Sunday, June 26, 2011
The Deterrence Effects of SEC Enforcement and Class Action Litigation, by Jared N. Jennings, University of Washington; Simi Kedia, Rutgers University, Newark - School of Business, Newark, Department of Finance & Economics; and Shivaram Rajgopal, Emory University - Goizueta Business School, was recently posted on SSRN. Here is the abstract:
The United States’ (U.S.) Congress specifically requires the SEC to deter potential miscreants via its enforcement actions against firms that engage in fraudulent financial reporting. The U.S. is also unique in allowing private enforcement via class action lawsuits. In this paper, we investigate whether SEC enforcement actions and class action lawsuits, over the years 1996-2006, deter aggressive financial reporting behavior among the peers of fraudulent firms. We find significant deterrence associated with both SEC enforcement actions and class action lawsuits. The average peer firm, subject to SEC action and/ or litigation, reduces discretionary accruals equivalent to 14% to 22% of the median return on assets (ROA) in the aftermath of such enforcement. The results also inform target selection criteria associated with greater deterrence. Moreover, repeated and sustained enforcement in an industry, as opposed to isolated investigations, provides more effective deterrence.