The Market Reaction to Arthur Andersen's Shredding of Documents: Loss of Reputation or Confounding Effects?

Abstract

This paper tests the hypothesis that negative client stock returns following the revelation that Enron documents had been shredded are attributable to confounding effects as opposed to a loss of Andersen's reputation. We find that a sharp decline in oil prices along with a disproportionate share of energy clients combine to produce significantly more negative returns for Andersen clients relative to other Big 4 clients, and for Andersen's Houston office clients relative to its clients in other locations. Further, the returns of Andersen clients are no different from those experienced by Big 4 clients in nine out of ten industry sectors. Additional tests of earnings response coefficients reveal no change in the market's valuation of clients' earnings after the shredding announcement. Overall, we conclude the market reaction surrounding the shredding date is attributable to market-wide news events rather than the loss of Andersen's reputation.