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Stock Market Reaction to Corporate Crime: Evidence from South Korea

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Abstract

This paper examines the impact of corporate crime on the stock market in South Korea. Specifically, we examine the effect of crime type (white-collar vs. street crime, operational vs. financial), industry type (financial vs. industrial), business group affiliation (chaebol-affiliated vs. non-chaebol-affiliated), and corporate governance (strong vs. weak board structure index) on the relationship between corporate crime announcement and stock market reaction. We find negative reactions to stock prices around the announcements of corporate crimes but no significant difference in reactions between announcements of individual and organizational crimes. Individual white-collar crimes have a stronger negative impact on stock prices than do individual street crimes on average, while financial crimes have a significantly greater negative impact than do operational crimes in organizations. Moreover, financial sector firms are impacted more significantly by the announcement of corporate crimes than are non-financial firms. In addition, the stock prices of chaebol-affiliated firms decrease less than do those of non-chaebol-affiliated firms, and those with a higher board committee subindex seem to be influenced less by news of corporate crimes if the size control variable is excluded. Multivariate cross-sectional analyses show consistent findings after controlling for firm-specific factors, crime-type effect, and industry and year effects. The results of this study provide valuable insights because it covers several types of corporate crime, including those committed by individuals and those perpetrated by firms.

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Notes

  1. For example, Karpoff and Lott (1993) conceptualized corporate fraud rather broadly, categorizing it into four different types: fraud of stakeholders, fraud of government, financial reporting fraud, and regulatory violations. These four types seem to cover most of the illegal activities that can be perpetrated by individuals and organizations in the corporate world. Barnett (2000) classified white-collar crime into individuals’ misdeeds (e.g., forgery, investment scams, misappropriations, swindles) and organizational crimes (e.g., antitrust violation, ecology law violation, tax law violation). Palmer and Maher (2006) proposed a model of collective corruption that categorized organizational crimes into the crimes of an organization (e.g., price-fixing) and those of employees (e.g., embezzlement schemes). Coleman (1987) also classified white-collar crimes into organizational crimes with support from an organization (e.g., price-fixing, bribing to win contracts) and the occupational crimes of individual criminals (e.g., theft, embezzlement).

  2. Based on three elements common to all frauds (Albrecht et al. 2004), Albrecht et al. (2010) examine the mechanisms of South Korean chaebols’ fraudulent acts and argue that South Korean chaebols have a high propensity to commit fraudulent acts for the following reasons: (1) the opportunities to commit fraud (e.g., family relationships, no checks and balances, weak financial structure, cross-subsidization, and no separation between entities), (2) pressures (e.g., foreign demands, weak financial structure, and family pressures), and (3) rationalization (e.g., too big to fail or state guarantees).

  3. The FN Guide (http://www.fnguide.com) has provided the DataGuide (http://www.dataguide.co.kr) database since 2000. This database is used in Korean studies such as Lee et al. (2009), Cho et al. (2012), Han et al. (2014, 2015.

  4. This regulation is available at http://eng.krx.co.kr/m7/m7_1/m7_1_1/JHPENG07001_01.jsp.

  5. Following Black and Kim (2012), the board structure index is the sum of the board independence and board committee subindices. The definitions of those two subindices are as follows.

    • Board independence subindex = 10(b1 + b2)/2:

      • b1 = 1 if the firm has 50 % outside directors on its board, and zero otherwise;

      • b2 = 1 if the firm has more than 50 % outside directors on its board, and zero otherwise.

    • Board committee subindex = 10(b3 + b4 + b5)/3:

      • b3 = 1 if the firm has an outside director nominating committee, and zero otherwise;

      • b4 = 1 if the firm has an audit director committee, and zero otherwise;

      • b5 = 1 if the firm has a compensation committee, and zero otherwise.

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Acknowledgment

This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (2014S1A3A2044459).

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Correspondence to Chanhoo Song.

Appendices

Appendix 1: Keywords used in corporate crime literature

Paper

Definition

Key Word

Sanyal, R. (2005). Determinants of bribery in international business: The cultural and economic factors. Journal of Business Ethics

The offering, promising, or giving something in order to influence a public official in the execution of his/her official duties

Bribery

Albrecht, W. S., Albrecht, C. C., and Albrecht, C. O. (2004). Fraud and corporate executives: Agency, stewardship and broken trust. Journal of Forensic Accounting

There are three elements common to all frauds: (1) a perceived pressure, (2) a perceived opportunity, and (3) some way to rationalize the fraud as acceptable and consistent with one’s personal code of ethics

Fraud

Fraudulent behavior

Albrecht, C., Turnbull, C., Zhang, Y., and Skousen, C. J. (2010). The relationship between South Korean chaebols and fraud. Management Research Review

Slash fund, accounting irregularities, and others cheated minority shareholders while they strengthened their secret grip on the business

