The Deterrent Effects of SEC Enforcement and Class Action Litigation

50 Pages Posted: 21 Jun 2011 Last revised: 30 Apr 2012

Jared N. Jennings

Washington University in St. Louis

Simi Kedia

Rutgers Business School

Shivaram Rajgopal

Columbia Business School

Date Written: December 2011

Abstract

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

Jennings, Jared N. and Kedia, Simi and Rajgopal, Shivaram, The Deterrent Effects of SEC Enforcement and Class Action Litigation (December 2011). Available at SSRN: https://ssrn.com/abstract=1868578 or http://dx.doi.org/10.2139/ssrn.1868578

Jared N. Jennings

Washington University in St. Louis ( email )

Olin Business School
St. Louis, MO 63130-6431
United States

Simi Kedia (Contact Author)

Rutgers Business School ( email )

117 Levin
94 Rockafellar Road
Piscataway, NJ
United States
8484454195 (Phone)

Shivaram Rajgopal

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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