۱- Introduction

۲- Institutional background and hypothesis development

۳- Research design

۴- Empirical results

۵- Additional tests

۶- Conclusion

References

Abstract

This study examines whether crackdown on political corruption in China affects future stock price crashes. Using data from corruption-related prosecutions, we find that firms under prosecuted official jurisdictions experience a significant decrease in crash risk after the crackdown. Cross-sectional tests show that results are more pronounced for firms with higher political dependence on governments and for firms with worse information environment. Moreover, channel tests provide direct evidence that crackdown decreases crash risk by reducing political risk and bad news hoarding. Overall, our study offers novel evidence on how crackdown on corruption benefits firms.

Introduction

This paper investigates how China’s crackdown on political corruption affects the stock price crash risk of local firms. 1 Political corruption, commonly defined as the use of power by government officials for private gains, is pervasive around the world, especially in emerging economies. Existing literature documents that political corruption is detrimental to economic development as it distorts resource allocation, impairs competition, and hinders productivity growth (Murphy et al., 1993; Shleifer and Vishny, 1993; Mauro, 1995; Fisman and Miguel, 2007; Lin et al., 2016). Political corruption may also adversely affect business environments and influence firm-specific decision making (DeBacker et al., 2015; Smith, 2016; Liu, 2016; Ellis et al., 2016). 2 However, to the best of our knowledge, none of the previous studies provides evidence of the effect of corruption crackdown on future stock price crashes. Stock price crash risk (hereafter crash risk), namely, extremely negative return outliers, has drawn increased attention in recent literature, especially after the 2008 financial crisis. From a theoretical point of view, stock price crash may be caused by increase in perceived political risk (Pastor and Veronesi, 2012, 2013) and/or by greater ability of mangers to suppress bad news (Jin and Myers, 2006).