Did the Dodd–Frank Whistleblower Provision Deter Accounting Fraud?

• Published date: 01 September 2022
• Author: PHILIP G. BERGER,HEEMIN LEE
• Date: 01 September 2022
• DOI: http://doi.org/10.1111/1475-679X.12421

DOI: 10.1111/1475-679X.12421

Journal of Accounting Research

Vol. 60 No. 4 September 2022

Printed in U.S.A.

Did the Dodd–Frank Whistleblower

Provision Deter Accounting Fraud?

PHILIP G. BERGER∗AND HEEMIN LEE†

Received 17 March 2019; accepted 19 December 2021

ABSTRACT

We examine the deterrence effect of the Dodd–Frank whistleblower provi-

sion on accounting fraud. To facilitate causal inference, we use state False

Claims Acts (FCAs), under which whistleblowing about accounting fraud at

a firm invested in by a state’s pension fund can result in monetary rewards

from that state’s government. We divide our sample into firms exposed and

not exposed to whistleblowing risk from a state FCA during the 2008–2010 pe-

riod that preceded the 2011 SEC implementation of the Dodd–Frank whistle-

blowing provision. We hypothesize that firms already exposed to a state FCA

whistleblower law are less affected by the Dodd–Frank whistleblower provi-

sion. Using the companies exposed to a state FCA as control firms in our

Dodd–Frank tests, the remaining firms constitute the treatment sample. We

find that exposure to Dodd–Frank reduces the likelihood of accounting fraud

∗Booth School of Business, University of Chicago; †Baruch College, City University of New

York.

Accepted by Regina Wittenberg Moerman. This paper was circulated under the name of

“Do Corporate Whistleblower Laws Deter Accounting Fraud?” We thank Ray Ball, John Bar-

rios, Matt Bloomfield, Andrew Borowick, Matthias Breuer, Jung Ho Choi, Hans Christensen,

John Gallemore, Pingyang Gao, Rachel Geoffroy, Brandon Gipper, Nargess Golshan (discus-

sant), Joao Granja, Anya Kleymenova, Christian Leuz, Mark Maffett, Carol Marquardt, Lillian

Mills, Michael Minnis, Valeri Nikolaev,Geoffrey Rapp, Susan Shu (discussant), Doug Skinner,

Abbie Smith, Sorabh Tomar, Rimmy Tomy, Anastasia Zakolyukina, JingJing Zhang (discus-

sant), workshop participants at Baruch College, HKUST, University of Chicago, University of

Minnesota, University of Texas at Dallas, University of Toronto, the AAA Annual meeting,

the FARS midyear meeting, and the MIT Asia Conference in Accounting, and especially the

anonymous reviewer for their helpful comments. We gratefully acknowledge financial support

from the University of Chicago Booth School of Business, the Accounting Research Center at

Chicago Booth, and the Zicklin School of Business at Baruch College. All errors are our own.

1337

© 2022 The Chookaszian Accounting Research Center at the University of Chicago Booth School of

Business.

1338 p. g. berger and h. lee

of treatment firms by 12%–22% relative to control firms, but do not find that

it affects audit fees.

JEL codes: G34, G38, K22, M41, M48

Keywords: whistleblowing; fraud; Dodd–Frank Act; False Claims Act

1. Introduction

“Complex economic wrongdoing cannot be detected or deterred effec-

tively without the help of those who are intimately familiar with it. Law

enforcement will always be outsiders to organizations where fraud is oc-

curring. They will not find out about such fraud until it is too late, if at

all… Given these facts insiders who are willing to blow the whistle are the

only effective way to learn that wrongdoing has occurred…”

-The 2008 Senate Judiciary Committee Report [emphasis added]

After several high-profile financial frauds involving whistleblowers, reg-

ulators took steps to strengthen whistleblowing provisions. A prominent

example is the Dodd–Frank whistleblower program (implemented by the

U.S. Securities and Exchange Commission (SEC) in 2011), which provides

financial rewards to whistleblowers who report financial fraud to the SEC.

Regulators believe the Dodd–Frank whistleblower law deters accounting

fraud, but whistleblower tips can be frivolous and handling them is costly.

Despite the attention to this debate, little is known about the effectiveness

of the Dodd–Frank whistleblower provision in deterring accounting fraud.

