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We document that regulatory enforcement actions for financial misrepresentation cluster in industry-specific waves and that wave-related enforcement has information spillovers on industry peer firms. Waves and spillovers have significant effects on share prices. Early-wave target firms have the largest short-run losses in share values and the largest information spillovers on industry peer firms. Late-wave targets’ short-run losses are smaller, but not because they involve less costly instances of misconduct. Rather, late-wave targets are subject to more information spillovers from earlier in the wave. These results indicate that prices incorporate changes in the likelihood that a firm will face wave-related enforcement action for financial misconduct. Short-window share-price losses understate the total share-price impact, particularly for firms whose financial misrepresentation is revealed late in an enforcement wave. This paper was accepted by David Simchi-Levi, finance. Supplemental Material: The internet appendix and data are available at https://doi.org/10.1287/mnsc.2023.4711 .

Regulators claim to reward firm cooperation in the enforcement process. However, critics question which actions constitute firm cooperation and contend that cooperation leads to “harsh” and “unfair” outcomes. Examining 1,162 enforcement actions for financial misrepresentation initiated by the Securities and Exchange Commission and Department of Justice, we find that regulator-cited cooperation credit is best explained by remedial actions and self-reported law violations. Cooperation credit is negatively associated with firm monetary penalties assessed by regulators. Our estimates suggest that firms with cooperation credit realize an average penalty reduction of $23.8 million (49 percent). We also estimate that average reputation-related losses are $756 million (70 percent) lower for firms with cooperation credit. We find no association between cooperation credit and related private action outcomes. Our results provide important insight into what constitutes meaningful cooperation with regulators, and suggest that the benefits can be substantial for firms deemed to be cooperative. JEL Classifications: G38; K22; K42; M41.

Whistleblowers are ostensibly a valuable resource to regulators investigating securities violations, but whether there is a link between whistleblower involvement and the outcomes of enforcement actions is unclear. Using a dataset of employee whistleblowing allegations obtained from the U.S. government and the universe of enforcement actions for financial misrepresentation, we find that whistleblower involvement is associated with higher monetary penalties for targeted firms and employees and with longer prison sentences for culpable executives. We also find that regulators more quickly begin enforcement proceedings when whistleblowers are involved. Our findings suggest whistleblowers are a valuable source of information for regulators who investigate and prosecute financial misrepresentation. This article is protected by copyright. All rights reserved

An extensive literature examines the causes and effects of financial misconduct based on samples drawn from four popular databases that identify restatements, securities class action lawsuits, and Accounting and Auditing Enforcement Releases (AAERs). We show that the results from empirical tests can depend on which database is accessed. To examine the causes of such discrepancies, we compare the information in each database to a detailed sample of 1,243 case histories in which regulators brought enforcement actions for financial misrepresentation. These comparisons allow us to identify, measure, and estimate the economic importance of four features of each database that affect inferences from empirical tests. We show the extent to which each database is subject to these concerns and offer suggestions for researchers using these databases. JEL Classifications: G38; K22; K42; M41.

We use a comprehensive database of regulatory enforcement actions for financial misrepresentation and apply Receiver Operating Characteristics theory to construct a misrepresentation prediction model. The model performs well both in and out of sample, with an average area under the curve (AUC) of 0.78 in out-of-sample tests. The model’s base case implies that 22.3% of Compustat-listed firms are engaged in financial misrepresentation that is potentially sanctionable by regulators in an average year. The average violation period is 3.1 years, implying that 7.2% of firms initiate new programs of financial misrepresentation each year. Of these, 3.5% eventually are caught and sanctioned. These findings yield numerical estimates of the size of the price distortions imposed by misrepresentation on the shares of both misrepresenting and non-misrepresenting firms, and the size of firms’ ex ante expected costs – incorporating both the probability of getting caught and the penalties if caught – of engaging in financial misrepresentation.

Whistleblowers are ostensibly a valuable resource to regulators investigating securities violations, but whether there is a link between whistleblower involvement and the outcomes of enforcement actions is unclear. Using a dataset of employee whistleblowing allegations obtained from the U.S. government and the universe of enforcement actions for financial misrepresentation, we find that whistleblower involvement is associated with significantly higher monetary penalties for targeted firms and employees, and with significantly longer prison sentences for culpable executives. We also find enforcement actions involving whistleblowers are associated with significantly longer regulatory proceedings. Our findings contribute empirical evidence on the role of whistleblowers in the enforcement process and inform managers and policymakers, and the regulators who utilize these programs in their enforcement efforts.

