The Valuation Impact of SEC Enforcement Actions

On Non-Target Cross-Listed Firms◊

Roger Silvers

University of Massachusetts

rsilvers@som.umass.edu

Pieter Elgers

University of Massachusetts

elgers@acctg.umass.edu

Abstract: The objective of this study is to provide a market-based test of the valuation

impact of legal bonding. We examine the Securities and Exchange Commission (SEC)

enforcement policy towards non-U.S. firms under its jurisdiction in the post-2002 time period.

In contrast to Siegel (2005) which examines earlier time periods, we find that the current

pursuit of non-U.S. firms by the SEC is by no means rare and is, in fact, active and significant.

We examine non-target cross-listed and foreign firm market returns using event windows

surrounding SEC announcements of enforcements against non-U.S. firms. These actions

isolate the effect of a changing legal environment and enable a test of the legal bonding

hypothesis that is not affected by self-selection problems or confounded by other factors such

as the information environment, liquidity, and market segmentation. The results indicate that

when the SEC takes action against a non-U.S. firm, non-target non-U.S. firms experience

substantial increases in market valuation. These positive effects are amplified for firms from

weak home legal environments, suggesting that the increases in value are due to closer legal

scrutiny by the SEC. In sum, the results provide evidence that legal bonding plays a

significant role in increasing the value of cross-listed firms.

Keywords: SEC, cross-list, foreign, legal bonding, insider trading, restatements

JEL codes: K22, G38, F22, F23, F59, M48

◊ We acknowledge Steve Perreault and Brooke Beyer as well as participants at the 2011 International Accounting

Section mid-year meeting and workshop participants at the University of Massachusetts. The usual disclaimers

apply.

1

1. Introduction

All firms electing to trade securities in U.S. markets fall under SEC jurisdiction,

including those domiciled in other countries and/or trading in foreign markets (see footnote

1).1 The literature has proposed several reasons why non-U.S. firms choose to list in U.S.

markets, most of which are associated with reducing the cost of financing (Stulz, 1999).2 The

ability of cross-listing to influence a firm‟s cost of capital has been explained by some via the

bonding hypothesis. This hypothesis proposes that firms listed abroad register in, and subject

themselves to the additional scrutiny of, U.S. markets in order to signal the firm‟s

commitment to quality financial reporting and investor protection (Coffee, 1999, 2002; Licht,

2003; Doidge, 2004). The pledge to meet the demands of the U.S. legal environment implied

by a U.S. listing allows companies to signal their credibility. Karolyi (2010), Hail and Leuz

(2009), Leuz (2006), and Benos and Weisback (2004) discuss the inherent difficulties in

testing the bonding hypothesis, and we propose that out research design can fill this void by

circumventing such shortcomings. Therefore, the objective of this manuscript is to provide a

market-valuation based test of the efficacy of bonding.

While some prior research supports the bonding hypothesis, other literature calls into

question the practical ability of cross-listed firms to bond to more stringent regulations. For

example, SEC's enforcement policy towards cross-listed firms has been described as a “free

pass” (Shnister, 2010), “rare” (Coffee, 2002, pg 47; 2007, pg 55), and "hands off" (Licht,

2003), while Licht et al. (2011) opine that “the rumors of the SEC‟s imminent threat of public

1 All firms that we examine trade in U.S. markets. For expositional convenience, we refer to the union of cross-

listed and non-cross listed foreign firms that are listed in U.S. markets as “non-US” firms in the remainder of the

paper. Foreign firms are those which are incorporated outside the U.S. but listed only on U.S. exchanges,

whereas cross-listed refers to firms that are first listed in a home market and secondarily listed on the U.S.

markets. 2 Other motives suggested by prior research include affecting business restructures (mergers), access to foreign

capital markets, greater liquidity, prestige, legal protection, brand recognition, and personal compensation

(Amihud and Mendelson, 1988; Karolyi, 1998).

2

enforcement have been greatly exaggerated.” In a study of cross-listed Mexican firms, Siegel

(2005) finds that SEC enforcement actions against these firms are lacking and suggests that

this trend extends to all non-U.S. firms.

Siegel‟s (2005) criticism of the SEC enforcement policy in the pre-2002 period

notwithstanding, the overall role played by the SEC in prosecuting non-U.S. firms is currently

active and significant. The terrorist attacks of September 11, 2001 increased the priority of

cross-border information sharing resulting in more intra-jurisdictional enforcement

cooperation. This has taken place domestically at the SEC and the Department of Justice and

around the world via the efforts of the International Organization of Securities Commissions

(IOSCO), Financial Action Task Force (FATF), and Financial Stability Forum (FSF)

(Friedman et al., 2002). These efforts may have prompted a meaningful change from the

ineffective regime documented by Siegel (2005) to aggressive extraterritorial enforcement by

the SEC in the post-2002 time period. Indeed, evidence from this study indicates that the SEC

currently pursues non-U.S. firms at a rate that is comparable with their representation in the

market. These enforcement actions are used in testing the legal bonding hypothesis in a

manner that is not confounded by factors that accompany secondary (cross) listing events,

such as self-selection bias or simultaneous changes to liquidity, shareholder base, market

segmentation, or the information environment.3

We examine the market valuation impact on non-target cross-listed firms of SEC

enforcement releases that charge a non-U.S. firm. Results indicate that in pursuing non-U.S.

3 Anecdotal evidence also suggests that SEC is a formidable power. Conrad Black, Chairman and CEO of

Hollinger International, a Canadian holding company for multiple national news syndicates, was pursued by the

SEC for fraud and self-dealing. He exclaims, “It also became clear that such was the weight of the onslaught of

the most powerful organization in the world, the US government, acting initially through the Securities and

Exchange Commission, but various other agencies became involved including the Internal Revenue Service, and

ultimately the Department of Justice. The pressures that it is possible for such an organization to bring are

extremely severe. They are stigmatizing, they are isolating, and they affect your life in ways that casual

observers wouldn‟t immediately imagine” (ideaCity06 Conference, 2006).

3

firms, the SEC actions confer significant positive abnormal returns to such cross-listed firms,

suggesting that legal enforcement boosts the value of non-U.S. firms. In economic terms, the

market valuation impact on non-target non-U.S. companies associated with the SEC

enforcement actions is considerable. Moreover, we find that the country of origin plays a

significant role in determining the magnitude of the reaction. Specifically, firms from

countries with weak legal environments have a greater positive response to SEC enforcement.

Taken together, these findings provide strong support of the legal bonding motivation for

cross-listing.

Various prior studies evaluating the bonding hypothesis examine the market response

to firm-specific announcement or consummation of cross-listings (Doidge et. al, 2004;

Karolyi, 2006; Stulz, 2009; Hail and Leuz, 2009).4 These efforts are plagued by an inability

to separate bonding from alternative explanations (e.g. risk premium reduction, market

segmentation reduction, changes in liquidity, or information disclosure). In contrast, the

available history of SEC actions toward non-U.S. firms allows a test of legal bonding while

avoiding such potential confounding factors.5 Consequently this study provides a direct test

of legal bonding that does not suffer from these alternative interpretations. In doing so, we

contribute to several concurrent debates about U.S. market competitiveness and optimal

regulatory structures by offering important evidence about the consequences of enforcement.

The paper proceeds as follows: Section 2 discusses background literature, and Section

3 develops the hypotheses. A description of the sample data is presented in Section 4.

4 One exception is Hail and Leuz (2008) who show that the valuation increase is not due exclusively to changes

in expectations of growth. Rather, this valuation increase is in part due to changes in the cost of capital.

Although their results are consistent with bonding, they emphasize that their paper is not an outright test of the

bonding hypothesis. 5 The support of legal bonding certainly does not exclude the possibility that alternative cross-listing

explanations are also relevant because these theories are not mutually exclusive.

