This paper examines the relation between corporate lobbying and fraud detection. Using data on corporate lobbying expenses between 1998 and 2004, and a sample of large frauds detected during the same period, we find that firms' lobbying activities make a significant difference in fraud detection: Compared to nonlobbying firms, on average, firms that lobby have a significantly lower hazard rate of being detected for fraud, evade fraud detection 117 days longer, and are 38% less likely to be detected by regulators. In addition, fraudulent firms on average spend 77% more on lobbying than nonfraudulent firms, and they spend 29% more on lobbying during their fraudulent periods than during nonfraudulent periods. The delay in detection leads to a greater distortion in resource allocation during fraudulent periods. It also allows managers to sell more of their shares.
We perform transaction-level analyses of entrusted loans-one of the largest components of shadow banking in China. Entrusted loans involve firms with privileged access to cheap capital channeling funds to less privileged firms, and increase when credit is tight. Nonaffiliated loans have much higher interest rates than both affiliated loans and official bank loans, and largely flow into real estate. The pricing of entrusted loans-especially of nonaffiliated loansincorporates fundamental and informational risks. Stock market reactions suggest that both affiliated and nonaffiliated loans are fairly compensated investments.
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