of durable goods industries of Yogo (2006) and
find a positive correlation between rival CARs and the dummy variable indicating durable goods
industries in Model 4. This finding is consistent with the importance of the industry competition
effect in determining rival stock price reactions.
The results from the Herfindahl Index, the Parrino Index, and the durable goods industries are
all consistent with Implication 1 of the industry competition hypothesis.

B. Testing Implication 2: Importance of the Event


Implication 2 concerns the importance of the event. The competition hypothesis predicts that
a more important event is associated with a higher (more positive) rival CAR since the rival
is expected to attract customers from the accused firm. Alternatively, the information spillover
hypothesis predicts that more important events are associated with lower (more negative) rival
CARs.
In all of the models, we find a positive association between the CAR of the accused firm,
as a proxy for the importance of the event, and the CAR of the rival firm. This finding is
consistent with the interpretation that the information spillover effect typically dominates the
competition effect. However, given that we find higher (positive) rival CARs in more concentrated
industries, consistent with Implication 1, we test whether a more important event in concentrated

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Financial Management r Winter 2012

industries also leads to a more positive rival CAR, and whether a more important event in
competitive industries leads to a more negative rival CAR. Thus, to further test Implication 2,
we construct an interaction variable between the CAR (and sales) of the accused firm and the
level of industry competition, HIGH HERF, that takes a value of one for rivals in industries in
the highest Herfindahl decile (most concentrated), and zero otherwise. In Model 5, we find a
significantly positive coefficient on the accused firms CAR, while the interaction with HIGH
HERF is significantly negative. The coefficient on the interaction variable is 0.057, while the
coefficient on the accused firms CAR is 0.016. Thus, rival firms in very concentrated industries
experience a significantly higher (positive) CAR when the event is worse for the accused firm.
This is consistent with the interpretation that the information spillover effect dominates the
industry competition effect in competitive industries, while the reverse is true in less competitive
industries.
The results are weaker when we use the accused firms sales as a proxy for the importance
of the event. In Model 6, we find a marginally significant positive coefficient on the interaction term between the sales of the accused firm and HIGH HERF indicating that rivals of
a larger accused firm benefit more from the event, but only in very concentrated industries.
However, we find no significant coefficient on the sales of the accused firm. Thus, rivals in
more competitive industries do not seem to suffer more if the accused firm had larger reported
sales.
While sales and CAR of the accused firm are event-level variables (i.e., they are all the
same value for each rival of an accused firm), ERC is a proxy that differs for each rival.
A positive (negative) ERC indicates that the rivals stock price reaction is positive (negative)
when the accused firm reports better than expected earnings (in the three years prior to the
event). A zero ERC indicates no correlation between earnings surprises in the past and rival firm value. Implication 2 predicts a negative (positive) correlation between ERC and rival CAR under the industry competition (information spillover) hypothesis. If, in the past, a
rivals stock price went down upon positive earnings surprises in the accused firm, this variable suggests competition between the rival and accused firms for the same customers. In
addition, the more negative the ERC, the more important the event is expected to be for the
rival.
In Regression 7, we find a significantly negative coefficient on ERC. This finding is consistent
with the competition hypothesis. The more negative the ERC, the more positive the rival reaction
to the accusation of financial misrepresentation of the competitor. Interestingly, after introducing
ERC, the coefficients on the Herfindahl Index and on the CAR of the accused firm lose significance. This is due to the fact that ERC is both a proxy for the competition between the accused
firm and its rivals and a proxy for the extent to which news about the accused firm is important
to the value of the rival.
The analysis of the importance of the event for the rival firms indicates that more important financial misrepresentations have, on average, a larger effect on rivals, consistent with Implication 2.
Whether rival firm stock prices are affected positively or negatively, however, depends upon the
competitiveness of the industry, consistent with Implication 1.

C. Testing Implication 3: Rival Firm Opacity


Implications 3 and 4 concern the opacity of the rival and accused firms, respectively. The
industry competition hypothesis posits no correlation between our proxies for opaqueness and
the rival firm CARs. Meanwhile, the information spillover hypothesis posits more negative rival

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

931

CARs for more opaque rival firms and less negative CARs for rivals of more opaque accused
firms.
Table V, Models 811, demonstrate a negative correlation between rival CAR and rival bidask spread, rival market-to-book ratio, rival intangibles-to-assets ratio, and rival analyst forecast
dispersion. While the first three coefficients are significant, the last is not. One reason for
this lack of significance may lie in the fact that our sample size drops from approximately
26,000 observations to about 10,000 as we require at least two analysts to be following the
firm to compute forecast dispersion. Using the number of analysts (not shown), we find a
significant negative coefficient. These coefficients are consistent with the information spillover
hypothesis, which predicts that stock prices of more opaque rival firms should suffer more
when it is more likely that the accused firms financial information is used in setting rival stock
price.

