Does Industry Employment of Active Regulators Weaken Oversight?

Abstract

I study whether industry employment of active regulators weakens oversight. To examine this question, I exploit that the Financial Reporting Enforcement Panel (FREP), the German capital-market regulator responsible for enforcing public firms’ compliance with accounting standards, allows its senior regulators to serve on boards of public firms during their FREP tenure. I find that firms are less likely to face enforcement actions after they appoint active regulators to their board. After such an appointment, firms are more likely to receive a qualified audit opinion, more likely to have an above normal risk of accounting manipulation as measured by an F-Score greater than 1, and exhibit higher income-increasing abnormal accruals. These findings suggest that directorships of active regulators can result in conflicts of interest that weaken oversight.

Keywords: Conflict-Of-Interest Policies, Directorships, Enforcement Actions, Industry Employment, Self-Regulatory Organizations.

JEL Classification: M40, M41, M43