Does financial reporting misconduct pay off even when discovered?
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Does financial reporting misconduct pay off even when discovered? Dan Amiram 1 & Serene Huang 2 & Shiva Rajgopal 2 # Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract Experts and popular belief contend that it pays to engage in financial misconduct. We 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 stock price reaction in which investors presumably suspect fraud. We then compare estimates of the benefits from reporting 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 31%, as conjectured in the literature, more than half of the perpetrators in our sample would benefit from engaging in financial reporting misconduct. Hence our evidence suggests that financial reporting misconduct can pay off for perpetrators. Keywords Misconduct . Fraud . Misreporting . Penalty . Cost benefit . SEC . Restatements .
Class action lawsuits JEL classification G14 . M40 . M41
* Shiva Rajgopal [email protected] Dan Amiram [email protected] Serene Huang [email protected]
1
Tel Aviv University, Tel Aviv, Israel
2
Columbia Business School, New York, NY, USA
D. Amiram et al.
1 Introduction Does it pay to engage in financial misconduct, especially when it is eventually discovered? Echoing a strong popular belief, Phil Angelides, the former chairman of the Financial Crisis Inquiry Commission, states the amount of penalty that executives’ pay for financial misconduct is “akin to someone who robs a 7-Eleven, takes $1,000 and being able to settle for $25 with no admission of wrongdoing” (Angelides 2013). Dichev et al. (2013) find that 60% of surveyed chief financial officers believe that the perpetrators will most likely get away with misreporting. In a recent book, Eisinger (2017) uses numerous anecdotes and interviews to argue that executives who commit financial misconduct were let off the hook by the justice system. Empirical evidence from the period before 2003 suggests that perpetrators of financial misconduct did incur significant penalties. Karpoff et al. (2008) show that 93% of the individuals identified in U.S. Securities and Exchange Commission (SEC) and Department of Justice (DOJ) enforcement actions related to misconduct between 1978 and 2003 lost their jobs by the end of the regulatory period and also bore substantial financial losses via devalued stockholdings and SEC fines. Desai et al. (2006); Arthaud-Day et al. (2006); and Hennes et al. (2008) find evidence of forced executive turnover and
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