D. Testing Implication 4: Accused Firm Opacity


We find very little evidence of a significant relationship between proxies for the opaqueness
of the accused firm and rival CAR. Models 811 in Table V display insignificant coefficients on
the accused firms bid-ask spread, market-to-book ratio, and intangibles-to-assets ratio. Only the
accused firms analyst forecast dispersion is significantly positively related to rival CAR. Thus,
we conclude that the data are not consistent with the predictions of the information spillover
hypothesis with regard to the importance of the opaqueness of the accused firm (Implication 4).
Consequently, our results suggest that rival firm reactions are dependent upon opaqueness at the
rival level, consistent with the information spillover effect, but not at the accused firm level,
inconsistent with the information spillover effect of Implication 4.
Finally, note that Lang and Stulz (1992) find that leverage is a key determinant of rival firm
portfolio reactions to a bankruptcy announcement by a competitor. We control for leverage (book
leverage) in all regressions, but find no significant effect. This finding highlights the difference
between the bankruptcy announcements these authors study and our event.

E. Economic Significance
We find that, on average, the information spillover effect dominates given that the average rival
CAR is negative. However, in more concentrated industries, more homogenous industries, and
durable goods industries, the competition effect dominates. In these industries, rival CARs are
higher (positive).
To highlight the economic impact, we compute the aggregate dollar value impact on rivals of
firms that are accused of financial misrepresentation. Figure 3 illustrates the stock market value
change (in dollars) over the three days around the event date aggregated over all rivals in a given
Herfindahl decile. In competitive industries (Herfindahl Deciles 13), the aggregate market value
loss among rivals is about $295 billion, substantially more than the aggregate $80 billion loss
for all accused firms in these industries. In contrast, rival firms in more concentrated industries
(Deciles 810) gained about $690 million in market capitalization, while accused firms lost about
$39 billion in these industries. Analysis of the wealth effects on rivals highlights the differing
externalities caused by cases of financial misrepresentation in competitive and concentrated
industries.
Our analysis also documents the importance of rival firm-level characteristics as determinants of
rival firm stock market reaction to an accusation of financial misrepresentation by the competitor.

932

Financial Management r Winter 2012

Figure 3. Aggregate Market Value Changes by Herfindahl Deciles


Aggregate stock market value (MV ) changes (for rivals and accused firms) in the three days surrounding the
enforcement begin date are reported by Herfindahl deciles. The stock market value change is computed as
the change in market value from Day 1 to Day +1 from the enforcement begin date. All changes are added
up across firms in the same Herfindahl decile, differentiating between the accused firms and their rivals.
Rivals are selected using the historical four-digit SIC in Compustat. The Herfindahl index is computed
based on sales of companies listed in Compustat, at the four-digit SIC level. Herfindahl deciles are formed
based on one Herfindahl index per four-digit SIC industry. The lowest Herfindahl decile corresponds to the
most competitive industries.

To illustrate the additional importance of these characteristics, we form two subsamples of firms
that are predicted to be more affected either by the industry competition effect or by the information
spillover effect, respectively. For the subsample of firms that are predicted to be most affected
by the competition effect (rivals in the least competitive industries, rivals of large accused firms
with very negative event date CARs, least opaque rivals, and most opaque accused firms), we
find that the average three-day rival CAR is 3.2%.10 For the subsample of rival firms predicted
to be most affected by the information spillover effect (rivals in the most competitive industries,
large accused firms with very negative CAR, most opaque rival, and least opaque accused firms),
we find that average rival CAR is 1.5%.
Thus, we conclude that industry- and firm-level characteristics both play an important role in
understanding rival firm shareholder reaction to the event, with some rivals significantly gaining

10

A rival firm is selected to be part of the subgroup based on the following selection process. For each criterion (e.g.,
competitiveness of industry), we place the rival firms into five buckets. Rivals in the most competitive industries go into
Bucket 1. Those in the most concentrated industries go into Bucket 5. We apply the same assignment process to the other
four criteria. We then select rival firms that have a combined score of 23, 24, or 25 for the industry competition subsample
(5, 6, or 7 for the information spillover subsample). Note that the score of the bucket depends upon the hypothesis. We
have a sample of 451 rival firms that should be most affected by the industry competition effect, and a sample of 231
firms most affected by the information spillover effect.

