The Valuation Impact of SEC Enforcement Actions on Nontarget Foreign Firms

• DOI: http://doi.org/10.1111/1475-679X.12098
• Published date: 01 March 2016
• Date: 01 March 2016
• Author: ROGER SILVERS

DOI: 10.1111/1475-679X.12098

Journal of Accounting Research

Vol. 54 No. 1 March 2016

Printed in U.S.A.

The Valuation Impact of SEC

Enforcement Actions on Nontarget

Foreign Firms

ROGER SILVERS

∗

Received 22 March 2014; accepted 5 October 2015

ABSTRACT

This study shows that the Securities and Exchange Commission’s (SEC) en-

forcement intensity toward the foreign firms under its jurisdiction has in-

creased dramatically over the past two decades. Because enforcement events

signify an increased threat of future enforcement, I examine the stock re-

turns of foreign firms not targeted by the SEC during windows around enforce-

ment actions that target foreign firms. This design captures the net effects

of public enforcement and helps to rule out omitted variables as alternative

explanations, because other factors would have to align with enforcement

∗University of Utah.

Accepted by Christian Leuz. I thank the two anonymous referees for many help-

ful comments. I am indebted to Rachel Hayes and my dissertation committee mem-

bers: Pieter Elgers (chair), Mark Bradshaw, Ben Branch, Craig Doidge, and Bing Liang.

I also received helpful comments from Brooke Beyer, Christine Botosan, Brian Cadman,

Richard Carrizosa, Melissa Lewis-Western, Laura Li, Dave Michayluk, James Naughton,

Derek Oler, Steve Perreault, Marlene Plumlee, Terry Shevlin, D. Shores, Holly Skaife, Chris

Stanton, Jake Thornock, Terry Warfield, and Sarah Zechman as well as participants at

the 2011 Edwards Symposium on Markets and Institutions, 2011 International Account-

ing Section mid-year meeting, 2011 AAA annual meeting, the 2011 FMA annual meet-

ing, and 2012 BYU Accounting Conference and workshop participants at the University

of Wisconsin, University of Utah, University of Washington, University of Illinois, and

University of Massachusetts. I gratefully acknowledge the funding of Gene and Ronnie

Isenberg through the Isenberg Scholarship award. I am also grateful to the AAA’s Inter-

national Accounting Section for awarding this paper the 2013 Outstanding International

Accounting Dissertation Award. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

187

Copyright C, University of Chicago on behalf of the Accounting Research Center,2015

188 R.SILVERS

events that do not occur in an obvious pattern (and are therefore unlikely

to map onto other news). Nontarget firms experience positive stock returns

during the event windows, which is consistent with enforcement constrain-

ing the risks of expropriation. The cross-sectional pattern in returns reveals

greater returns for firms from weak home legal environments. Finally, consis-

tent with the market adjusting to a new enforcement regime, the magnitude

of event returns declines over time. Overall, SEC enforcement is associated

with increases in the value of foreign firms, supporting the premise of the

legal bonding hypothesis.

JEL codes: K20; K42; G18; G38; F23; M48

Keywords: SEC; enforcement; bonding; insider trading; restatements;

FCPA

1. Introduction

Research on securities law enforcement is expanding, but the literature

remains divided regarding the valuation impact of enforcement. Theory

proposes that enforcement can increase firm value because it reduces

expropriation and agency-related concerns—which allows investors to

receive a greater share of the after-tax cash flows and lower the discount

rate applied to expected future cash flows (La Porta et al. [1998, 2002],

Glaeser, Johnson, and Shleifer [2001]). In the context of U.S.-listed foreign

firms, this theme is described as the bonding hypothesis. This hypothesis

proposes that foreign firms achieve lower financing costs and higher

valuations by cross-listing in the United States because the robust legal

framework helps protect shareholders and facilitates disclosure (Coffee

[1999], Stulz [1999], Doidge, Karolyi, and Stulz [2004], Hail and Leuz

[2003]).