4

Section 5 describes the research design and presents the empirical results. Section 6 offers

robustness tests to ensure that the results are not driven by our specification of expected

returns, and Section 7 concludes.

2. Background

Prior research generally supports the idea that cross listing intends to, and succeeds in,

reducing a firm‟s cost of capital. However, researchers have contrasting hypotheses about the

mechanisms by which this reduction takes place. Some suggest that the value of cross-listing

is a result of reduced market segmentation (Merton, 1987; Errunza and Losq, 1985).

However, although several studies document significantly positive abnormal returns around

secondary listing dates or announcement dates (Karolyi, 1998; Foerster and Karolyi, 1999;

Miller, 1999), the economic significance is often meager (Karolyi, 2011). Furthermore, the

patterns of abnormal returns persist for firms from well integrated markets (that is, with little

market segmentation). Stulz (1999) therefore argues that a firms cost of capital rests upon the

pillars of the legal system, capital markets, and regulations regarding disclosure, among

others. The ongoing debate therefore consists of two contending fundamental hypotheses:

bonding (or signaling) and avoiding.6

Avoiding proposes that cross-listing reduces market segmentation and that legal and

regulatory structures impose a costly burden. Cross listing therefore presents an investment

opportunity to a broader class of investors who were previously unaware of the firm (Merton,

1987; Karolyi and Stulz, 2002). This awareness increases access to capital and widens a

firm‟s shareholder base, thus promoting risk sharing via better dispersion of securities, and

6 Karolyi (2011) provides an excellent discussion about the evolution of the bonding hypothesis and its various

forms. Licht (2003) articulates the family of avoiding hypotheses.

5

thereby lowering the cost of capital (Foerster and Karolyi, 1999; Stulz, 1999). These benefits

have been demonstrated in both short- and long-run increases in value (Kadlec and

McConnell, 1994; Miller, 1999; Foerster and Karolyi, 2000).

In contrast, bonding asserts that shareholders benefit from cross-listing because cross-

listed companies are required to uphold higher standards of governance and disclosure than

their home markets require. Two types of bonding are proposed: legal bonding and

reputational bonding. The legal bonding hypothesis suggests that cross-listing signals a firm‟s

commitment to high-quality disclosure and investor protection thereby reducing agency costs

(Coffee, 1999, 2002; Doidge, 2004; Stulz, 2009). Under this view, cross-listed firms are

compelled by SEC mandates and the U.S. legal framework to protect minority shareholders

and improve their information environment, regardless of more lenient laws or practices in a

firm's home country.7

The reputational version of bonding asserts that, despite the lack of protection

purveyed by the U.S. regulatory and legal environment (Siegel, 2005), bonding may

nonetheless endure (Coffee, 2002). Indeed, Siegel (2005) finds in a study of Mexican cross-

listed firms that, although the firms are not forced to abide by the U.S. rules (legal bonding),

the act of voluntarily following the rules creates a “reputational asset.” Firms with insiders

who engage in illicit asset taking are less likely to receive outside resources (i.e. equity, public

debt, or syndicated loans) during economic hardships. Reputational bonding suggests that the

market itself, rather than the SEC, is the key driver of value by “routing out governance

abuses” (Siegel, 2005, p. 356).

7 Empirically consistent with this view, several studies demonstrate increased capital availability, valuation

premium, lower cost of capital, improved information environments, and higher quality financial reporting

associated with cross-listing (Reese and Weisbach, 2002; Doidge et al., 2004; Doidge, 2004; Ayyagari, 2004;

Doidge, et al., 2008; Lel and Miller, 2008; Hail and Leuz, 2009; Lang, et al. 2003; Lang et al., 2003).

6

Although severe lack of enforcement by the SEC and possible failure of the private

right of action lead Siegel to conclude that legal bonding cannot have a meaningful impact,

some research raises concerns about the methods used and conclusions drawn from Siegel‟s

study (Benos and Weisbach, 2004; Doidge, 2004; Leuz, 2006; Coffee, 2007). Leuz (2006)

and Coffee (2002) stress that legal bonding does not imply that scrutiny of cross-listed firms

and U.S. firms be equivalent. The necessary condition for legal bonding merely requires that

entry into U.S. markets provides incremental improvement in disclosure or minority

shareholder protection. Coffee (2002) goes on to point out that SEC oversight can take place

in a multitude of ways, including informal and unobservable contact. Furthermore, ad hoc

examination of specific SEC actions (or lack thereof) does not constitute an effective test of

bonding (Coffee, 2002; Benos and Weisbach, 2004).8

For several reasons, inferences from prior studies concerning the validity of bonding

and its various forms remain open for debate (Doidge, 2004; Leuz, 2006; Hail and Leuz,

2009, Karolyi, 2011). First, the effects of bonding and market segmentation reductions (the

key value driver for the avoiding hypothesis) are not mutually exclusive. Furthermore, legal

bonding and reputational bonding are also not incongruous. Second, research designs used in

prior studies are subject to causality issues (Karolyi, 2010). Because firms voluntarily elect to

cross-list, most designs, such as those that evaluate the effects of a cross-listing announcement

or consummation, are subject to self-selection issues. Moreover, simultaneous changes often

occur to firm-specific characteristics that coincide with the cross-listing that could exacerbate

8 Siegel‟s (2005) results indicate that of the illegal asset taking (Table 3, pg 336), only three firms are listed ADR

programs. The other firms are part of unlisted (level I) programs which are exempt from the majority of SEC

requirements (e.g. SOX compliance, reconciliation 20-F, size/earnings requirements). Given the increase in

subsequent SEC scrutiny documented later in this paper, the examination of SEC policy in more recent times is

prudent before proclaiming that the SEC does not take action against non-U.S. firms.

7

an omitted variable problem. For example, changes to firm size, capital structure, growth

opportunities, access to capital, liquidity, and disclosure quality obscure the root causes of

changes in valuation. Therefore it is extremely difficult to assign changes in valuation to one

specific catalyst.

The ideal test of legal bonding would observe the effects of an exogenous change that

is confined to the legal environment. As Siegel (2005) points out, a potentially critical but

deficient element of legal bonding is enforcement. Indeed, several papers opine about the

vital role of enforcement activity in obtaining compliance with existing regulations (Coffee,

2007; Christensen, Hail, and Leuz, 2011), but enforcement intensity is empirically difficult to

capture. Bhattarcharaya and Daouk (2002) document that the cost of equity capital is

unaffected by the passage of insider trading prohibitions, but is associated with a reduction

following the enforcement of the first prosecution. Coffee (2007) suggests that tangible

outputs of regulators (fines, number of actions, criminal sanctions, etc.) may be an important

factor related to market development (although he hastens to emphasize the potentially

endogenous nature of cross-sectional association of market development and enforcement).

Jackson and Roe (2009) proxy for enforcement intensity by measuring enforcement-related

inputs (resources) across countries. Their results demonstrate that public enforcement is at

least as important in explaining financial market development around the globe.

We identify a regime shift in the intensity of enforcement by the SEC (described in

detail in Section 4) that provides a tractable opportunity to evaluate the bonding hypothesis

while circumventing selection issues. Presumably the market sentiment during the pre-2002

time period reflects the “hands off” policy documented by Seigel (2005), but, as a matter of

national security, this policy shifted dramatically in response to the events of September 11,

8

2001. Both the Department of Justice and the SEC established more formal mechanisms that

promoted cross-border cooperation and anti-terrorism intelligence (by way of Multilateral

Legal Assistance Treaties (MLATs) and the Multilateral Memorandum of Understanding

(MMOU), respectively). The MMOU outlines the scope of the international assistance,

permissible uses of the information acquired, and explicitly states conditions under which the

information will be confidential (Friedman, et al., 2003).9 Importantly, the MMOU does not

require that the activities be illegal in both countries (dual criminality), and establishes

channels through which the SEC can execute asset freezes (see

http://www.sec.gov/news/press/2010/2010-153.htm).