Regulators claim that firm cooperation is rewarded in the enforcement process. Critics contend, however, that firm cooperation leads to “harsh” and “unfair” penalties for cooperating firms. Using 1,162 enforcement actions for financial misrepresentation initiated by the SEC and DOJ, we find that cooperation credit is best explained by remedial actions (e.g., termination of culpable employees) and self-reporting the law violation to regulators. Although we find that cooperation credit increases the likelihood of the firm being charged and penalized, firms receiving cooperation credit realize an average monetary penalty reduction of $25.5 million (46.1 percent). For those firms without cooperation credit, the penalties nearly double. These estimates are robust to controlling for potential selection issues. Our results provide important insights into what constitutes meaningful cooperation with regulators and indicate that there are significant monetary benefits for firms that regulators deem to be cooperative.

We use data from enforcement actions initiated under the U.S. Foreign Corrupt Practices Act (FCPA) to examine the hypothesis that managers engage in foreign bribery because it is profitable. We find that bribery is associated with projects that have positive ex ante net present value. Even net of costs and penalties, the average ex post NPV for bribe-related projects is non-negative for firms that are caught, and the reputational loss is negligible. For a subset of firms that face comingled charges for financial fraud, however, the direct cost and reputational loss are larger and the ex post NPV is negative.

An extensive accounting and finance literature examines the causes and effects of financial misreporting or misconduct based on samples drawn from four popular databases that identify restatements, securities class action lawsuits, and Securities and Exchange Commission (SEC) Accounting and Auditing Enforcement Releases (AAERs). We show, however, that the results from empirical tests can depend on which database is accessed. To examine the causes of such discrepancies, we compare the information in each database to a detailed sample of 1,243 case histories in which the SEC brought enforcement action for financial misrepresentation. These comparisons allow us to identify, measure, and estimate the economic importance of four characteristics of each database that affect inferences from empirical tests. First, these databases contain information on only the event that is used to proxy for misconduct (e.g., restatements), so they omit other relevant announcements that affect a researcher’s interpretation and use of the events. Second, the initial public revelation of financial misconduct occurs, on average, months before the initial coverage in these databases, leading to discrepancies in event study measures and pre/post comparison tests. Third, most of the events captured by these databases are unrelated to financial fraud, and efforts to cull out non-fraud events yield heterogeneous results. Fourth, the databases omit large numbers of events they were designed to capture. We show the extent to which each database is subject to these concerns and offer suggestions for researchers seeking to use these databases.

This paper provides the first integrated analysis of the complex mix of private and regulatory penalties for financial misrepresentation. We examine the sizes, types, and determinants of legal penalties imposed for all 697 enforcement actions initiated by the Securities and Exchange Commission for financial misrepresentation from 1978 through 2004. These penalties include private class action awards, monetary penalties imposed by the SEC and Department of Justice, and such non-monetary sanctions as censures, trading suspensions, and jail time. Contrary to many criticisms of private lawsuits and regulatory actions, we find that legal penalties are highly systematic, and in particular, are positively related to the size and severity of the harm from the misconduct. The data also indicate deep pockets effects, as both private and regulatory monetary penalties are related to defendants' abilities to pay. A recent increase in regulatory penalties has coincided with a decrease in private monetary penalties, consistent with regulatory penalties crowding out the use of private penalties.

We examine the penalties imposed on the 585 firms targeted by SEC enforcement actions for financial misrepresentation from 1978–2002, which we track through November 15, 2005. The penalties imposed on firms through the legal system average only $23.5 million per firm. The penalties imposed by the market, in contrast, are huge. Our point estimate of the reputational penalty—which we define as the expected loss in the present value of future cash flows due to lower sales and higher contracting and financing costs—is over 7.5 times the sum of all penalties imposed through the legal and regulatory system. For each dollar that a firm misleadingly inflates its market value, on average, it loses this dollar when its misconduct is revealed, plus an additional $3.08. Of this additional loss, $0.36 is due to expected legal penalties and $2.71 is due to lost reputation. In firms that survive the enforcement process, lost reputation is even greater at $3.83. In the cross section, the reputation loss is positively related to measures of the firm's reliance on implicit contracts. This evidence belies a widespread belief that financial misrepresentation is disciplined lightly. To the contrary, reputation losses impose substantial penalties for cooking the books.