Market Efficiency and Investor Reactions to SEC Fraud Investigations

摘要

This study investigates investor reactions to SEC fraud investigations in the 2001-2003 period when investors were especially sensitive to fraud allegations in the wake of large-scale frauds such as Enron and WorldCom. The results indicate that investors penalize fraud firms surrounding both the fraud discovery date and the SEC’s investigation announcement date. Specifically, we observe a 29 percent decline in cumulative abnormal returns during the three-day window surrounding the market’s discovery of the fraud. We also find that investors penalize fraud firms by an additional eight percent during the three-day window surrounding the SEC’s subsequent investigation announcement. If markets were completely efficient, prices would fully adjust as soon as information about the fraud is made public. These results suggest that investors do not fully realize the severity of a fraud (and prices do not fully adjust) until the SEC begins its formal investigation. Moreover, this result is consistent with the notion that an SEC fraud investigation confirms the suspicions of investors regarding the gravity of previously released public information about fraud firms. We also examine different types of violations that lead to fraud investigations and find that the market responds more negatively to investigations related to revenue recognition, asset overstatement, and insider trading allegations than other types of violations. Finally, we identify factors associated with the likelihood that a firm will be investigated by the SEC for financial statement fraud.