3. Hypothesis development

The legal bonding hypothesis suggests that firms benefit from signaling their superior

reporting quality by withstanding the scrutiny of the SEC.10

Legal bonding requires that the

oversight of the SEC and the threat of enforcement be sufficient to reduce investor

perceptions of risks (e.g. risks decline due to an increased cost of rogue management behavior

(Zimring and Hawkins, 1973)). Indeed, Kedia and Rajgopal (2011) demonstrate that the

propensity to engage in rogue behavior is inversely related to enforcement threat salience

(measured by historical county-level SEC enforcement). Accordingly, we expect that non-

U.S. firms are a relevant peer group used by both firms and the market to assess enforcement

oversight. If the market perceives that the SEC is providing scrutiny of non-U.S. firms that

would otherwise not be held to such standards, the potential for legal bonding exists.

9 The SEC obtained an exemption from the U.S. Freedom of Information Act (amended, 2002), to ensure that

after a foreign regulator surrenders information, its public disclosure is still at the discretion of the original

regulator. 10

The legal system as a whole is the critical element, but the SEC ostensibly plays a sizeable role as the most

powerful financial regulatory body in the U.S. legal landscape.

9

However, we again note that legal bonding does not imply that scrutiny of cross-listed firms

and U.S. firms be equivalent (Leuz, 2006; Coffee, 2002). As Leuz (2006) points out “[the

bonding hypothesis] only maintains that the U.S. cross listings provide some additional

reassurance to outside investors.”

To test the bonding hypothesis, we first examine the market response of non-target

cross-listed firms to SEC actions against non-U.S. firms, and then study the association

between home country legal characteristics and the magnitude of the market response. The

theoretical grounds for our expectations relate to legal bonding, which is classically pertinent

to cross-listed firms. However, extraterritorial SEC oversight of both cross-listed and non-

U.S. firms was once deficient and has subsequently expanded. Therefore, to the extent that

the market considers extraterritorial SEC enforcement actions relevant to both subsets of firms

(cross-listed and foreign firms), we expect similar valuation consequences. Accordingly, we

include analyses of foreign firms (both in terms of SEC actions and non-target response firms)

in the following sections (see footnote 1 for important definitions of cross-listed, foreign, and

non-U.S. firms).

In the pre-2002 time period examined by Siegel (2005), pursuit of non-U.S. firms was

rare, despite compelling evidence of asset taking by Mexican firm insiders. However, a recent

SEC regime shift that motivates enforcement of cross-listed firms may amplify the effects of

legal bonding. For example, in August of 2002, Gary Goodenow, an attorney at the SEC‟s

Division of Enforcement described the practical level of enforcement cooperation: “The SEC

and other regulators…have only very recently begun considering information sharing between

financial regulators” (Vaknin, 2002). Market awareness can also be demonstrated by

PriceWaterhouseCoopers‟ 2003 Securities Litigation Study which observes that “the SEC

10

entered into new cooperation agreements with the European Union and various EU countries‟

securities regulators, as many more securities litigation matters went „global‟”

(PriceWaterhouseCoopers, 2004, pg 2). However, because the SEC never provided an official

“free pass” to non-U.S. firms, a publicly expressed amendment to this policy is a tacit

admission that a “hands off” policy was applied in the past, which is inconsistent the SEC‟s

mission. We neither expect nor find an explicit announcement that the extraterritorial policy

changed, although in Section 4 we demonstrate that the practical enforcement of non-U.S.

clearly increases.

The SEC has entered into similar information sharing agreements in the commission‟s

history, with little observable impact. Therefore, investors may be skeptical of the practical

effects of the MMOU information sharing agreement. For example, the SEC‟s Policy

Statement on Regulation of International Securities Markets, formally emphasizing the

importance of cross-border regulatory networks, had been in place since 1988, but resulted in

the relatively weak oversight documented by Siegel (2005). Furthermore, while the IOSCO

requires a review panel that ensures that MMOU members are capable of fulfilling the terms

and conditions therein, there is nothing legally binding about the MMOU, and the right to

refuse to cooperate is at the discretion of the foreign authority.

As a result, the market valuation effects of such a regime shift require evidence of

specific actions for the market to resolve uncertainty concerning the actual pace and scope of

the more aggressive SEC enforcement policy. Therefore, notification that the SEC has

successfully performed this function by pursuing a non-U.S. firm may cause market

participants to revise or reaffirm their prior beliefs about the standard to which non-U.S. firms

are held. The cost of consuming private benefits in non-U.S. firms concomitantly increases

11

(and becomes more salient), creating additional deterrents to wrongdoing and reminding the

market that non-U.S. firms are not beyond the reach of the SEC (Becker, 1968; Jennings,

Kedia, and Rajgopal, 2011). If investors perceive that the monitoring role of the SEC has

expanded, positive returns to non-target non-U.S. firms may result. This reason motivates the

first hypothesis (stated in alternative form):

H1: Around the dates of SEC enforcements against non-U.S. firms, abnormal

returns to non-target non-U.S. firms will be positive.

Under the bonding hypothesis, one major driver of increased value for cross-listed

firms is the commitment to higher legal, governance, and investor protection standards, all of

which are under the jurisdiction of the SEC. Ultimately, SEC actions generate larger marginal

benefits to firms with the most room for improvement. For example, companies from

developing countries with poor investor protection (i.e. weak legal systems, disclosure

mandates, and anti-director rights) are likely to experience the largest cross listing benefits

(Miller, 1999; Doidge, et al. 2004; Doidge, 2004). Also, Doidge, et al. (2007) show that firm-

level characteristics have little impact on governance scores in under-developed markets

beyond country-level characteristics. This suggests that firms from countries known for poor

governance may be unable to change investor sentiments through increasing their governance

practices alone and are therefore likely to experience the largest marginal impact from SEC

scrutiny. Hail and Leuz (2009) show that the reduction in the cost of equity capital provided

by cross-listing (after controlling for changes in expected growth) is greater for firms

domiciled in weak home regulatory environments. Taken together, these results suggest that

12

if bonding drives returns around SEC enforcements of non-U.S. firms, those firms which are

cross-listed in countries with the weakest financial environments should reap the largest

benefits.11

This reasoning leads to the second hypothesis (in alternative form):

H2: The legal strength of firms’ home countries is inversely related to the market

value impact of SEC enforcement action for non-target cross-listed firms.

(H3) agreements

4. Sample

4.1 Enforcement sample

Data for the sample is collected from multiple sources pertaining to insider trading-

and restatement-related SEC enforcement actions over 14 years (1995 to 2008). We split the

sample into two 7-year periods (1995-2001 and 2002-2008) because Siegel (2005) shows that

SEC actions are sparse in the earlier period.12

The Securities and Exchange Commission annual reports provide a description of

insider trading enforcement actions. We collect measures of a host of pertinent characteristics

for each insider trading release including: the total amount of illegal gains, the length of the

announcement delay, whether the trade involved a merger or acquisition, and whether the case

11

Note that these arguments do not necessarily extend to foreign firms who are fully listed solely in U.S. markets

because their legal environments are ostensibly the same as a U.S. domiciled firm. Current research has not

examined whether there is a “stigma” for foreign firms from weak home legal institutions that are listed in U.S.

markets, although this effect has been documented for cross-listed firms (see Zhu, 2009). 12

Also, we expect that the establishment of the IASB in 2001 and the 2002 agreement between the FASB and the

IASB to work toward convergence may facilitate changes in the international affairs policy at the SEC. In

addition, the SEC budget increased by 21% in 2002 and 40% in 2003, the largest two increases during the 14-

year period.