However, some researchers question the idea that public regulatory in-

tervention is socially optimal or even beneficial (Coase [1960]). They point

out that regulators can be incompetent or captured—that is, the regula-

tors tend to succumb to influential coalitions (Stigler [1971], Peltzman

[1976]). This type of problem may undermine the ability of the SEC to

achieve its investor-protection mandate (Becker [1968]). And, although

few researchers dispute the existence of valuation benefits in the case of

secondary U.S. listings, critics of the bonding hypothesis argue that cross-

listing provides only a trivial increase in enforcement and thus cannot ex-

plain these valuation benefits. For example, Siegel [2005] finds SEC en-

forcement toward Mexican cross-listed firms to be practically nonexistent,

even in cases of severe asset taking, and suggests that this lax enforcement

extends to all foreign firms. On these grounds, some conclude that enforce-

ment could not contribute to the valuation benefits of cross-listing (Licht,

Li, and Siegel [2012]).

This debate continues, in part, because of persistent research-design

challenges. Enforcement is difficult to measure and exhibits little variation

THE VALUATION IMPACT OF SEC ENFORCEMENT ACTIONS 189

in most settings. In cases where enforcement differs across countries, the

effects of omitted institutional features are hard to rule out (Coffee

[2007]). Changes in enforcement over time are challenging to link to val-

uation because they are often driven by endogenous factors, such as mar-

ket failures and economic crises, that can directly affect valuation on their

own (Leuz [2007]). Similar issues also complicate tests of the bonding hy-

pothesis. Because firms choose to establish a secondary listing, compar-

isons to other firms face selection concerns. Some studies use firms as their

own control by examining valuation changes around the secondary list-

ing announcement or event (Foerster and Karolyi [1999], Miller [1999]).

However, changes to fundamentals, expected growth, capital access, and

liquidity are all bundled with the listing event. These changes confound

the source of any measured valuation benefit from a U.S. listing (Karolyi

[2006], Hail and Leuz [2003]) and make it difficult to attribute such ben-

efits to the enhanced legal framework in the United States or to other

factors.

Using a research design that attempts to mitigate these issues, I study the

effect of enforcement on firm value by exploiting a wave of SEC enforce-

ment targeting U.S.-listed foreign firms. To my knowledge, this sequence

of SEC actions includes the first events ever to target foreign firms. Several

developments during the sample period foreshadow additional expansion

of oversight for foreign firms: The SEC and foreign authorities entered

into information-sharing agreements intended to facilitate cross-border en-

forcement against foreign firms. The Sarbanes-Oxley Act (SOX) enhanced

management liability for disclosure (Bargeron, Lehn, and Zutter [2010])

and expanded the SEC’s budget. The SEC established a Foreign Corrupt

Practices Act (FCPA) unit, which aims to increase antibribery enforcement.

And, an SEC review of foreign firms’ disclosure under both International

Financial Reporting Standards (IFRS) and U.S. GAAP prompted a wave of

restatements.

Increased enforcement directed toward U.S.-listed foreign firms presents

four main research design opportunities. First, from the perspective of a

U.S.-listed foreign firm that is not accused of wrongdoing (i.e., a nontar-

get firm), additional enforcement actions represent a series of exogenous

shocks to the legal environment. If investors believe that enforcement re-

duces the risks of expropriation and agency costs, then these signals of en-

hanced enforcement should be impounded into security prices. Therefore,

the setting is ideal for a short-window event study that can link SEC enforce-

ment actions to nontarget foreign firms’ value.

Second, heterogeneity across several dimensions of the nontarget group

makes the design less susceptible to the “reflection problem”—a type of

endogeneity in which the causal direction of common outcomes between

an individual and its peer group cannot be determined (Manski [1993]). In

my study, endogeneity could take the form of omitted economic shocks that

apply to all (both target and nontarget) firms because of latent economic

similarities, as the firms are similar with respect to cross-border regulatory