Fraud

Corruption

Davidson, W. N., Worrell, D. L., and Lee, C. I. (1994). Stock market reactions to announced corporate illegalities. Journal of Business Ethics

Criminal activity conducted by the firm or employees on behalf of the firm’s profitability and owner’s wealth

Corporate crime

Bribery

Tax evasion

Theft of trade secrets

Financial reporting violation

Violations of government contracts

Kickbacks

Criminal fraud

Price fixing

Security law violations

Overcharging customers

Davis, J. L., Payne, G. T., and McMahan, G. C. (2007). A few bad apples? Scandalous behavior of mutual fund managers. Journal of Business Ethics

Illegal corporate behavior attributable to unique organizational characteristics, individual employee malfeasance, leadership inadequacies (Sims and Brinkmann 2002), job stress (McShulskis 1997), declining organizations (Lemke and Schminke 1991), level of bureaucracy (Zimmerman 2001), financial incentive structures and reward systems (Bilimoria 1995; Duska 1999; Hegarty and Sims 1978), social networks and interorganizational relationships (Brass et al. 1998; Coleman 1988), corporate culture (Fraedrich 1992; Victor and Cullen 1988)

Corporate wrongdoing

Agency duality

Fee-illegal behavior

Late trading

Market-timing

Rapid trading

Mispricing

Insider trading

Daboub, A. J., Rasheed, A. M., Priem, R. L., and Gray, D. A. (1995). Top management team characteristics and corporate illegal activity. Academy of Management Review

Corporate conduct by a corporation, or individuals acting on behalf of the corporation, that is proscribed by law (Braithwaite). But it is too narrow

Antitrust offense

Securities violation

Pollution

Worker safety violation

Bilimoria, D. (1995). Corporate control, crime, and compensation: An empirical examination of large corporations. Human Relations, 48(8), 891–906

Corporate crime is any violation of administrative, civil or criminal law committed by corporations

Antitrust violation

Trade violation

Violations of environmental protection laws

Workforce violations

Baucus, M. S., and Near, J. P. (1991). Can illegal corporate behavior be predicted? An event history analysis. Academy of Management Journal, 34, 9–36

Violations in which the law assumed a firm acted with knowledge or intent, and the courts ruled that the firm was guilty of illegal behavior

Discrimination violations

Antitrust violation

Product liability

Violating consent decree

Intentional securities fraud

Patent infringement

Baucus, M. S., and Baucus, D. A. (1997). Paying the piper: An empirical examination of longer-term financial consequences of illegal corporate behavior. Academy of Management Journal

Behavior in which stakeholders appear to paint all corporate wrongdoers with the same brush, ignoring the seriousness of the illegalities

Discrimination

Price fixing

Bid rigging

Violating a consent decree

Intentional securities fraud

Patent infringement

Barnett, C. (2000). The measurement of white-collar crime using uniform crime reporting (UCR) data. U.S. Department of Justice, Federal Bureau of Investigation, Criminal Justice Information Service (CJIS) Division

White-collar crime, illegal acts characterized by deceit, concealment, or the violation of trust and not dependent upon the application or threat of physical force or violence.

Fraud

 False pretenses

 Swindling

 Confidence game

 Credit card/ATM fraud

 Impersonation

 Welfare fraud

 Wire fraud

Forgery

Counterfeiting

Embezzlement

Property crime

Bribery

Bad checks

Almond, P., and Colover, S. (2010). Mediating punitiveness: Understanding public attitudes towards work-related fatality cases. European Journal of Criminology

Crimes caused by the governance of privatized markets rather than the moral disciplining of the poor. For example, work-related fatality cases (WRFs), situations where the activities of a corporation of organization have caused the death of a worker or member of the public

Work-related fatality

Corporate manslaughter

Corporate homicide

Appendix 2: Cumulative abnormal returns of windows (-10, +10) on corporate wrongdoing announcements

See Figs. 1, 2, 3, 4, 5, 6, 7, 8, and 9.

Fig. 1
figure 1

Cumulative abnormal returns

Fig. 2
figure 2

Cumulative abnormal returns (individual vs. organizational)

Fig. 3
figure 3

Cumulative abnormal returns (financial firms vs. industrial firms)

Fig. 4
figure 4

Cumulative abnormal returns (white vs. street)

Fig. 5
figure 5

Cumulative abnormal return (financial crime vs. operational crime)

Fig. 6
figure 6

Cumulative abnormal returns (chaebol vs. non-chaebol)

Fig. 7
figure 7

Cumulative abnormal returns (board independence > median vs. board independence ≤ median)

Fig. 8
figure 8

Cumulative abnormal return (board committee > median vs. board committee ≤ median)

Fig. 9
figure 9

Cumulative abnormal return (board structure > median vs. board structure ≤ median)

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Song, C., Han, S.H. Stock Market Reaction to Corporate Crime: Evidence from South Korea. J Bus Ethics 143, 323–351 (2017). https://doi.org/10.1007/s10551-015-2717-y

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