The Spillover Effect of Chinese Reverse Merger Frauds: Chinese or Reverse Merger?

• In Event: Reverse Mergers

Abstract

This paper examines the spillover effect of the news about fraud allegedly committed by Chinese reverse mergers. In a reverse merger, a private, operating company becomes public by being acquired by a public shell company. A large number of Chinese companies became public in the last 10 years through reverse merger with U.S. shell companies rather than through the traditional initial public offering. A number of these companies, however, have been found to be involved with fraudulent activities or reporting. Once the regulators and the public became alarmed by the frequency of fraud revelations, the stock prices of not only the offending companies but also those of other companies were hammered. Those that were affected more negatively are other Chinese reverse mergers and U.S.-listed Chinese IPOs. The negative spillover effect differs across non-fraudulent CRMs according to operation locations and auditor characteristics. Since reverse mergers involving non-Chinese companies appear to have escaped the wrath of investors, the stock market reaction to fraud news appears to be China bashing rather than reverse merger bashing.This paper examines the spillover effect of the news about fraud allegedly committed by Chinese reverse mergers. In a reverse merger, a private, operating company becomes public by being acquired by a public shell company. A large number of Chinese companies became public in the last 10 years through reverse merger with U.S. shell companies rather than through the traditional initial public offering. A number of these companies, however, have been found to be involved with fraudulent activities or reporting. Once the regulators and the public became alarmed by the frequency of fraud revelations, the stock prices of not only the offending companies but also those of other companies were hammered. Those that were affected more negatively are other Chinese reverse mergers and U.S.-listed Chinese IPOs. The negative spillover effect differs across non-fraudulent CRMs according to operation locations and auditor characteristics. Since reverse mergers involving non-Chinese companies appear to have escaped the wrath of investors, the stock market reaction to fraud news appears to be China bashing rather than reverse merger bashing.

Authors

• Masako Darrough, Baruch College–CUNY

• Rong Huang, Baruch College–CUNY

• Sha Zhao, Baruch College–CUNY