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

933

and others losing. We identify the reasons behind the differing reactions to accusations of financial
misrepresentation by a competitor.

III. Robustness
A. Between Effects Regressions
An additional approach to testing Implications 1, 2, and 4 is to analyze the response of rivals
at the event level. Using a between effects regression framework (Greene, 1997) allows us to test
for event-level implications while suppressing all rival firm variation within an event. The only
variation here is in average rival characteristics across events. The between estimator has the
advantage of removing any unstructured cluster effects. Therefore, it can increase the efficiency
of least squares estimation.
The dependent variable is the average rival CAR of a given event. All independent variables
are event-level averages as well. Note that variables such as the accused firms CAR remain
unaffected by the averaging. However, given that each event now has only one observation (i.e.,
the number of observations is equal to the number of events), the problem of correlations in
computing the standard errors is solved. However, testing Implication 3 (on the opaqueness of
the rivals) is now a cross event test rather than a within and across event test.
Table VI reports the regression results. The sequence of the regressions is identical to that in
Table V and the main conclusions drawn from the OLS regressions remain robust to this change
in regression technique. In Model 1, we find that rival firm average CAR is positively related
to the degree of industry competition. This is true for the various approaches used to compute
industry competition (Herfindahl Index, Herfindahl segments, Parrino Index, and durable goods
industries), and is consistent with Implication 1 for the competition hypothesis.
Implication 2 predicts that the more important the event is, the higher (lower) the rival CAR
under the competition (information spillover) hypothesis. Consistent with the OLS results in
Table V, we find a significant positive coefficient on the accused firms CAR and a negative
coefficient on the interaction term between the accused firms CAR and HIGH HERF in Model
5 of Table VI. While the interaction term has a p value of only 0.11, the size of the coefficient is
virtually the same as in the OLS regression indicating that firms in very concentrated industries
experience a higher (positive) average rival CAR the worse the accused firms reaction to the
event. The findings using the accused firms sales as a proxy for the importance of the event are
again weaker. Only the interaction term between the accused firms sales and HIGH HERF is
significant, consistent with the importance of the competition effect (Model 6).
One major difference from the OLS regression is that we find an insignificant coefficient on
ERC in Model 7. However, this is less surprising given that the between effect regression takes
the average across all rivals. Thus, the Herfindahl Index and the accused firms CAR seem to be
stronger event-level proxies for the level of competition than average ERC.
Implication 3 relates to the opacity of the rival firm. The information spillover hypothesis
predicts that more rival opacity leads to lower (more negative) rival CAR. In Models 8-11 of
Table VI, we find that proxies for average rival opaqueness are negatively related to average
rival CAR. However, only the coefficients on the bid-ask spread and the market-to-book ratio
are statistically significant. These findings also suggest that average rival firm opaqueness is
related to rival stock price reaction, consistent with the predictions of the information spillover
hypothesis and Implication 3; however, it seems that within event variation of opaqueness is an
important driver of rival firm CAR.

Financial Management r Winter 2012

934

Table VI. Between Effects Regressions


The table presents the parameter estimates of the between effects (events) regressions using weighted least
squares to adjust for unbalanced data. The rival firm market-adjusted return (CAR) cumulated over the three
days around the enforcement begin date [1,+1] is the dependent variable. Variables are either computed
for the rival or the accused firm (AF). HERFINDAHL is based on sales in Compustat and is computed by
historical four-digit SIC codes. HIGH HERF is a dummy equal to one if the rival firm is in an industry
in the tenth decile of the Herfindahl industry distribution in a given year (most concentrated industries).
HERFINDAHL SEGMENTS is based on sales reported in the Compustat segment database. The PARRINO
INDEX is based on Parrino (1997) and computed as the partial correlation between monthly common stock
returns and an industry equally weighted index. A larger index value is associated with a higher degree of
product homogeneity with the industry. The DURABLE INDUSTRY dummy is equal to one if the four-digit
SIC industry is classified as delivering durable goods according to the definition of Yogo (2006). SALES
is from Compustat measured at the fiscal year-end prior to the enforcement begin date. BLEV is the ratio
of long-term debt divided by the book value of assets. ERC is computed based on a regression estimating
the sensitivity of the rivals abnormal announcement return to the accused firms earnings surprises during
the three years prior to the enforcement begin date using quarterly earnings surprise data from IBES. The
BID ASK SPREAD is calculated as (closing ask-closing bid) divided by closing midpoint. For each firm,
we average the bid ask spread over one year based on daily spreads. The market-to-book ratio (MB) is
(total debt + market value of equity) divided by the book value of assets. INTANGIBLES is the ratio of
intangibles to total assets. FORECAST DISP is the analyst earnings forecast dispersion based in IBES. More
than one analyst is required with an earnings forecast. We use the fiscal year-end earnings forecast closest,
but prior to the enforcement begin date. With the exception of the cumulative abnormal return (CAR), all
variables are calculated for the year preceding the event date. p Values, based on standard errors that are
heteroskedasticity robust, are reported in parentheses below the coefficient estimates. F-statistics of each
model are reported including its p value.
Panel A. Alternative Proxies for the Competitive Effect
Dependent Variable