13

was settled at the time of the release.13

Table 1 Panel A describes the sample of 333 total

insider trading enforcement actions brought against firms and their insiders.14

Over the entire

sample period, non-U.S. firms represent 11.7% of the cases (39/333), of which 8.7% are

cross-listed and 3.0% are foreign. The frequency and percentages of non-U.S. enforcements

in Panel A do not change radically from the 1995-2001 to the 2002-2008 partition.15

We also gather restatement data from the SEC website, Audit Analytics database, and

the GAO database from 1995 to 2008 on all public restatements and financial reporting

infractions. We include SEC-prompted restatements only and do not include restatements due

to mergers, acquisitions, stock splits, or other sanctioned business reporting that arise from

unusual, but legitimate, operations (Hennes, et al. 2008). We assemble the date the

restatement is announced, the dates covered by the restatement period (sometimes referred to

as the class period), whether the restatement involved fraud, and the restatement amount

(scaled by market value of equity). Table 1 Panel A describes the resultant sample of 779

available restatements, of which 66 are non-U.S. firms. The fraction of non-U.S. SEC

enforcement actions dramatically increases from 2.4% during 1995-2001 to 10.6% during

2002-2008. The 34 cross-listed firms account for 4.4% of all restatements in the entire sample

period (1995-2008). In contrast to the insider trading sample, non-U.S. restatements have

13

To be included in the insider trading sample the SEC must pursue a firm, or firm insider. Almost 40% of the

enforcement cases represent SEC pursuits of individuals that are not insiders of (employed by) any specific firm

and are therefore excluded. 14

Analyses by firm rather than by enforcement action (unreported) buttress the notion that enforcement actions

against non-U.S. firms are far from rare, and ensure that results are not driven by multiple litigation releases for

the same firm. For example, insider trading cases from 2000-2008 show that the total number of companies

pursued by the SEC is 237. Of the 237 total target firms 21 are cross-listed and 10 are foreign. 15

In the following section, we show that the representation of non-U.S. firms as a fraction of SEC enforcement

actions is in line with non-U.S. firms‟ representation in the markets as a whole.

14

increased remarkably both in frequency and as a percentage of all SEC-prompted

restatements.16

Panel A of Table 1 also shows additional SEC enforcements against 17 non-U.S. firms

that are not readily classified. These miscellaneous infractions include actions such as tax

evasion, aiding and abetting other companies committing fraud, and false disclosures

(unrelated to financial statements). Many of these events involve significant fines, which

average over 70 million dollars.17

We collect the amount of such fines and the dates the

alleged crimes were committed. The final combined sample of 122 non-U.S. actions in Table

1 Panel A represents 39 insider trading, 66 restatement, and 17 miscellaneous enforcement

actions. Enforcement of listed securities is more than 5 (4) times as likely for insider trading

(restatement) actions. This lack of enforcement intensity may contribute to the reduced

benefits of cross listing on cost of capital documented by prior literature (Hail and Leuz,

2009).

4.2 Universe of non-U.S. SEC-regulated firms

To facilitate a better understanding of the frequencies presented in Table 1 Panel A,

we collect data to describe the representation of non-U.S. firms listed in U.S. markets by

exchange listing destination (that is, the second exchange upon which the firm lists).18,19

Data

is obtained via the Bank of New York, OTC Bulletin Board, NASDAQ, and NYSE/AMEX

16

Although these results are similar to Shnister (2010), she concludes that the SEC pursuit of cross-listed firms is

lower than that of domestic firms. Her results are in part driven by not recognizing the regime shift in 2002, and

heavily influenced by failing to evaluate exchange listed firms separately from non-exchange-listed firms. 17

See, for example, http://www.sec.gov/litigation/litreleases/2006/lr19716.htm. 18

Hereafter, “listed” securities represent those trading on a major U.S. exchange (such as the NYSE). These

firms correspond to Level II and III American Depositary Receipts (“ADRs”). In contrast, “unlisted” refers to

the OTC markets, which includes Level I and rule 144A cross-listings. 19

Because the miscellaneous infractions are not clearly classified into a category, we do not report comparable

domestic SEC actions.

15

websites and is cross-validated by information from the SEC website. Table 1 Panel B,

provides the composition of the universe of U.S. markets in percentage terms by type of

listing and listing destination (for example, the 17.8% represents over 2,000 non-U.S. firms in

U.S. markets as a percentage of roughly 11,000 total SEC regulated firms). The cross-listed

fraction of the sample is comparable to that reported by Reese and Weisbach (2002). Table 1,

Panel B also reports non-U.S. firms as a percentage of corresponding SEC enforcement

actions in the period from 2002-2008.20

The enforcement proportions reported in Table 1, Panel B are inconsistent with the

view that the SEC abdicates its responsibility for non-U.S. firms. Enforcement against listed

non-U.S. companies as a percentage of total enforcement is generally comparable to the non-

U.S. representation in listed markets. For listed securities, the cross-listed insider trading

enforcement actions by the SEC (8.33%) exceed the underlying representation of cross-listed

firms in the market (5.6%). The only major deficiencies in enforcement activity in

comparison to the underlying representation are found in the OTC market. The OTC under-

representation of non-U.S. firms in SEC enforcement actions is perhaps not surprising given

prior research, which shows that the SEC radar for illegal actions appears attenuated for

unlisted firms (Miller, 1999; Coffee, 2002; Lang, Raedy and Yetman, 2003; Doidge, et al.,

2004, 2008; Hail and Leuz, 2009).

The data summarized in Table 1 provide descriptive evidence that the detection and

pursuit of firms in less prestigious (OTC) markets is, not surprisingly, reduced.21

Consistent

with prior literature and the reduced regulatory and disclosure requirements for such listing

20

For example, the 8.97% represents 14 SEC insider trading enforcement actions against cross-listed firms that

took place from 2002-2008 as a percentage of the 156 total insider trading cases from that time period. 21

Coffee (2002, p 35) states, “In short, from a corporate governance perspective, little of significance happens

when only a Level I [unlisted/OTC] facility is created; there is no upgrading in the quality of financial disclosure

and no bonding of any consequence.”

16

types, the information demonstrates that listing type does matter. Given the empirical support

for the SEC‟s disciplinary role in regulating cross-listed firms, it is not appropriate to dismiss

the SEC‟s role in regulating non-U.S. firms as inactive, laissez-faire, inconsequential, or

nonexistent.

The information in Table 1 should be interpreted cautiously in assessing SEC

enforcement equality because the groups may have differences in the underlying frequency or

severity of misconduct, as well as the fact that the home country may share a portion of the

regulatory burdens with the SEC. Although this evidence is useful in informing the

contemporary understanding of cross-listing, the descriptive properties are ad hoc in nature.

However, the panels are striking in light of assumptions made by prior research (Licht, 2003;

Siegel, 2005; Licht et al., 2011; Shnister, 2010).

5. Research design and empirical results

5.1 Introduction

The hypothesis tests are presented in the following two sections. First, we examine

the magnitude and timing of the market response using a portfolio-based event study

framework (H1). Second, we assess the home country characteristics that condition the

market response at the firm level using a cross-sectional regression framework (H2).

5.2 Portfolio CAR

If the SEC has historically been inactive in the monitoring of non-U.S. firms (Siegel,

2005), and subsequently increases the level of monitoring, we expect that the market for the

securities of non-U.S. firms will benefit because SEC scrutiny reduces the cost of external

17

monitoring and increases the cost of insider malfeasance. Both of these effects should

enhance firm value for outside shareholders. H1 assumes that investors benefit from legal

actions against non-U.S. firms (i.e. legal bonding) and that investors are aware of SEC actions

towards non-U.S. firms.

Muradoglu and Huskey (2008) and Salavei, et al. (2009) examine the market response

of target firms to SEC enforcement actions and find that such firms experience significant

negative abnormal returns that accompany SEC announcements. These returns to target firms

begin around day -1 and change little after day +8 relative to the announcement date.

