A series of multivariate show that measures we expect to be related to the effect of the scandal on the value of firms’ reputational capital and information risk are significantly related to changes in shareholders’ wealth.
Under this hypothesis, the losses generated by the option backdating scandal can arise because management’s involvement in backdating practices may prompt investors to reassess the agency costs stemming from the separation of ownership and control.
Firm announcements of backdating have lead to adverse publicity from the media and negative pronouncements from academics regarding the economic effects and motivation of those involved.
This research finds that backdating signals to the capital markets that these firms have ineffective governance systems and poor internal controls.
And, tellingly, the losses are attenuated when tainted management of less successful firms is more likely to be replaced and relatively many firms become takeover targets.
We thank Thomas Lys (the Editor) and an anonymous referee for helping us improve the paper.