Information complementarities and the dynamics of transparency shock spillovers

Abstract

We show that information complementarities play an important role in the spillover of transparency shocks. We exploit the revelation of financial misconduct by S&P 500 firms, and in a “Stacked Difference-in-Differences” design, find that the implied cost of capital increases for “close” industry peers of the fraudulent firms relative to “distant” industry peers. The spillover effect is particularly strong when the close peers and the fraudulent firm share common analyst coverage and common institutional ownership, which have been shown to be powerful proxies for fundamental linkages and information complementarities. We provide evidence that increase in the cost of capital of peer firms is due, at least in part, to “beta shocks” (Lambert et al. [2007], Leuz and Schrand [2009]). Disclosure by close peers – especially those with co-coverage and co-ownership links – also increases following fraud revelation. While disclosure remains high in the following years, the cost of equity starts to decrease.