Corporate Fraud Case Study

1.Introduction

Corporate fraud is a serious financial problem which attracted global attention of how banks enhancing their ability to corporate with those fraudulent enterprises. There are many instance in the world such Enron Corporation and WorldCom case. In China, there are increasing instances of corporate fraud emerged, where the capital market has been intensively impacted. About one-fifth of Chinese firms have been punished by China Securities Regulatory Commission (CSRC) for financial fraudulent behaviors. Corporate fraud is one category of financial fraud (Ngai et al, 2010). Wang et al. (2006) demonstrated the fraud as “a deliberate act that is contrary to law, rule, or policy with intent to obtain unauthorized financial benefit.”

Firstly, it introduces the background and related literatures of corporate fraud. These literatures present how corporate fraud reduce market value and increase the cost of equity. Secondly, it provides the background of Chinese stock market and regulators which are different from developed countries. Since the firm’s financial information can not be completely reflected by stock price in inefficient stock market of China, an alterantive perspective of debt financing has been proposed by several researchers. On the other hand, increasing occurrence of corporate fraud lead regulators’ credibility to be questioned and thus it is necessary to investigate on the long-term influence of fraudulent behaviors on the firm’s activities. Thirdly, it introduces the background of Chinese bank and the importance of bank loans for firms. It is emphasized that bank loan plays an importance role in debt financing for firms and decreasing quantity and quality of loan contracts will affect the firm’s future performence. Further, it documents the negative effect of corporate fraud on the cost of debt due to credit risk and information asymmetry (Karpoff et al., 2008; Kravet and Shevlin, 2010). Credit risk will lead to lower expected future cash flow via increased default risk, and information asymmetry will increase monitoring costs via increased the uncertainty of furture cash flow. Both effects translate into higher costs of debt via increasd loan interest