Three essays on corporate fraud in Chinese listed companies : a thesis presented in fulfilment of the requirements for the degree of Doctor of Philosophy in Finance at Massey University, Palmerston North, New Zealand
This thesis investigates the detection, processes and capital market impact of corporate fraud in China. Three specific issues are researched in the Chinese context through three interconnected essays: the identification of fraudulent financial statements; the measurement of illegal tunnelling of company funds by controlling shareholders; the evaluation of the stock market response to the public exposure of firm fraud violations.
First, the link between accounting balance sheet values and the exposure of fraudulent activities in Chinese firms is investigated. Other receivables, inventories, prepaid expenses, employee benefits payables and long-term payables are found to be important indicators of fraudulent Chinese financial statements. The findings from previous studies that document asset accounts that are associated with fraudulent financial statements are confirmed, but previous evidence that overstates the value of total liabilities is challenged. A new model applied to all Chinese listed firms correctly predicts the absence of fraud approximately 81% of the time. Balance sheet accounting values scaled by total assets or sales are found to provide valuable information to predict fraudulent financial statements.
Next, valuable insights are provided into the factors and processes surrounding cash tunnelling, a form of embezzlement by controlling shareholders, in firms accused of fraud. The controlling shareholder‘s financial motivation for tunnelling is found to be negatively related to the percentage of shareholdings of the top owner, the profitability of the firm, and the costs of tunnelling. A new theoretical model of cash tunnelling is developed, through which the process of tunnelling in the Chinese market is revealed. The overall tunnelling loss in the sample of fraudulent firms is about 5.54 times that of net income.
Lastly, long-term market responses surrounding announcements of firm fraud are investigated. Although fraudulent firms are shown to display worse operating performance, lower dividends and higher other equity distributions than matching firms, long-term abnormal stock returns following the fraud announcements are insignificant. This is consistent with a view that stock market prices in China do not fully reflect the losses incurred by fraudulent firms and that in this regard, the stock market in China is not fully efficient.