The Deterrent Effects of SEC Enforcement and Class Action Litigation
50 Pages Posted: 21 Jun 2011 Last revised: 30 Apr 2012
Date Written: December 2011
The United States’ (U.S.) Congress specifically requires the Securities and Exchange Commission (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 against miscreants 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 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.
Suggested Citation: Suggested Citation