Do Fraudulent Firms Engage in Disclosure Herding?

Do Fraudulent Firms Engage in Disclosure Herding?

Gerard Hoberg University of Maryland – Department of Finance

Craig M. Lewis Vanderbilt University – Finance

July 25, 2013

We present two new hypotheses regarding the strategic qualitative disclosure choices of firms involved in potentially fraudulent activity. First, these firms have incentives to herd with industry peers in order to escape detection. Second, these firms have incentives to locally anti-herd with the same peers on specific aspects of disclosure consistent with achieving fraud-driven objectives. We use text-based analysis of firm disclosures and compare disclosures across firms involved in SEC enforcement actions to benchmarks based on industry, size and age, and also to each firm’s own disclosure before and after SEC alleged violations. We find especially strong support for the conclusion that firms involved in alleged fraud anti-herd with industry peers on localized disclosure dimensions. We find moderately strong support for the conclusion that they herd with industry peers on broader disclosure dimensions. Content analysis then reveals key vocabulary terms used by firms involved in enforcement actions, and suggests that these firms use complexity to potentially conceal fraudulent activity, and these firms often discuss issues relating to uncertainty, litigation, and speculative statements.

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