Corporate Fraud and Business Conditions: Evidence from IPOs





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    • Wang and Winton are at the Carlson School of Management, University of Minnesota. Yu is at the Kelley School of Business, Indiana University and the Shanghai Advanced Institute of Finance, Shanghai Jiaotong University. We are grateful for comments from Jie Gan, Kathleen Hanley, Campbell Harvey (the Editor), Kose John, Ronald Masulis, David Mauer, Lin Peng, Yiming Qian, Ann Sherman, Scott Weisbenner, two anonymous referees, an anonymous associate editor, and seminar participants at Arizona State University, Baruch College, Drexel University, Indiana University, Southern Methodist University, University of Hong Kong, University of Kentucky, University of Minnesota, the 4th Annual Conference on Corporate Finance (Washington University in St. Louis), the 3rd FIRS Conference on Banking, Corporate Finance and Intermediation, the 2008 Western Finance Association Annual Meeting, the 2008 China International Conference on Finance, and the 2009 Napa Conference on Financial Market Research. We thank Alex Borisov, Diana Holden, Daniil Osipov, Yihui Pan, Tao Shen, and Huijun Wang for excellent research assistance; Jay Ritter for providing the list of internet IPO firms and underwriter rankings; and Philip Bond, Wei Jiang, and Thomas Issaevitch for supplying the data on MBA placement.


We examine how a firm's incentive to commit fraud when going public varies with investor beliefs about industry business conditions. Fraud propensity increases with the level of investor beliefs about industry prospects but decreases when beliefs are extremely high. We find that two mechanisms are at work: monitoring by investors and short-term executive compensation, both of which vary with investor beliefs about industry prospects. We also find that monitoring incentives of investors and underwriters differ. Our results are consistent with models of investor beliefs and corporate fraud, and suggest that regulators and auditors should be vigilant for fraud during booms.