“Real Investment and Corporate Securities Fraud” by Tracy Yue WANG
Tracy Yue WANG
University of Minnesota
This paper examines the two-way interaction between a firm's investment and its incentive to commit fraud. I statistically disentangle the observed incidence of detected frauds into two latent components: the probability of committing fraud and the probability of detecting fraud conditional on fraud occurrence. I find that investments influence both latent probabilities. A larger R&D investment is associated with a higher probability of fraud and a lower probability of detection. Mergers and acquisitions tend to increase the likelihood of detection, and their effect on fraud propensity depends on the financing of transactions. Cash-financed (stock-financed) acquisitions are related to a lower (higher) probability of fraud. Capital expenditures have no significant impact on either probability. Second, there is evidence suggesting that fraud leads to overinvestment in risky projects and externally-financed projects. The investments generally reverse following fraud detection. Overall, the empirical findings suggest that fraud has real economic costs and the costs can be endogenous.