Enforcement Waves and Spillovers

Abstract

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 efficiently incorporate changes in the likelihood a firm will face enforcement action for financial misconduct. As a result, short-window losses are biased measures of the total share price impact, particularly for firms whose financial misrepresentation is revealed late in an enforcement wave.