Accordingly, we choose to examine 10-day (-1, +8) returns to a portfolio of non-U.S. firms on

U.S. stock exchanges as the event period return window. We also report the anticipatory

period (-14, -2) and the subsequent period (9, 16) returns. We measure abnormal returns as

market adjusted returns using a value-weighted index, although similar to Leuz, Triantis, and

Wang (2008) our results are similar using a variety of abnormal return specifications, detailed

in Appendix A. The number of events is reduced from the sample of 122 enforcements to 94

(30 insider trading, 50 restatement, and 14 miscellaneous activities) for reasons described in

Appendix A. We use the universe of foreign and cross-listed firms covered by CRSP to form

equally-weighted portfolios at each SEC action date because there are roughly 75,000

observations (firm-events) available in CRSP (see Appendix A for details). This approach

mitigates potential cross-sectional dependencies that could bias the standard error estimates

(Sefcik and Thompson, 1986). The 94 portfolios constructed for each unique SEC

enforcement action date assume that different events are uncorrelated, which is not

unreasonable given the random nature of the enforcement announcement dates (see Figure 1).

Standard errors are estimated using an approach similar to Fama and MacBeth (1973).

18

Figure 1 displays the 94 portfolio returns to enforcement announcements over time by

type of enforcement. The number of SEC actions targeting non-U.S. firms increased sharply

around 2002. Figure 2 shows the daily Cumulative Abnormal Return (CAR, hereafter) for the

anticipatory, event, and subsequent periods. The graphical results appear consistent with the

view that the enforcement announcement positively affects market returns. Table 2 provides

statistical evaluations of the market reaction to SEC actions against non-U.S. firms based on

event portfolios. Panel A reports the anticipatory, event, and subsequent period returns and

buttresses the inference in Figure 2. The anticipatory (day -14 to -2) and subsequent period

(9, 16) returns are insignificant while the event period (-1, 8) returns are positive and

significant, consistent with H1. Non-U.S. firms appear to benefit from the SEC action by

about 0.72% over the 10-day window. The results are economically and statistically

significant and comparable in magnitude to prior research (Gleason, et al. 2008; Armstrong, et

al. 2010). The Bank of New York estimates that in 2008 the NYSE and NASDAQ held 1.2

trillion dollars of market capitalization for cross-listed firms (BNY, 2009), making 0.72% an

impressive increase in dollar value.

Panel C of Table 2 partitions firms by the type of violation (insider trading,

restatement, and miscellaneous). The abnormal returns in each partition and are again tested

at the portfolio level and the abnormal return estimates for all three types are positive in the

2002-2008 partition. The lack of statistical significance for the insider trading and

miscellaneous partitions is likely due to a lack of power afforded by the portfolio design

(which provides 30 and 14 observations, respectively). The restatement partition has 50

observations which permits the tests to reach statistical significance at conventional levels.

Overall, Table 2 provides support for H1.

19

5.3 Cross-sectional regression analyses of firm-specific abnormal returns

Results shown in Table 2 indicate that non-target foreign firms listed on U.S.

exchanges experience a significantly positive increase in value when the SEC takes financial

reporting or insider trading actions against other non-U.S. firms.22

Given the significant

response at the portfolio level reported in Table 2, it is potentially informative to explore both

event- and firm-specific characteristics that may influence the magnitude of the market

response to SEC enforcement actions.

Country specific factors may contribute to the market value implications of SEC

enforcement actions. H2 posits that returns for cross-listed firms are conditioned by their

home legal environments such that greater returns accrue to firms with weak home country

origins. The empirical results are developed in two stages. In the first stage, we regress firm-

event specific (-1, 8) CARs of the non-target firms on firm-specific attributes (such as size

and listing type) and enforcement event-specific variables (meant to capture the egregiousness

of the violation) as well as size (to control for visibility) and listing status of the target firm.23

We also include year and firm fixed effects to control for residual dependencies. The first

stage purges abnormal return variance that can be ascribed to characteristics other than the

main variables of interest. The residual from the first regression, orthogonal CAR (OCARei),

is the dependent variable for the second stage regression. The second stage relies upon

indices used in La Porta, et al. (2006) (LLS, hereafter) to measure country environmental

factors that, under the bonding hypothesis, would be expected to condition abnormal returns.

22

We continue to report the results from the miscellaneous category for completeness. 23

Additional details describing the first stage regression variables and results are found in Appendix B. Results

are equivalent when exploring the relation in one stage.

20

We run separate regressions for the cross-listed and the foreign samples. Despite their

similarities in terms of non-U.S. incorporation, these two distinct groups may have

fundamental differences in the way that SEC actions are interpreted. Such differences may

arise because they likely vary in terms of the information environment, risk profile, and

fundamental reasons for choosing a U.S. listing (see footnote 13). We also allow for a

differential effect of insider trading, restatement, and miscellaneous investigations by further

separating regressions by type of enforcement. This procedure yields 6 distinct regressions.24

We regress OCAR on a set of indices developed by LLS (2006) that are intended to

capture legal origin, corruption, private enforcement, and various measures of the public

regulatory environment. The regression results are reported in Table 3. Consistent with H2,

the abnormal returns of the cross-listed firms exhibit a significant inverse relation to the

indices, indicating that those countries with the weakest financial reporting environments

serve to benefit the most from the expanding SEC oversight. The variables English Law and

Class Action in Panel A are binary, and facilitate simple interpretation. The returns to

countries of English legal origin (stronger legal systems) are less than their weaker legal

origin counterparts by a about .55%. Class action is more pertinent for explaining insider

trading enforcement return variation and shows that countries without class action at their

disposal reap an additional .39% over the 10-day return interval.

The bonding hypothesis implies that financial reporting enforcement-related returns

should be most sensitive to the Disclosure Requirements, Order, and Efficiency of Judiciary

24

Results of the first stage regression are shown in Appendix C which indicates that the overall significance of

the regression is high with F-values ranging from 8.33 to 31.01. The explanatory power as measured by

adjusted-R2 ranges from 1.66% to 2.80%, which is similar to prior research (Gleason, et al., 2008). Reported

results pool observations from the pre- and post-2001 time periods, but results are similar when restricted to the

post-2001 period.

21

indices.25

Panel B of Table 3 shows coefficient estimates that are significantly negative for

each of these variables indicating that firms from the weakest home legal environments garner

the greatest marginal benefit from the SEC enforcements. Insider trading enforcement return

variation should be most readily explained by Supervisor Characteristics (i.e. regulatory

characteristics), and Investigative Powers. This pattern is also supported by the negative

coefficients in Panel B.

As in other analyses, the miscellaneous partition results differ from the other two

partitions. Results indicate that the foreign firm sub-sample is less sensitive to home-country

characteristics (of the six indices that are significant for foreign firms, five are contrary to

expectations).

Overall, the negative relation between home country legal strength and abnormal

returns shown in Table 3 suggests that the firms from weak home legal environments

experience the greatest marginal benefit from increased SEC oversight, supporting H2 and the

legal bonding hypothesis. This is consistent with Miller (1999), Doidge, et al. (2004), and

Doidge (2004) who show that home country characteristics similarly condition the benefits

demonstrated at the time of the cross listing. Extending their work, our results distill the

effects of legal bonding in isolation by excluding the potential for selection problems or

simultaneous changes in liquidity, market segmentation, etc. that may be associated with the

cross-listing event.

6. Robustness and additional tests

6.1 Robustness tests of the abnormal return (CAR) specifications

25

The nature of the LLS (2006) index construction does not facilitate intuitive interpretation of the magnitude of

the coefficients. However, the sign and statistical significance enable assessment of whether the marginal benefit

of expanded SEC oversight is greater for firms in weaker home legal environments (H2).

22

Our specification of abnormal returns presumes that foreign firms do not have omitted

risk characteristics that are determinants of expected returns. In order to give closer

inspection to the potential impact of alternative specifications of abnormal returns, we follow

Armstrong, et al. (2010) by comparing returns during event period dates to randomly assigned

dates. If the abnormal returns in event periods significantly exceed those in non-event

periods, we have additional confidence that the results documented in this paper are not driven

by misspecification of expected returns.

