Causal Evidence on the Effects of Enforcement Investigations

Abstract

We examine the costs and benefits of financial reporting enforcement investigations using a proprietary data set on randomly and risk-based selected enforcement investigations of listed German firms from 2005 to 2018. We find that risk-based selected firms show significant abnormal returns of -15.4 percent during investigations, whereas randomly selected firms do not show abnormal changes in firm value. Analyzing the role of selection reveals that the negative abnormal returns for risk-based selected investigations are likely the result of selection, and not caused by investigations themselves. Consistently, we find that risk-based selected firms, but not randomly selected firms, change their financial reporting behavior and transparency during enforcement investigations. Collectively, our study suggests that the negative firm-level outcomes of enforcement investigations as shown by prior research are likely a result of the selection process, and that enforcement investigations per se do not cause significant costs or benefits.

Keywords: costs and benefits of enforcement, financial reporting enforcement, firm-level effects of investigations

JEL Classification: G14, G18, G38, K22, K42, M41