Local Institutions, Audit Quality, and Financial Fraud of US-Listed Foreign Firms

May 14, 2013 Leave a comment

Local Institutions, Audit Quality, and Financial Fraud of US-Listed Foreign Firms

Lei Chen London School of Economics & Political Science (LSE) – Department of Accounting

Jan 16, 2013

Abstract: 
Using data on shareholder-initiated class action lawsuits in the US, I investigate financial misconducts of US-listed foreign firms. After controlling for type I errors (e.g. frivolous lawsuits), I document that firms domiciled in the countries with weak corporate governance were more likely to commit fraud, but such relation could be moderated by the presence of Big 4 auditors. Investors automatically adjusted for type II errors (e.g. undiscovered fraud) when valuating the stocks of non-sued firms. That is, non-sued firms that shared the same countries of origin with their sued peers experienced valuation declines around class periods end dates (the dates when the scandals were exposed rather than the dates when the litigation was filed). Investors relied on audit quality to form their expectations about the severity of type II errors, and thus posed less negative spillovers on firms with Big 4 auditors, especially when the firms were from countries with weak corporate governance. Taken together, my results suggest that a listing on US exchanges does not fully compensate weak local institutions; voluntarily bonding to more stringent audit process has an incremental effect on protecting shareholder interests, and enhances the confidence of investors in firms’ financial integrity.

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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