On dimensions of corporate misbehavior: Financial misrepresentation and operational misconduct

Abstract

This study examines whether corporate misbehavior toward shareholders and non-shareholders are complements or substitutes. Specifically, I ask whether firms engaged in misconduct against non-shareholders are also likely to mislead investors using financial reports. Using a hand-collected sample of 187 instances of misconduct, I find evidence that during periods in which firms engage in misconduct against non-shareholders, those firms are more prone to financial misrepresentation. This is consistent with financial misrepresentation and misconduct against non-shareholders being complements. That is, firms acting unethically in one domain appear to be engaged in a broader strategy of malfeasance that affects financial reporting. I also find some evidence that firms engaged in misconduct against non-shareholder related parties are subject to fewer internal control weaknesses and SEC enforcement actions, suggesting that misconduct imposing costs on shareholders is a substitute for misconduct imposing costs on customers and employees.