CAR Rival [1,+1]


(1)

Imp1: Product Market Competition


HERFINDAHL

(2)

(3)

0.026
(0.01)

HERFINDAHL SEGMENTS

SALES AF
SALES AF HIGH HERF
Control Variables
SALES RIVAL
BLEV RIVAL

(6)

0.057
(0.01)

0.024
(0.01)

0.023
(0.02)

0.016
(0.00)

0.003
(0.63)
0.009
(0.03)

0.044
(0.00)

DURABLE INDUSTRY

CAR AF HIGH HERF

(5)

0.016
(0.06)

PARRINO INDEX

Imp2: Importance of Event


CAR AF

(4)

0.009
(0.09)
0.015
(0.01)

0.019
(0.00)

0.015
(0.01)

0.012
(0.22)

0.000
(0.91)

0.000
(0.96)

0.000
(0.97)

0.001
(0.79)

0.016
(0.00)
0.055
(0.11)
0.000
(0.96)

0.003
(0.59)
0.009
(0.03)

0.000
(0.95)
0.008
(0.08)

0.004
(0.49)
0.010
(0.02)

0.008
(0.33)
0.002
(0.81)

0.003
(0.66)
0.009
(0.03)

0.000
(0.94)
0.091
(0.10)

(Continued)

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

935

Table VI. Between Effects Regressions (Continued)


Panel A. Alternative Proxies for the Competitive Effect
Dependent Variable
Constant
Events
Observations
R2
Adj. R2
F
Prob > F

CAR Rival [1,+1]


(1)

(2)

(3)

(4)

(5)

(6)

0.000
(0.91)
428
27,655
0.04
0.0325
3.873
0.0019

0.002
(0.41)
428
27,655
0.04
0.0296
3.601
0.0034

0.006
(0.66)
428
27,655
0.05
0.0414
4.686
0.0004

0.010
(0.10)
157
5,287
0.10
0.0610
2.688
0.0166

0.001
(0.79)
428
27,655
0.05
0.0349
3.576
0.0018

0.001
(0.72)
428
27,655
0.05
0.0342
3.517
0.0021

Panel B. Alternative Proxies for Rival and Accused Firm Opaqueness


Dependent Variable
Imp1: Product Market Competition
HERFINDAHL
Imp2: Importance of Event
CAR AF
ERC
Imp3: Opacity of Rival Firm
BID ASK SPREAD
RIVAL

CAR Rival [1,+1]


(7)

(8)

(9)

(10)

(11)

0.014
(0.29)

0.017
(0.10)

0.020
(0.04)

0.033
(0.00)

0.010
(0.53)

0.026
(0.00)
0.000
(0.17)

0.017
(0.00)

0.014
(0.01)

0.017
(0.01)

0.022
(0.01)

0.236
(0.00)
0.003
(0.04)

MB RIVAL

0.023
(0.21)

INTANGIBLES RIVAL

0.001

FORECAST DISP
RIVAL

(0.92)
Imp4: Opacity of Accused Firm
BID ASK SPREAD AF
MB AF
INTANGIBLES AF
FORECAST DISP AF

0.100
(0.05)
0.000
(0.85)
0.001
(0.95)
0.000
(0.08)
(Continued)

Financial Management r Winter 2012

936

Table VI. Between Effects Regressions (Continued)


Panel B. Alternative Proxies for Rival and Accused Firm Opaqueness
Dependent Variable
Control Variables
SALES AF
SALES RIVAL
BLEV RIVAL
Constant
Events
Observations
R2
Adj. R2
F
Prob > F

CAR Rival [1,+1]


(7)

(8)

(9)

(10)

(11)

0.000
(0.78)
0.004
(0.22)
0.001
(0.15)
0.001
(0.63)
139
6,603
0.01
0.006
7.351
0.0001

0.000
(0.83)
0.004
(0.60)
0.006
(0.10)
0.005
(0.12)
392
26,841
0.06
0.042
3.426
0.0014