We examine whether the Dodd–Frank whistleblower law has a causal ef-

fect on the deterrence of fraud and quantify the size of the deterrence

effect. Our central test is of whether the underlying (or ex ante) likeli-

hood of accounting fraud decreases for firms subject to Dodd–Frank and

not previously exposed to the risk of whistleblowing via a state False Claims

Act (FCA). The SEC’s Dodd–Frank whistleblower program implemented in

2011 is similar to state FCAs in that both offer financial rewards to whistle-

blowers if their tips lead to successful enforcement actions.

Using firms already exposed to state FCAs as a control group, we expect

that firms not previously exposed to state FCAs will respond more strongly

to the new federal whistleblower program because it is their first treatment

by a whistleblower law with a bounty model. Our approach allows us to

evaluate the effectiveness of the SEC provision, which would otherwise be

difficult because the federal rule simultaneously affected all U.S. firms sub-

ject to securities laws (Baloria, Marquardt, and Wiedman [2017], Wiedman

and Zhu [2020]).

A challenge in empirical research concerning the causal impact of

whistleblower laws is that federal laws such as the SEC’s Dodd–Frank

whistleblower program are applied to all public U.S. firms at almost the

same time. It is thus hard to find an appropriate control group and iso-

late the deterrence effect from other concurrent events. We address this

challenge with a quasi-experimental design by using the passage of FCAs by

the deterrence effect of dodd-frank whistleblowing 1339

some U.S. state governments in the years preceding the passage of Dodd–

Frank.

A state FCA whistleblower law protects whistleblowers who bring to light

fraud against a government and offers them financial rewards. Fraud at a

firm invested in by a state government via the state’s pension funds can

be interpreted as defrauding the state government (Rapp [2007]). While

Rapp lays out the legal theory under which general state FCAs can create

a whistleblowing risk for accounting fraud firms owned by state-sponsored

pension funds from FCA states, he notes that as of 2007 he was not aware

of any test cases using this approach. Nevertheless, as discussed in detail

in subsection 2.3, several related legal and institutional developments in-

crease the plausibility of general state FCAs creating a whistleblowing risk

at accounting fraud firms beginning shortly after the publication of the

Rapp [2007] paper.

Thus, because FCAs were adopted by some states prior to Dodd–Frank’s

2011 enactment, the extent to which a firm is influenced by the Dodd–

Frank whistleblowing provisions varies depending on whether the firm has

previously been exposed to a state FCA that creates a whistleblowing risk for

it. If a firm has already been exposed to a state FCA prior to Dodd–Frank,

it has incentives to reduce fraud risk after its exposure to the state FCA and

thus may be less affected by Dodd–Frank. In sum, we identify firms that are

more or less incrementally exposed to the threat of whistleblowing from

Dodd–Frank’s passage depending on whether or not they had prior expo-

sure to state FCA whistleblower laws. We then use this variation in the extent

to which Dodd–Frank adds a whistleblowing threat to examine its causal ef-

fect on the likelihood of accounting fraud (i.e., the deterrence effect).

We predict that, faced with the increased risk of whistleblowing, man-

agers of firms not previously exposed to a state FCA have stronger incentives

to avoid accounting misstatements and improve financial reporting quality

when they get exposed to the Dodd–Frank whistleblower law in 2011. In

addition, because both the Department of Justice (DOJ) and the SEC place

a premium on a firm’s self-disclosure of problems, managers would want

to uncover existing problems before whistleblowers report and regulators

investigate. Hence, the Dodd–Frank whistleblower provisions can create in-

centives for companies to detect and correct fraud and prevent the devel-

opment of new fraud. As a result, we predict the likelihood of accounting

fraud will decrease.

Unlike prior studies that have used detected fraud (e.g., Bowen, Call, and

Rajgopal [2010], Dyck, Morse, and Zingales [2010], Wilde [2017], Call et al.

[2018]), we measure the underlying probability of fraud by using a proxy

of the probability of accounting manipulation: the F-score (Dechow et al.

[2011]). One empirical challenge in an investigation into the deterrence

effect of whistleblower laws is that accounting fraud is unobserved unless

and until it is detected (Gow, Larcker, and Reiss [2016], Dyck, Morse, and

Zingales [2021]). Thus, using detected (or ex post) fraud would not allow