Whistle-Blowing: Target Firm Characteristics and Economic Consequences

TLDR

The study documents systematic evidence on the characteristics and economic consequences of firms facing employee whistle‑blowing allegations. The authors compare whistle‑blowing firms to a control group, identifying firm‑specific factors that trigger employee exposure of alleged financial misdeeds. Whistle‑blowing firms experience a 2.8 % negative five‑day stock‑price reaction (−7.3 % for earnings‑management claims), increased earnings restatements, lawsuits, and poorer future performance, yet they are more likely to improve governance, indicating whistle‑blowing is a valuable tool for uncovering agency problems.

Abstract

ABSTRACT: We document the first systematic evidence on the characteristics and economic consequences of firms subject to employee allegations of corporate financial misdeeds. First, compared to a control group that avoided public whistle-blowing allegations, firms subject to whistle-blowing allegations were characterized by unique firm-specific factors that led employees to expose alleged financial misdeeds. Second, on average, whistle-blowing announcements were associated with a negative 2.8 percent market-adjusted five-day stock price reaction; this reaction was especially negative for allegations involving earnings management (−7.3 percent). Third, compared to a control group that exhibits similar characteristics, firms subject to whistle-blowing allegations were associated with further negative consequences including earnings restatements, shareholder lawsuits, and negative future operating and stock return performance. Finally, whistle-blowing targets exposed by the press were more likely to make subsequent improvements in corporate governance. Our results suggest whistle-blowing is far from a trivial nuisance for targeted firms, and on average, appears to be a useful mechanism for uncovering agency issues.