Signaling via Earnings Downgrades: How Reputational Concerns Shape Analyst Responses to Corporate Fraud?
Dr. Lerong He *
School of Business & Management
State University of New York at Brockport
Brockport, NY, 14420, USA
Tel: 585-3955781
Email: lhe@brockport.edu
Dr. Martin J. Conyon
Bentley University
Waltham, MA, 02452, USA
Email: martin.conyon@gmail.com
Ms. Xuan Qing
School of Management
Fudan University
Shanghai, China
Email: 15210690031@fudan.edu.cn
*Corresponding author
Abstract
Manuscript Type: Empirical
Research Question/Issue: This study examines reactions of financial analysts to the
disclosure of corporate fraud. We posit that analysts downgrade earnings forecasts of fraud
firms after fraud disclosure to signal their quality and integrity. We explore how internal and
external contingencies shape analysts’ reputational concerns, influence their motivation to
signal via earnings downgrades, and consequently affect their responses to corporate fraud.
Research Findings/Insights: Using longitudinal data on Chinese publicly traded firms
between 2002 and 2013 and employing a difference-in-differences design, this study
documents that financial analysts significantly lower their earnings estimates of fraudulent
firms after fraud disclosure compared to the control group of non-fraud firms. In addition,
post-disclosure earnings downgrades are larger for more experienced analysts, for analysts
following firms with stronger analyst coverage, and after the revision of the professional
ethics code for analysts.
Theoretical/Academic Implications: This study provides empirical support to signaling
theory. We show that earnings downgrades of fraudulent firms may serve as a signal for
financial analysts to indicate their quality and integrity. We document that analysts’
motivation to signal via earnings downgrades is influenced by their reputational concerns,
which are moderated by their career experience, peer pressure, professional norm and social
expectations.
Practitioner/Policy Implications: This study offers insights to policy makers on how a
professional labor market and codes of ethics could serve as disciplinary mechanisms to
strengthen the external governance role of financial analysts.