The Effects of the U.S. SEC Enforcement Actions on the Market Response to Earnings Information

In this study, I look at earnings responses coefficients (ERCs) of the firms investigated by the U.S. Securities and Exchange Commission (SEC) for having issued false or misleading financial reports. The SEC enforcement action is expected to negatively affect investors’ perception of a company’s financial reporting process. That is, an SEC enforcement action has the potential to affect the stock market’s response to earnings information by signaling to the market that earnings reported by the firm are noisier (less precise) than previously assumed. The lower the earnings precision is, the less investors learn about the firm’s operating results and the lower the stock price reaction to reported earnings will be. Specifically, I investigate whether firms experience lower ERCs after they are cited in the AAERs issued between 1999 and 2006. The results indicate that (i) the ERCs of sample firms included in the AAERs are lower than those of sample firms not included in the AAERs, and (ii) for sample firms included in the AAERs, the ERCs for the post-AAER periods are lower than the ERCs of the same firms for the pre-AAER periods.