0.001
(0.71)
0.005
(0.43)
0.010
(0.01)
0.007
(0.10)
416
26,505
0.05
0.035
3.143
0.0030

0.000
(1.00)
0.001
(0.84)
0.005
(0.25)
0.001
(0.77)
369
19,856
0.05
0.034
2.841
0.0068

0.001
(0.68)
0.004
(0.68)
0.002
(0.82)
0.000
(0.99)
242
10,675
0.04
0.016
1.556
0.1490

The between effects framework provides additional support for Implication 4 relative to the
OLS regressions. Implication 4 predicts a positive correlation between rival CAR and proxies for
the opacity of the accused firm. Both the bid-ask spread and the analyst forecast dispersion of the
accused firm are positively related to the average rival CAR, although the coefficients are only
marginally significant.
B. Industry-Adjusted Regressions
One remaining question is whether the OLS results are driven predominantly by average rival
characteristics across events (industries) or individual rival firm differences within an event.
To address this question, Table VII provides regressions with industry-adjusted variables. The
industry adjustment is performed using all Compustat firms median value within a four-digit
SIC by year of a given variable. The dependent variable is rival firm CAR. The results from
the industry-adjusted regressions are qualitatively the same as those from the OLS regressions.
Thus, we conclude that differences between rival firms within an event play a significant role
in explaining the rival firm announcement reaction above and beyond industry-level differences
(Lang and Stulz, 1992).
Yet another way to test for the importance of rival firm characteristics is to run event fixed
effects regressions. These regressions include only rival firm variables. We find that the inferences
drawn from Table VII hold true with event fixed effects regressions (not shown).
C. Changes in Market Share
In the next robustness test, we examine the change in the realized market share of rival firms.
The industry competition hypothesis implies that the accusation of financial misrepresentation
by one firm can change the rival firms market share. In competitive industries, this change is
likely to be smaller than in concentrated industries. We calculate the change in the rivals market

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

937

Table VII. Industry Adjusted Regressions


The table reports the OLS estimation results with the rival firm market adjusted return (CAR) cumulated
over the three days around the enforcement begin date [1,+1] as the dependent variable. Variables are
either computed for the rival or the accused firm (AF). (Iadj) following the variable name indicates that the
variable has been industry-adjusted by the industry median. HERFINDAHL is based on sales in Compustat
and is computed by historical four-digit SIC codes. HIGH HERF is a dummy equal to one if the rival firm is
in an industry in the tenth decile of the Herfindahl industry distribution in a given year (most concentrated
industries). HERFINDAHL SEGMENTS is based on sales reported in the Compustat segment database. The
PARRINO INDEX is based on Parrino (1997) and computed as the partial correlation between monthly
common stock returns and an industry equally weighted index. A larger index value is associated with a
higher degree of product homogeneity with the industry. The DURABLE INDUSTRY dummy is equal to one
if the four-digit SIC industry is classified as delivering durable goods according to the definition of Yogo
(2006). SALES is from Compustat measured at the fiscal year-end prior to the enforcement begin date. BLEV
is the ratio of long-term debt divided by the book value of assets. ERC is computed based on a regression
estimating the sensitivity of the rivals abnormal announcement return to the accused firms earnings surprises
during the three years prior to the enforcement begin date using quarterly earnings surprise data from IBES.
The BID ASK SPREAD is calculated as (closing ask-closing bid) divided by closing midpoint. For each
firm, we average the bid ask spread over one year based on daily spreads. The market-to-book ratio (MB)
is (total debt + market value of equity) divided by the book value of assets. INTANGIBLES is the ratio of
intangibles to total assets. FORECAST DISP is the analyst earnings forecast dispersion based in IBES. More
than one analyst is required with an earnings forecast. We use the fiscal year-end earnings forecast closest,
but prior to the enforcement begin date. With the exception of the cumulative abnormal return (CAR), all
variables are calculated for the year preceding the event date. p Values, based on standard errors that are
heteroskedasticity robust and clustered at the event level, are reported in parentheses below the coefficient
estimates. F-statistics of each model are reported including its p value.
Panel A. Alternative Proxies for the Competitive Effect
Dependent Variable

CAR Rival [1,+1]


(1)

Imp1: Product Market Competition


HERFINDAHL

(2)

(3)

0.020
(0.09)

HERFINDHAL SEGMENTS

SALES AF (Iadj)
SALES AF HIGH HERF
Control Variables
SALES RIVAL (Iadj)
BLEV RIVAL (Iadj)

(6)

0.055
(0.05)

