In the paper, The Deterrence Effects of SEC Enforcement and Class Action Litigation, we study whether SEC enforcement actions are associated with significant change in behavior of peer firms towards greater compliance. As complete compliance is not feasible, a rational enforcement policy implies enforcement efforts that maximize deterrence. Maximum deterrence is also explicitly mandated in directives from the US Congress as one of the main objectives of the SEC’s enforcement policy. Private securities class action litigation, though it does not aim to explicitly deter others, also has the potential to generate deterrence as such enforcement is more frequent and imposes higher monetary sanctions than the SEC.

We study accrual based earnings management in peers, operationalized as firms in the same industry, as the targeted firm in the aftermath of SEC enforcement and litigation to ascertain the existence and magnitude of deterrence. The results suggest significant reduction in accruals for peer firms of targets that are subject to SEC enforcement and/or litigation. Such reversal of accruals is not only highly statistically significant but also economically important. On average, every peer firm reduces discretionary accruals to the tune of 14% to 22% of its average ROA. This evidence of significant deterrence is robust to different definition of industry. It is also not isolated to events in a few years. Significant evidence of deterrence is seen in sub-samples and also over the extended time period from 1976 to 2006.

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