Does Financial Reporting Misconduct Pay Off Even When Discovered?
59 Pages Posted: 9 Apr 2019
Date Written: March 7, 2019
Experts and popular belief suggest that it pays to engage in financial misconduct due to lax enforcement and punishment after 2003. We focus on the most serious cases of financial reporting misconduct and hand collect data on three subsamples of severe misconduct cases, between 2003 and 2016: a sample of 37 (100) SEC enforcement actions (class action lawsuits) that explicitly allege fraud and a sample of 100 restatements with the most negative market reaction in which investors presumably suspect fraud. We then compare estimates of the benefits from the misconduct to top managers against estimates of the costs of its discovery. We find that 32.9% of perpetrators experience an overall net benefit from discovered misconduct. The percentage of officers who benefit is highest for the restatement subsample (43.5%), followed by the class action lawsuit subsample (27.7%), and is the lowest for the SEC enforcement subsample (8.1%). Stated differently, if we assume that the probability of detection is 25% as conjectured in the prior literature, more than half (53%) of the perpetrators in our sample would find it beneficial to engage in financial reporting misconduct. Hence, our evidence suggests that financial reporting misconduct can pay off for a significant portion of the perpetrators. We discuss several implications of our results to academics, practitioners and policymakers.
Keywords: misconduct, fraud, misreporting, penalty, cost benefit, SEC, restatements, class action lawsuits
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