0.018
(0.12)

0.016
(0.19)

0.017
(0.00)

0.038
(0.05)

DURABLE INDUSTRY

CAR AF HIGH HERF

(5)

0.014
(0.06)

PARRINO INDEX

Imp2: Importance of Event


CAR AF

(4)

0.009
(0.06)
0.016
(0.01)

0.020
(0.00)

0.016
(0.01)

0.011
(0.34)

0.000
(0.82)

0.000
(0.96)

0.000
(0.52)

0.000
(0.46)

0.017
(0.00)
0.060
(0.00)
0.000
(0.78)

0.000
(0.01)
0.001
(0.23)

0.000
(0.02)
0.001
(0.30)

0.000
(0.00)
0.001
(0.23)

0.000
(0.03)
0.004
(0.22)

0.000
(0.01)
0.001
(0.23)

0.000
(0.79)
0.104
(0.04)
0.000
(0.01)
0.001
(0.23)
(Continued)

Financial Management r Winter 2012

938

Table VII. Industry Adjusted Regressions (Continued)


Panel A. Alternative Proxies for the Competitive Effect
Dependent Variable
Constant
Events
Observations
R2
Adj. R2
F-stat
Prob > F

CAR Rival [1,+1]


(1)

(2)

(3)

(4)

(5)

(6)

0.001
(0.55)
428
27,655
0.00
0.0045
3.4080
0.0050

0.000
(0.87)
428
27,655
0.00
0.0045
3.5670
0.0036

0.017
(0.06)
428
27,655
0.01
0.0058
3.8410
0.002

0.010
(0.09)
157
5,287
0.02
0.0172
2.5750
0.0209

0.001
(0.69)
428
27,655
0.01
0.0051
4.9910
0.0001

0.001
(0.82)
428
27,655
0.01
0.0051
4.0090
0.0006

Panel B. Alternative Proxies for Rival and Accused Firm Opaqueness


Dependent Variable

CAR Rival [1,+1]


(7)

Imp1: Product Market Competition


HERFINDAHL
Imp2: Importance of Event
CAR AF
ERC

(8)

(9)

(10)

(11)

0.019
(0.21)

0.014 0.018
(0.23) (0.15)

0.029
(0.03)

0.003
(0.89)

0.012
(0.31)
0.001
(0.06)

0.018 0.016
(0.00) (0.01)

0.016
(0.01)

0.025
(0.01)

Imp3: Opacity of Rival Firm


BID ASKED SPREAD RIVAL(Iadj)

0.053
(0.08)
0.000
(0.10)

MB RIVAL (Iadj)

0.011
(0.09)

INTANGIBLES RIVAL (Iadj)

0.001
(0.51)

FORECASTS DISP RIVAL (Iadj)


Imp4: Opacity of Accused Firm
BID ASK SPREAD AF (Iadj)

0.110
(0.06)

MB AF (Iadj)

0.000
(0.95)

INTANGIBLES AF (Iadj)

0.000
(0.97)

FORECASTS DISP AF (Iadj)


Control Variables
SALES AF (Iadj)
SALES RIVAL (Iadj)

0.000
(0.00)
0.000
(0.74)
0.000
(0.06)

0.000 0.000 0.000


(0.67) (0.47)
(0.89)
0.000 0.000 0.000
(0.06) (0.03)
(0.01)

0.000
(0.20)
0.000
(0.20)
(Continued)

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals

939

Table VII. Industry Adjusted Regressions (Continued)


Panel B. Alternative Proxies for Rival and Accused Firm Opaqueness
Dependent Variable
BLEV RIVAL (Iadj)
Constant
Events
Observations
R2
Adj. R2
F-stat
Prob > F

CAR Rival [1,+1]


(7)

(8)

(9)

(10)

(11)

