Regulatory Sanctions and Reputational Damage in Financial Markets
University of Oxford - Faculty of Law; University of Oxford - Said Business School; European Corporate Governance Institute (ECGI)
University of Oxford - Said Business School; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); University of Oxford - Said Business School
Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Barcelona Graduate School of Economics (Barcelona GSE)
March 9, 2015
Oxford Legal Studies Research Paper No. 62/2010
ECGI - Finance Working Paper No. 300/2010
We study the impact of the announcement of enforcement of financial and securities regulation by UK regulators on the market price of penalized firms. Theory suggests that announcements of misconduct trigger reputational losses, reflecting a decline in wrongdoer firms’ terms of trade. Prior empirical literature, mostly based on US data, suffers from multiple confounding factors making it hard to disentangle reputational from other losses. The UK enforcement process during our period of study involves only a single public announcement per firm, permitting much cleaner identification of reputational losses than the typical sequence of public announcements, stretching over several years, for equivalent enforcement actions in the US. We find reputational losses are very real, averaging nearly nine times the size of financial penalties imposed. Consistently with theory, reputational losses are confined to misconduct harming parties who trade with the firm--for example, mis-selling to customers or misstatements to investors. In contrast, in the case of harms to third parties who do not trade with the firm--for example, failure to implement money laundering checks--the announcement of a fine has no, or even a weakly positive, effect on the stock prices of fined firms. Moreover, even in cases of harms to trading partners, the scale of reputational losses appears unrelated to the magnitude of fines imposed. These results have significant implications for regulatory enforcement and the design of regulation to promote compliance with regulatory rules.
Number of Pages in PDF File: 48
Keywords: Regulation, Reputation, Enforcement, Corporate Law, Financial Regulation
JEL Classification: G28, G38, K22, K42, L51
Date posted: September 16, 2010 ; Last revised: March 11, 2015
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