In order to test abnormal returns around randomly assigned dates, we calculate the (-1,

8) 10-day abnormal returns to non-U.S. firms for each trading day from 1995 to 2008. We

then select 94 days at random, and repeat this sampling method 1,000 times. This approach

has the advantage of requiring no assumptions about the distributional properties of the

abnormal portfolio returns. Of the 1,000 portfolio returns using randomly assigned dates,

none reach portfolio returns as great as the .72 % achieved using actual event dates (simulated

p<.001). The average of the simulated returns is -.000041%. These simulation results

indicate that the market adjusted returns used in our primary tests are well specified. In

additional analyses (not tabulated) we stratify the simulation to ensure that the random sample

represents the year-by-year SEC enforcement sample and inferences are unchanged.

6.2 Intertemporal comparisons of market reaction to enforcement events

Consistent with legal bonding, results indicate that SEC enforcement actions increase

the security values of non-target cross-listed firms and that such returns are greatest in firms

from weak home legal environments. These results imply that a change in the expectation of

the SEC‟s enforcement policy is a contributor to the market‟s valuation of a firm. One would

23

expect that the initial enforcements in a new enforcement regime cause the greatest revisions

in the market expectations and consequently the greatest changes in valuation. Therefore, we

present portfolio-level intertemporal contrast results both for the entire sample and separately

for each of the three subsample (insider trading, restatements, and miscellaneous) of

enforcement actions. The separate analyses are presented because we expect that the

restatement enforcement activities represent the focus of the regime shift (see Table 1, Panel

A). We first identify the surge in SEC enforcement actions in the year 2002 as the beginning

of a new enforcement regime. Next we partition the sample based on time of occurrence (i.e.

the earlier period and later periods) and contrast the abnormal returns across the partitions.

The results, shown in Table 4, are directionally consistent for the full sample, insider trading,

and restatements. The return magnitude for restatements is about twice as large in the earlier

period. This supports the premise that the market partially impounds the valuation effects of

SEC financial reporting oversight at the time of earlier enforcement actions. The finding that

the more emphatic significant results are apparent in the restatement sample may reflect the

fact that this subsample has experienced the most dramatic increase in enforcement frequency

during the time period. These intertemporal comparisons, while directionally consistent with

our expectations, must be interpreted cautiously because of time-specific factors that may

affect the magnitude of market capitalization rates (e.g. interest rates, inflation rates, shifts in

inherent risk premia, etc.). For this reason, we suggest that the inter-temporal contrasts

reported in Table 4 may best be regarded as descriptive in nature. The comparisons indicate

the abnormal return magnitudes have declined from the earlier to the later period, consistent

with the market‟s anticipatory response to the later enforcement actions.

24

7. Conclusion

This paper assesses the valuation impact of SEC enforcement action on the share

prices of non-target cross-listed firms. We evaluate the premise that “legal bonding” of cross-

listed firms to the SEC‟s presumably more stringent regulations reduces investment risks and

capital costs, and consequently enhances market values of the equity shares of such firms.

Prior studies have concluded that the SEC has historically followed a “hands off” policy

toward cross-listed firms, thereby reducing or eliminating the potential valuation benefits of

legal bonding. However, more recent (post-2001) years witness a surge of SEC enforcement

actions against cross-listed firms. This more recent regime of active and aggressive SEC

enforcement enhances the credibility of the legal bonding premise, and also provides an

archive of data useful for evaluating the valuation impacts of the SEC enforcements on the

share prices of non-target cross-listed firms.

Our results indicate that in pursuing non-U.S. firms, the SEC actions confer significant

positive abnormal returns to cross-listed firms. Moreover, we show that the magnitudes of

such returns are associated with country-specific characteristics that measure the strength of

various aspects of a nation‟s financial system. Firms cross-listed from weak home legal

environments reap the greatest returns to the SEC action announcements. Ultimately, we

document that legal bonding is at least in part a driver of the cost of capital reduction for firms

who can stand up to increased scrutiny. Although prior research has had difficulty in

discriminating between bonding and avoiding explanations, results from this study cannot be

explained by market segmentation reductions, or other changes taking place at the time of the

secondary listing.

25

In addition to the bonding question, this study is relevant to concurrent debates in the

accounting policies literature. Our results are consistent with the intuition of Doidge et al.

2009, Leuz (2007), and Coffee (2007) who suggest that the Sarbanes-Oxley Act is not the

culprit for a slowdown in cross-listings in the US. A complementary explanation suggests

that as the legal landscape became more formidable for existing cross-listed firms, firms with

marginal reporting and governance quality who were considering a cross listing were

intimidated, leaving other countries‟ exchanges to cater to such lower quality firms intending

to cross-list (Piotroski and Srinivasan, 2007).26

This paper supports the sentiment of Ball and Shivakumar (2005), Burgstahler, et al.

(2006), Hail and Leuz (2006) and Holthausen (2009), Hail, et al. (2010) who stress that higher

quality reporting standards, such as IFRS, cannot independently supplant the institutional,

economic, legal, and regulatory factors that jointly contribute to reporting quality. The role

played by the enforcement of existing rules may actuate a key component of the regulatory

system.

More broadly, this research represents an important step in testing whether regulatory

enforcement provides benefits to markets and to whom such actions bestow the greatest gains.

Few studies have shown positive effects to specific regulatory actions that cannot be

explained by competitive effects.

Although the findings in this study document a positive impact of SEC enforcement

actions on the share values of non-target foreign firms, the implications for the wealth impact

of legal bonding in general should be drawn cautiously. The legal system to which foreign

26

In fact, of the 59 sample firms examined by Doidge et al. (2009) who delisted, more than 20% (12 firms) were

former targets of SEC enforcement (9) or class action lawsuits (3).

26

firms may adhere embraces a variety of regulatory protections with potential for positive and

negative impacts on security valuations.

For example, Licht et al. (2011), a study performed concurrently with our study,

examines capital market reactions to a U.S. Supreme Court decision that changed the civil

liability regime for U.S.-listed foreign issuers. This change, which denied the protection of

U.S. civil liability to investors in foreign located transactions, exhibits a positive association

with abnormal returns, suggesting that the reduction in potential liability actually benefitted

the value of U.S.-listed foreign firms, consistent with the interpretation that the previous civil

liability regime may have been too onerous.

The findings in Licht et al. (2011) that a reduction in potential civil liability has a

positive impact on share values does not necessarily conflict with our findings that increased

SEC enforcement activity is also associated with increased share values. Adhering to a legal

system with multiple aspects undoubtedly includes some legal components that presently are

overly burdensome, and other components that enable reduced capital costs and higher share

values. The empirical results in this paper provide emphatic support for the interpretation that

SEC enforcement actions have created shareholder value for non-target cross-listed firms in

the contemporary (post-2001) era.

27

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33

Appendix A: Portfolio Details

Enforcement Actions

The number of events is reduced from the sample of 122 enforcements to 94 (30 insider trading, 50

restatement, and 14 miscellaneous activities) because there are overlapping event periods and

potentially confounding events. We remove 7 insider trading, 15 restatement, and 3 miscellaneous

events due to multiple observations occurring on, or within 5 days of the same date. We also search

for information in the media (The Wall Street Journal and Google) to prevent the inclusion of events

that simultaneously occur with confounding market developments. Three observations (whose

portfolio abnormal returns average -.0004) are excluded. Untabulated results including these

observations are equivalent. Results are likewise unchanged when firms with earnings announcements

that take place within 5 days of the event date are included. In section 5.3, we use dummy variables to

capture the effect of adjacent enforcements that were discarded.

