The spillover effect of fraudulent financial reporting on peer firms' investments

We investigate how high-profile accounting frauds affect peer firms' investment. We document that peers react to the fraudulent reports by increasing investment during fraud periods. We show that this finding is not driven by frauds that have a higher ex ante likelihood of detection or by an association between fraud and investment booms. In addition, we find that peers' investments increase in fraudulent earnings overstatements, and in industries with higher investor sentiment, lower cost of capital and higher private benefits of control. We also find evidence consistent with equity analysts potentially facilitating the spillover effect.

► We study how industry leaders' falsified financial reports affect peers' investments. ► Peer firms' investments increase with leaders' overstatements. ► This finding is not driven by frauds with a higher ex ante likelihood of detection. ► This relation is stronger when investor sentiment and agency costs are high and cost of capital is low. ► These relations only exist when analysts are more likely to cover both peers and leader.