Finding patterns

Hae Mi Choi teaching in a classroom with a whiteboard in the background

“The takeaway is corporate ethics matter,” says Associate Professor Hae Mi Choi about her research on SEC enforcement.

Associate Professor Hae Mi Choi's groundbreaking research on U.S. Securities and Exchange Commission (SEC) enforcement was recently published by Management Science Journal, a top journal of its kind.

In the article, Choi and her co-authors examined how SEC applies enforcement and its impact on companies, industries, and investors.

Uncovering trends

The research discovered patterns in SEC enforcement, including that enforcement comes in waves across firms of specific industries. The documentation of these waves is the first of its kind.

"We test for SEC targeting, and if the number of firms in the industry are abnormally high, we identify it as an enforcement wave," Choi said.

The enforcement waves seem to happen in a cyclical nature, according to Choi.

"There are groups of firms that have a general tendency to commit financial misrepresentation," she said.

"If they're underperforming in the industry based on different conditions such as recession, there is incentive to 'manage earnings' or 'cook the books.' Other firms in the same industry have similar conditions, so there is a cycle or grouping affect, which leads to enforcement waves."

Widespread consequences

The research finds that financial managers have incentive to commit fraud due to pressure from boards of directors and investors to report positive earnings. However, if the firm is investigated by the SEC, consequences for the company and the industry are dire.

"Stock prices go down by an average of 30% in just a one-day return," Choi said.

Due to the nature of enforcement waves, those returns are felt throughout the industry. To Choi's surprise, those negative returns are the same whether a firm is investigated first, last, or anywhere in between.

Beyond stock values, the research of more than 1,000 firms shows that enforced firms have increased rates of CEO turnover and higher rates of bankruptcy.

"You would think this would prevent firms from cooking the books, but history repeats itself," Choi said.

Leaning into ethical business

When it comes to future generations of business leaders, Choi hopes this research serves as an example to students of the consequences of financial misconduct.

"The takeaway is corporate ethics matter," she said. "It aligns with Quinlan's mission of emphasizing ethics and thinking about society."

Choi asks business leaders to consider the consequences that go beyond stock prices.

"Think of all the stakeholders: it will have a negative impact on suppliers, customers, employees. It goes beyond the stock market," she said. "The cost of financial misconduct is pretty significant."

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