TY - JOUR
T1 - Financial fraud and investor awareness
AU - Gui, Zhengqing
AU - Huang, Yangguang
AU - Zhao, Xiaojian
N1 - Funding Information:
We are grateful to the Editor, Daniela Puzzello, the Associate Editor, and two anonymous referees for their constructive comments. We also thank Sarah Auster, Yan Chen, Kim-Sau Chung, Yuk-Fai Fong, Kohei Kawamura, Martin Peitz, Jean Paul Rabanal, Olga A. Rud, Burkhard Schipper, Heiner Schumacher, Ernst-Ludwig von Thadden, Jidong Zhou, as well as seminar and conference participants at the Chinese University of Hong Kong (Shenzhen), East China Normal University, Hong Kong Baptist University, Hong Kong University of Science and Technology, Monash University, Nankai University, Osaka University, University of Melbourne, CMES 2018, EEA-ESEM 2018, EARIE 2018, ASSA 2019, Tsinghua BEAT 2019, and Zoom Mini-Workshops on Unawareness 2021 for stimulating discussions. Huang acknowledges financial support from HKUST Institute for Emerging Market Studies (Grant No. IEMS19BM01). Zhao acknowledges financial support from Monash Economics Department (B03005-1758334).Regarding the submission of “Financial Fraud and Investor Awareness” to Journal of Economic Behavior & Organization, we declare that we have no relevant or material financial interests that relate to the research described in this paper, whereas this project is supported by the Qianhai Institute for Innovative Research and HKUST Institute for Emerging Market Studies (Grant No. IEMS19BM01).
Funding Information:
We are grateful to the Editor, Daniela Puzzello, the Associate Editor, and two anonymous referees for their constructive comments. We also thank Sarah Auster, Yan Chen, Kim-Sau Chung, Yuk-Fai Fong, Kohei Kawamura, Martin Peitz, Jean Paul Rabanal, Olga A. Rud, Burkhard Schipper, Heiner Schumacher, Ernst-Ludwig von Thadden, Jidong Zhou, as well as seminar and conference participants at the Chinese University of Hong Kong (Shenzhen), East China Normal University, Hong Kong Baptist University, Hong Kong University of Science and Technology, Monash University, Nankai University, Osaka University, University of Melbourne, CMES 2018, EEA-ESEM 2018, EARIE 2018, ASSA 2019, Tsinghua BEAT 2019, and Zoom Mini-Workshops on Unawareness 2021 for stimulating discussions. Huang acknowledges financial support from HKUST Institute for Emerging Market Studies (Grant No. IEMS19BM01 ). Zhao acknowledges financial support from Monash Economics Department ( B03005-1758334 ).
Publisher Copyright:
© 2024 Elsevier B.V.
PY - 2024/3
Y1 - 2024/3
N2 - In a retail financial market, firms strategically choose whether to commit financial fraud to exploit naive investors who are unaware of such practices. In a leader-follower setting, we identify a segmented equilibrium in which an honest firm offers a normal product to sophisticated investors, while a dishonest firm offers a fraudulent product that targets naive investors. Competition may not benefit investors because the presence of a rival firm reduces the profitability of offering a normal product and thus discourages honest behavior. If there is a positive cost of entry, the incumbent firm may strategically switch to offering a fraudulent product to deter entry. As a result, policies that alter the entry barriers to the market may have unintended negative effects on welfare. In the segmented equilibrium with free entry, the honest firm has an incentive to disclose information about financial fraud and steal market share from the dishonest firm. However, this incentive is limited because such disclosure may prompt the dishonest firm to deviate and compete for the normal product market.
AB - In a retail financial market, firms strategically choose whether to commit financial fraud to exploit naive investors who are unaware of such practices. In a leader-follower setting, we identify a segmented equilibrium in which an honest firm offers a normal product to sophisticated investors, while a dishonest firm offers a fraudulent product that targets naive investors. Competition may not benefit investors because the presence of a rival firm reduces the profitability of offering a normal product and thus discourages honest behavior. If there is a positive cost of entry, the incumbent firm may strategically switch to offering a fraudulent product to deter entry. As a result, policies that alter the entry barriers to the market may have unintended negative effects on welfare. In the segmented equilibrium with free entry, the honest firm has an incentive to disclose information about financial fraud and steal market share from the dishonest firm. However, this incentive is limited because such disclosure may prompt the dishonest firm to deviate and compete for the normal product market.
KW - Endogenous entry
KW - Financial fraud
KW - Shrouding
KW - Unawareness
UR - http://www.scopus.com/inward/record.url?scp=85183168081&partnerID=8YFLogxK
U2 - 10.1016/j.jebo.2024.01.006
DO - 10.1016/j.jebo.2024.01.006
M3 - Article
AN - SCOPUS:85183168081
SN - 0167-2681
VL - 219
SP - 104
EP - 123
JO - Journal of Economic Behavior and Organization
JF - Journal of Economic Behavior and Organization
ER -