Causal Evidence on the Effects of Enforcement Investigations
Abstract
This study examines the ex-post consequences of enforcement investigations for investigated firms. While prior research suggests that investigations of firms’ financial reporting are associated with negative firm-level outcomes, these findings are based on endogenously selected investigations. Using proprietary data on random and discretionary enforcement investigations of listed German firms, we are able to disentangle investigation from selection effects. While firms subject to discretionary investigations experience severe negative consequences such as firm value declines and deterioration in financial reporting quality, randomly selected firms do not show any of those severe effects. We only find that random investigations lead to firms becoming slightly more opaque and modestly increasing audit costs for small firms. Further analyses of discretionary investigations consistently reveal that the severe adverse outcomes are not caused by investigations but reflect selection effects. Collectively, our findings imply that investigations per se do not create significant ex-post consequences for investigated firms.