Which Firms Get Punished for Unethical Behavior? Explaining Variation in Stock Market Reactions to Corporate Misconduct

Although there is ample evidence that stock markets react negatively
to unethical corporate behavior, our understanding of the mechanisms that shape
variation in these reactions across different incidents of misconduct remains
underdeveloped. We propose and test a framework for explaining this variation
by focusing on the role of the media in disseminating initial information about
misconduct. We argue that the signaling effects of this information are important
for investors because corporations have strong incentives to limit the information
they disclose about misconduct. More specifically, we hypothesize that investors
are more likely to react negatively when the media presents clear and credible
information that misconduct occurred, that the firm was responsible for it, and that
the misconduct was the result of deeper organizational problems. We also predict
that information which signals that a firm has restorative capacity tempers investor
reactions when the media places blame for misconduct on the corporation rather
than specific individuals. We test our hypotheses in a unique sample of 345 acts of
corporate misconduct in five European countries. Our findings provide broad support
for our hypotheses, and we discuss implications for research on corporate misconduct
and the role of non-state actors in regulating unethical corporate behavior.