Characteristics of firm misconduct and effects on capital market reactions

Abstract

This article replicates earlier literature on capital market reactions to firm misconduct with rarely used Continental European data, after the financial crisis, and combines characteristics that previous literature has analyzed separately. We hand-collect press articles on 96 illegal misconducts of German firms between 2010 and 2019 and use the content of those articles to determine the misconduct type, misconduct characteristics, and information characteristics. Short-term cumulative abnormal returns (CARs) proxy for market reactions. We hypothesize and find negative market reactions that are stronger when the misconduct harms connected (vs. third) parties and when it primarily benefits the firm (vs. the offending individual). For information characteristics, we only find support for the prediction that markets react more negatively to confirmed misconduct (vs. suspicions). Some results are sensitive to including both misconduct and information characteristics or excluding financial statement fraud. Earlier research rarely tests for such sensitivity. Our research shows that market reactions to illegal misconduct are robust overall, but robust common determinants of effect strength are difficult to establish. These insights are of relevance for researchers when using capital market reactions to study misconduct implications and when referencing earlier research in this area.