Does market discipline work? Evidence from violations by Chinese listed companies

Abstract

This paper analyzes the violation cases by Chinese listed companies. We use synthetic control method to study the impact of violations on firms. In the full sample, the empirical results show that Tobin’s Q rises. For investment, capital structure, cost of capital, selling and management expenses, there is not a significant change. As an index for governance, the boards independence increases. Due to the differences in geographic locations and development levels of China's provinces, we divide the companies into three groups based on the value of MINDEX in each province and the location of the companies. We find that selling and management expenses of companies increase at lower development levels. In provinces with a higher level of development, Tobin’s Q rise, and governance improves. Also, we show that firms with three or more violations reduce sales and increase cost of capital, selling and management expenses compared with firms that violate the rules once or twice. In sum, our results imply that the Chinese product and capital markets impose market penalties on fraudulent firms.