FROM GOVERNMENT REPORTING TO FINANCIAL MARKETS: SPILLOVER EFFECT OF INFORMATION RELIABILITY

Abstract

This study examines how the reliability of government reporting can affect financial markets by exploiting a recent scandal in China’s Liaoning province. This provincial government recently admitted that its economic data was falsified from 2011 to 2014. Upon this public revelation, firms headquartered in Liaoning (except for SOEs controlled by the central government) experience an average negative abnormal return. Following the revelation, the stock market exhibits increased skepticism towards cash flow news from Liaoning firms. Specifically, the market reacts severely when these firms have negative cash flow news. On the other hand, the market’s reaction to positive news regarding Liaoning firms is almost muted. Taken together, the evidence supports the view that the reliability of government reporting plays a significant role in shaping the information environment of financial markets, particularly in terms of investors’ belief in the reliability of corporate financial information.