Portfolio Construction

We use the universe of foreign and cross-listed firms covered by CRSP to form equally-weighted

portfolios at each SEC action date as follows. We identify cross-listed firms via Compustat and CRSP

ADR and ADS company name headings, depositary bank websites (JP Morgan, Citigroup, and the

Bank of New York‟s ADR.com), and the SEC website. We identify foreign firms using the location of

their incorporation in Compustat. We require that firms have data for each of the 10 days of the event

period window (-1,+8). We remove any firms who have daily returns (event period CARs) greater

than 10% (40%) in absolute magnitude as these represent extreme performance that is likely driven by

other firm-specific factors. The average number of firms per event with the necessary information to

calculate abnormal returns is about 800 (the range is from 699 to 888). On average, 51.2% of the

portfolio is comprised of cross-listed firms.

Alternative Returns Specifications Alternative windows are tested ((0, 4), (-2, +2), and (-1, 5)) yield results that are statistically

significant with the same sign and comparable (daily return) magnitudes as the ones reported. Results

using raw, market-model adjusted, size-adjusted, and Fama-French three-factor event period models

yield estimates that are directionally consistent with the market model results and each is significant at

the .01 level. Market-model adjusted returns have been prepared for all analyses and are available

from the author upon request.

34

Appendix B: First Stage Regression The first stage regression uses the equation below. The type of violation dictates what variables are included (for

example PROFIT is only used for insider trading and REST_PCT_MKTVAL is only used for restatements).

Separate regressions are run for each type of violation and separated by listing status. Year and firm-level fixed

effects are included to mitigate potential dependencies in the residuals.

WHERE:

CARei= (-1, 8) Cumulative Abnormal Return27

LMKCAPi=natural log of the reacting firms‟ U.S. market capitalization at the beginning of the calendar

year

X_LIST_ENFORCEe = indicator equal to „1‟ when SEC action involves a cross-listed firm, „0‟

otherwise

DELAY_YRSe =the number of years that pass between the first illegal action and the announcement date

LMKCAP_ENFORCEe = natural log of the enforcement firm market capitalization at the beginning of

the calendar year (when multiple firms are involved, the largest firm is used)

IT_CONFOUNDe = indicator equal to „1‟ when another SEC non-U.S. insider trading action takes place

within ten calendar days of the enforcement action, „0‟ otherwise

MERGERe = indicator equal to „1‟ when SEC action involves a merger or acquisition, „0‟ otherwise

SETTLEDe =indicator variable equal to „1‟ when the case was settled at the time of the announcement

PROFITe =average illegal profits made by corporate insiders

REST_CONFOUNDe = indicator equal to „1‟ when another SEC non-U.S. restatement related

enforcement action takes place within ten calendar days of the enforcement action, „0‟ otherwise

ADVERSEe = indicator equal to „1‟ when restatement has a detrimental effect on net income, „0‟

otherwise

FRAUDe = indicator equal to „1‟ when SEC action charges accused firm with fraud, „0‟ otherwise

REST_PCT_MKTVALe =restatement scaled by market cap at the beginning of the calendar year

FINEe=the U.S. dollar amount of any fines imposed by the SEC

εei=the residual; this is also OCARei which becomes the starting point for the second stage analyses

Year Fixed Effects= dummies for each year

Firm Fixed Effects=dummies for each firm

27

Note: e and i subscripts denote event „e‟ and firm „i‟, respectively

35

Appendix C: Results of First Stage Regression This table provides the results of the first stage regression of the variables in Appendix B. We delete any observations

whose 10-day CAR is greater than three standard deviations from the portfolio mean, and control for residual

dependencies using year and firm level fixed effects. White‟s (1980) t-statistics using heteroskedasticity-consistent

standard errors are reported below coefficient estimates. All coefficients are multiplied by 100 for ease of exposition.

Insider Trading Restatement Miscellaneous

Foreign Cross Foreign Cross Foreign Cross

Intercept .013 -.073***

.031***

.056***

-3.564***

-8.216***

(0.51) (-3.18) (3.76) (7.55) (-5.24) (-11.22)

LMKCAP .000***

.000

.000***

.000***

.000**

.000***

(2.68) (1.38) (6.08) (2.78) (2.18) (2.93)

X_LIST_ENFORCE 3.377 -.085***

-.252 .428**

-2.981***

-1.632***

(1.25) (-3.41) (-1.17) (2.28) (-5.13) (-2.67)

DELAY_YRS -.080 .012***

.083***

.090***

-0.000 0.4318***

(-0.26) (4.25) (2.68) (3.24) (0.01) (5.85)

LMKCAP_ENFORCE -.437 .028***

-.375***

-.496***

0.9205***

1.136***

(-0.55) (3.82) (-3.32) (-4.96) (6.97) (7.84)

IT_CONFOUND .060 .044***

-1.080***

.070

(0.06) (4.85) (-2.6) (0.19)

MERGER .049 -.032

***

(0.07) (-4.73)

SETTLE -.007 -.022

***

(-0.01) (-3.52)

AVE_PROFIT -.000 -.000

***

(-0.98) -(4.52)

REST_CONFOUND

-.011

*** -.220

(-5.34) (-1.19)

ADVERSE

-.003 -.589

*

(-0.69) (-1.82)

FRAUD

-.008

*** .143

(-4.18) (0.84)

REST_AS_PCT_MKVAL

.020

*** 2.184

***

(3.93) (5.06)

FINE

-.000***

-.000***

(-6.25) (-5.33)

F-value 8.33***

10.72***

16.58***

23.04***

20.31***

31.01***

Adj-R2 1.73% 2.58% 1.66% 2.53% 2.12% 2.80%

N 9,969 8,521 18,631 16,844 4,672 5,383

Year & Firm Fixed

Effects? Yes Yes

Yes Yes

Yes Yes

36

Figure 1: Portfolio Returns by Event Type This figure shows the market adjusted returns to the non-target portfolio of firms around the announcement of

enforcement actions by the SEC against non-U.S. firms. The 94 data points are represented by different symbols

which denote enforcement type.

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

1995 1998 2001 2004 2006

Mar

ket

Ad

just

ed

Re

turn

Time

Portfolio Returns by Event Type

Insider Trading

Restatements

Other

37

Figure 2: Daily Abnormal Return over Event Window This figure shows the market-adjusted daily returns to the portfolio of non-target non-U.S.

firms around the announcement of enforcement actions by the SEC again non-U.S. firms.

-0.20%

-0.10%

0.00%

0.10%

0.20%

0.30%

0.40%

0.50%

0.60%

0.70%

-14 -10 -6 -2 2 6 10 14

Ab

no

rmal

Re

turn

s

Time

Daily AR over Event Window

38

Table 1: Sample Description Cross-listed (foreign) firms represent firms domiciled outside the U.S. with (without) a home market listing in

addition to the U.S. listing. Non-U.S. firms are defined as the union of cross-listed and foreign firms. The left

hand side of Panel A describes the SEC enforcement of insider trading, restatement, and miscellaneous

enforcement actions, respectively, for non-U.S. firms.a We split the data into two equal time periods (1995-2001

and 2002-2008). The right hand side of Panel A partitions the non-U.S. enforcements based upon the target firms‟

listing type. Panel B compares the representation of non-U.S. firms under SEC jurisdiction (left side) to the

representation of non-U.S. firms pursued by the SEC (right side). On the left side, the percentage of SEC

regulated markets that are foreign, cross-listed, and non-U.S. are provided. The data is available from each

exchange and is cross validated via the SEC‟s website (as of April 2010). OTC firms that are exempt from SEC

requirements are excluded. On the right side, the percentage of all SEC enforcements that relate to foreign, cross-

listed, and non-U.S. firms are provided. The data in Panel B is restricted to the 2002-2008 period, which drops 25

actions. The denominator (156 for insider trading and 575 for restatements) comes from Panel A. The 17 firms

from the miscellaneous category are excluded from this Panel B because the comparable domestic enforcement by

the SEC in this category is not clearly defined.