0.002
(0.29)
0.002
(0.64)
139
6,603
0.01
0.007
1.774
0.109

0.001
(0.58)
0.001
(0.75)
392
26,841
0.01
0.005
2.459
0.0177

0.002
(0.24)
0.001
(0.64)
416
26,505
0.00
0.004
2.234
0.0307

0.001
(0.40)
0.002
(0.44)
368
19,856
0.01
0.008
2.775
0.0080

0.000
(0.74)
0.000
(1.00)
240
10,675
0.01
0.008
18.710
0.0000

share as the difference between the rivals market share in the four quarters preceding and the
four quarters following the event. Total market size is based on firm sales information from
Compustat. Results are qualitatively similar when we use the sales of the largest segment of the
firm (not shown).
In Models 14 of Table VIII, we report the results of OLS regressions where the dependent
variable is the change in rival firm market share. In Model 1, we find a positive and significant
coefficient on industry concentration (Herfindahl Index). This finding is consistent with the
interpretation that firms in concentrated industries are better able to extract market share from
the accused firm. The table also indicates that the larger the lagged market share of the accused
firm, the larger the market share gain of the rival firm. Additionally, we find that our proxies for
rival firm opaqueness (high bid-ask spread, high analyst forecast dispersion, and high MB) are
negatively related to rival firm change in market share. This is consistent with the interpretation
that information effects related to the accusation of financial misrepresentation have real consequences (Durnev and Mangen, 2009). Overall, these results are consistent with the interpretation
that event date rival CARs, at least in part, reflect future changes in the market share of rival
firms.
D. Repeated Events within an Industry
Table II reports some industry concentration among accused firms. In particular, there is a large
number of events in the software industry (SIC code 7372), as well as in several other industries to
a lesser extent. To test that our results are not driven by a particular industry and are not clustered
in time, we run our basic multivariate specification (Model 8, Table V) on the subsample of rivals
associated with all financial misrepresentation events that are not preceded by another event in
the same industry within a period 30 days prior to the event date (this restriction eliminates most
multiple industry events, leaving us with 364 events with available data). Model 5 in Table VIII
reports the results from this regression and determines that they remain significant and with the
same signs as in Table V. Thus, our main findings are not driven by any particular industry. In
further tests, we find that using only the first accusation of financial misrepresentation in an
industry (in our database) leaves the inferences unchanged (not shown). This is important, as
Gande and Lewis (2009) find that the announcement return of an accused firm does not reflect
the full extent of the event if the firm is in an industry in which previous events have occurred

INTANGIBLES RIVAL

MB RIVAL

Imp3: Opacity of Rival Firm


BID ASK SPREAD RIVAL

Imp2: Importance of Event


CAR AF

MK SHARE AF (LAG)

MK SHARE Rival (LAG)

Imp1: Product Market Competition


HERFINDAHL

Dependent Variable

0.012
(0.04)

0.001
(0.65)

0.012
(0.00)
0.085
(0.00)
0.032
(0.01)

(1)
Rival
Market
Share

0.001
(0.00)

0.001
(0.54)

0.012
(0.00)
0.072
(0.00)
0.030
(0.02)

(2)
Rival
Market
Share

0.003
(0.00)

0.001
(0.43)

0.012
(0.00)
0.070
(0.00)
0.031
(0.01)

(3)
Rival
Market
Share

0.001
(0.09)

0.019
(0.00)
0.127
(0.00)
0.039
(0.00)

(4)
Rival
Market
Share

0.044
(0.03)

0.021
(0.00)

0.018
(0.00)

(5)
CAR [1,+1]
(eliminate clustered
industry events)

0.065
(0.06)

0.015
(0.01)

0.019
(0.03)

(6)
CAR [2,0]
(different
window)

Columns (1)(4) of the table report the OLS estimation results with the rival firm change in market share (MK SHARE) as the dependent variable. The change
in market share ( MK SHARE) is calculated as the difference between the average market share in the four quarters preceding the event and the average market
share in the four quarters following the event. In Column (5), the dependent variable is the cumulative abnormal return (CAR) in the event window [1,+1].
We eliminate events that occur in the same industry within the next 30 days. CAR is the sum of the market-adjusted return in the respective event window.
In Column (6), we run the full sample OLS regression for a different window of [2,0]. Variables are either computed for the rival or the accused firm (AF).
HERFINDAHL is based on sales in Compustat and is computed by historical four-digit SIC codes. The BID ASK SPREAD is calculated as (closing ask-closing
bid) divided by closing midpoint. For each firm, we average the bid ask spread over one year based on daily spreads. The market-to-book ratio (MB) is (total
debt + market value of equity) divided by the book value of assets. INTANGIBLES is the ratio of intangibles to total assets. FORECAST DISP is the analyst
earnings forecast dispersion based in IBES. More than one analyst is required with an earnings forecast. We use the fiscal year-end earnings forecast closest,
but prior to the enforcement begin date. SALES is from Compustat measured at the fiscal year-end prior to the enforcement begin date. BLEV is the ratio
of long-term debt divided by the book value of assets. With the exception of the cumulative abnormal return (CAR), all variables are calculated for the year
preceding the event date. p Values, based on standard errors that are heteroskedasticity robust and clustered at the event level, are reported in parentheses below
the coefficient estimates. F-statistics of each model are reported including its p value.

