Enforcement Waves and Spillovers

We document that regulatory enforcement actions for financial misrepresentation cluster in industry-specific waves and that wave-related enforcement has information spillovers on industry peer firms. Waves and spillovers have significant effects on share prices. Early-wave target firms have the largest short-run losses in share values and the largest information spillovers on industry peer firms. Late-wave targets' short-run losses are smaller, but not because they involve less costly instances of misconduct. Rather, late wave targets are subject to more information spillovers from earlier in the wave. These results indicate that prices incorporate changes in the likelihood that a firm will face wave related enforcement action for financial misconduct. Short-window share-price losses understate the total share-price impact, particularly for firms whose financial misrepresentation is revealed late in an enforcement wave.

Automated summary

We find that regulatory enforcement actions for financial misrepresentation occur in industry-specific waves and have information spillovers on industry peer firms. These waves and spillovers significantly affect share prices. Target firms in the early waves experience the largest short-run losses in share values and have the largest information spillovers. Late-wave targets have smaller short-run losses, not because they involve less costly instances of misconduct, but because they are subject to more information spillovers from earlier waves. These findings suggest that stock prices reflect changes in the likelihood of a firm facing wave-related enforcement actions for financial misconduct. Short-window share-price losses underestimate the overall impact, especially for firms whose financial misrepresentation is revealed late in an enforcement wave.