The role of mutual funds in deterring corporate fraud in China

This study investigates whether mutual fund ownership deters corporate fraudulent behavior among Chinese listed firms. While the existing literature on corporate fraud in China focuses mainly on the impact of internal governance mechanisms, limited attention has been paid to the effect of external governance mechanisms. In China where investor protection and legal enforcement are relatively weak, mutual fund ownership is expected to enhance the effectiveness of the stock market to deter managerial expropriation. This is because mutual funds are institutional investors that have more resources and expertise than individual investors to monitor firm executives. However, the impact of mutual fund ownership in deterring fraudulent activities is expected to be greater among Chinese listed firms under private control than state control. This is because privately controlled firms receive less financial support from the government and are more reliant on external funding via the capital market. We confirm empirically the aforementioned assertions. Our findings imply that mutual fund ownership and state ownership generate offsetting corporate governance effects.