Table VIII. Other Robustness Checks


940
Financial Management r Winter 2012

Events
Observations
R2
Adj. R2
F-stat
Prob > F

Constant

BLEV RIVAL

SALES RIVAL

Control Variables
SALES AF

FORECAST DISP AF

INTANGIBLES AF

MB AF

Imp4: Opacity of Accused Firm


BID ASK SPREAD AF

FORECAST DISP RIVAL

Dependent Variable

0.000
(0.26)
0.000
(0.66)
391
25,287
0.03
0.03
5.739
0.000

0.008
(0.17)

(1)
Rival
Market
Share

0.000
(0.16)
0.000
(0.30)
415
24,960
0.03
0.03
6.316
0.000

0.000
(0.86)

(2)
Rival
Market
Share

0.000
(0.07)
0.000
(0.38)
427
26,070
0.03
0.03
7.378
0.000

0.001
(0.26)

(3)
Rival
Market
Share

0.000
(0.74)
0.000
(0.39)
240
10,079
0.08
0.08
11.420
0.000

0.001
(0.00)

0.001
(0.01)

(4)
Rival
Market
Share

Table VIII. Other Robustness Checks (Continued)

0.001
(0.72)
0.003
(0.06)
0.001
(0.39)
0.002
(0.56)
368
22,468
0.01
0.006
2.338
0.0253

0.064
(0.34)

(5)
CAR [1,+1]
(eliminate clustered
industry events)

0.001
(0.88)
0.002
(0.06)
0.001
(0.39)
0.002
(0.34)
391
25,287
0.01
0.005
2.370
0.0229

0.025
(0.59)

(6)
CAR [2,0]
(different
window)

Goldman, Peyer, & Stefanescu r Financial Misrepresentation and Its Impact on Rivals
941

942

Financial Management r Winter 2012

as the stock price has already reacted to some extent to the previous accusations of financial
misrepresentation of a rival.
E. Different Event Windows
We conduct our main analysis using a three-day event window [1, +1] to compute the
abnormal announcement returns for the accused firm and its rival firms. We re-run our regressions
using a [2, +0] event window and obtain qualitatively similar results, as shown in Model 6 of
Table VIII.
For our main measure of rival CAR, we use market-adjusted daily abnormal returns with the
CRSP value-weighted index as a benchmark. We find that the results are qualitatively similar
(not reported) using the Fama and French (1993, 1992) three-factor model instead of the CRSP
index as a benchmark.
F. Financial Misrepresentation versus Bankruptcy
Lang and Stulz (1992) investigate rival reactions to bankruptcy announcements. If fraudulent
financial misrepresentation were to lead to bankruptcy announcements (quickly), rival reactions to
the announcement of accusation of financial misrepresentation might be driven by the expectation
of the accused firm going bankrupt. To obtain a clearer picture of what happens to our sample
of firms accused of financial misrepresentation in subsequent years, we combine the delisting
codes in CRSP with the follow-up information about these events provided in the KLM database.
We find that 72% of our sample firms are still active two years after public accusation of
financial representation, 18% are in bankruptcy, 5% are acquired, 2.7% are privatized, 1.6% are
delisted for various reasons, and 0.7% are liquidated. Reasons for delisting include delinquency
in filing, nonpayment of fees, not meeting minimum exchange standards (float, minimum stock
price, information filed), or at company request. From this analysis, we conclude that the event of
accusation of fraudulent financial misrepresentation does not imply future bankruptcy, but simply
represents a discrete corporate event. As mentioned above, unlike Lang and Stulz (1992), we do
not find that rival leverage plays a significant role in determining rival CAR. Thus, financial
misrepresentation is likely to propagate through channels other than bankruptcy news.

IV. Conclusion
This paper examines how the announcement of an accusation of fraudulent financial misrepresentation affects industry rivals of the accused firm. Our results highlight the fact that while rival
firms generally tend to suffer from the announcement of accusation of financial misrepresentation, there is significant cross-sectional variation. We find that rival firm characteristics, as well
as industry characteristics, explain this cross-sectional variation. In addition, we find that both
the industry competition hypothesis and the information spillover hypothesis lead to predictions
that are consistent with the data.
This paper helps shed light on the broader costs and benefits of financial misrepresentation,
extending the work of Karpoff et al. (2008a) and Gande and Lewis (2009) that each analyze the
costs to the accused firm of financial misrepresentation. The analysis presented here is intended
to further the understanding of the broader impact of financial misrepresentation, while at the
same time providing additional evidence regarding the importance of the industry competition
effect and the information spillover effect.


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943

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