The Impact of Clients' Alleged Financial Reporting Fraud on Underwriter Reputation

[FaGal]

This paper examines underwriter reputation loss by using a sample of investment banks that have served corporate clients prior to the discovery of clients’ alleged financial reporting fraud. The
results indicate that underwriters lose reputation upon the filing of lawsuits against their clients. The magnitude of reputation loss is greater for clients causing larger recent dollar losses to investors, hiding misdemeanors longer, and for the IPO clients with larger weights in the underwriters’ portfolios. As the number of clients being sued increases, an underwriter loses credibilty in certification, and the market penalizes the underwriter more severely. However,
underwriters can avoid severe market discipline by diversifying their underwriting activities. Besides, we find little evidence that the market disciplines entrant commercial banks as underwriters who also diversify across traditional banking business.