Corporate Scandals and Household Stock Market Participation

We show that after the revelation of corporate frauds in a state, the equity holdings of households in that state decrease significantly both in the extensive and the intensive margins. Using an exogenous shock to fraud detection and exogenous variation in households’ lifetime experiences of corporate fraud, we are able to establish that the impact of fraud revelation in local companies on household stock market participation is causal. Even households that did not hold stocks in the fraudulent firms decrease their equity holdings and all households decrease their holdings in fraudulent firms as well as non-fraudulent firms. The decrease in households’ demand for equity due to corporate fraud generates significant economic costs for firms headquartered in the same state as the fraudulent firms, which experience an increase in the cost of capital and a decrease in valuation and in the number of shareholders. JEL classification: G30, D12, D14