Panel A: SEC Enforcements

Time Partition

Listing Type Partition

1995-2001 2002-2008

Total

(1995-2008)

Exchange

Listings OTC Other

Insider trading Cross-Listed 15 14 29 28 1 0

Foreign 3 7 10 8 2 0

Non-US 18 21 39 36 3 0

Domestic 159 135 294

Total 177 156 333

Restatements Cross-Listed 4 30 34 32 2 0

Foreign 0 32 32 23 7 2

Non-US 4 62 66 55 9 2

Domestic 200 513 713

Total 204 575 779

Miscellaneous Cross-Listed 4 8 12 12 0 0

Foreign 1 4 5 0 3 2

Non-U.S. 5 12 17 12 3 2

Total Sample Cross-Listed 23 52 75 72 3 0

Foreign 4 43 47 31 12 4

Non-US 27 95 122 103 15 4

Panel B: Representation of Non-U.S. firms in SEC Regulated Markets

SEC REGULATED MARKETS SEC ENFORCEMENTS

Total Exchange

Listings

OTC

Listings Total

Exchange

Listings

OTC

Listings Other

Insider Trading

Cross-List 10.0% 5.6% 16.8% 8.97% 8.33% 0.64% 0.00%

Foreign 7.8% 5.2% 11.9% 4.49% 3.21% 1.28% 0.00%

Non-US 17.8% 10.7% 28.7% 13.46% 11.54% 1.92% 0.00%

Restatements

Cross-List 10.0% 5.6% 16.8% 5.04% 4.70% 0.35% 0.00%

39

Foreign 7.8% 5.2% 11.9% 5.57% 4.00% 1.22% 0.35%

Non-US 17.8% 10.7% 28.7% 10.61% 8.70% 1.57% 0.35% a The SEC has brought more insider trading cases against defendants over the sample period than reported above.

We confine the sample to cases in which the SEC charges a firm insider because we are interested in pursuit of

firms. Therefore, we exclude cases in which the insiders are unassociated with any company (for example, see

http://www.sec.gov/litigation/litreleases/lr19212.htm). Roughly 40% of all insider trading cases fall into this

category. We exclude 236 firms from the restatement sample because we cannot identify the firms, so it is not

clear whether they are or are not non-U.S. firms. We exclude market manipulation, broker-dealer, touting,

“ponzi” and other localized violations involving non-U.S. firms from all analyses because they are not

representative of exchange-listed non-U.S. firms (for an exclusion example, see

http://www.sec.gov/litigation/litreleases/2006/lr19949.htm).

40

Table 2: Market Returns around Announcement Dates This table provides the market-adjusted returns to portfolios of firms centered on announcement dates of SEC enforcement of non-U.S.

firms. Unless noted otherwise, portfolio membership includes all foreign and cross-listed firms with requisite stock price data to compute

abnormal returns. Standard errors and t-statistics treat each event as one observation (similar to Fama and MacBeth (1973)).

Panel A: Non U.S. Firm Returns

Market Adjusted Returns

1995-2001

2002-2008

All Years

Window N Return t

N Return t

N Return t

(-14, -2) 21 -1.09%***

-3.14

73 .08% 0.61

94 -.18% -1.26

(-1, 8) 21 0.03% 0.05

73 .89%***††† 4.66

94 .72%***

3.45

(9, 20) 21 -0.21% -0.49

73 .22% 1.15

94 .12% 0.69

Panel B: By Listing Type 10-day Market Adjusted Returns

Foreign (-1, 8) 21 0.34% 0.67

73 0.80%***

4.28

94 0.70%***

3.04

Cross-listed (-1, 8) 21 -0.16% -0.28

73 1.01%***††† 4.85

94 0.75%***

3.51

Panel C: By Type of Violation

10-day Market Adjusted Returns Insider Trading (-1, 8) 12 0.36% 0.67

18 0.41% 1.25

30 0.39% 1.37

Restatements (-1, 8) 5 1.04% 0.82

45 0.93%***

3.35

50 0.94%***

3.42

Miscellaneous (-1, 8) 4 -1.79% -1.67

10 1.60%* 1.81

14 0.63% 0.79

Panel D: By Legal Origin

10-day Market Adjusted Returns English Legal Origin (-1, 8) 21 0.16% 0.31

73 0.85%***

2.87

94 0.69%***

2.7

Other Legal Origin (-1, 8) 21 0.06% 0.13

73 0.93%***††† 4.37

94 0.74%***

3.65 *, **, ***

denotes significance at the 10%, 5%, and 1% level for a two-tailed test, respectively. †, ††, †††

denotes significantly different from within panel row at the 10%, 5%, and 1% level for a two-tailed test, respectively.

41

Table 3: Regression Analysis of OCAR This table reports results of separate regressions for foreign and cross-listed firms by type of SEC action. Each

variable show on the left below is used as the independent variable in a separate regression and is defined in LaPorta

et al. (2006, Table 1). The dependent variable is the residual from the first stage (market-adjusted OCAR over the

(-1, 8) window, see Appendix B and C). The hypothesized sign (in parentheses) relates to the cross-listed firms. All

coefficients are multiplied by 100, and standard errors appear in parentheses below.

INSIDER TRADING RESTATEMENTS MISCELLANEOUS

Foreign Cross-Listed Foreign Cross-Listed Foreign Cross-Listed

Panel A: Legal Structures

English Law

Indicator

0.386 (-) -0.225 0.288* (-) -0.547*** -0.512 ? -0.154

(1.45)

(-1.13) (1.75)

(-4.24) (-1.5)

(-0.58)

Class Action

Indicator

-0.057 (-) -0.398** 0.557 (-) -0.217*** -0.450 ? -0.074

(-0.09)

(-2.12) (1.47)

(-1.83) (-0.36)

(-0.30)

Panel B: Country Indices* Disclosure

Requirements 0.966 ? -1.307** 0.59 (-) -2.085*** -1.175 ? -0.773

(1.1)

(-2.13) (1.08)

(-5.54) (-1.05)

(-0.96)

Liability 1.179* ? -0.025 0.684 (-) -0.307 -0.996 ? 0.557

(1.8)

(-0.07) (1.71)

(-1.32) (-1.19)

(1.13)

Rule Power 0.964** (-) 0.645*** 0.464* (-) -0.134 -0.843 ? -0.150

(2.23)

(3.07) (1.75)

(-1.02) (-1.53)

(-0.53)

Orders -0.468 ? -0.207 -0.173 (-) -0.418*** -0.052 ? -0.047

(-1.05)

(-1.02) (-0.62)

(-3.27) (-0.09)

(-0.17)

Private Enforcement 1.422 (-) -0.531 0.786 (-) -1.137*** -1.287 ? 0.720

(1.76)

(-0.99) (1.59)

(-3.35) (-1.24)

(1.01)

Public Enforcement -0.165 (-) -0.578 -0.01 (-) -0.408* -0.500 ? -0.074

(-0.2)

(-1.59) (-0.02)

(-1.79) (-0.48)

(-0.15)

Anti-Director Rights 0.1 ? -0.043 0.107 ? -0.114*** -0.152 ? 0.025

(0.9)

(-0.64) (1.54)

(-2.71) (-1.06)

(0.28)

Investigative Powers -0.624 (-) -0.473** -0.008 (-) -0.248* 0.054 ? -0.226

(-0.9)

(-1.92) (-0.02)

(-1.6) (0.06)

(-0.69)

Efficiency of

Judiciary -0.147 (-) -0.102* -0.358*** (-) -0.108*** 0.081 ? 0.125*

(-0.68)

(-1.88) (-2.76)

(-3.11) (0.29)

(1.73)

Investor Protection 0.073 (-) -0.033 0.055 (-) -0.08*** -0.083 ? 0.033

(1.32)

(-0.88) (1.6)

(-3.34) (-1.17)

(0.66)

Supervisor

Characteristics -0.831 (-) -0.861*** -0.357 ? 0.416** 0.637 ? -0.051

(-0.92)

(-3.05) (-0.66)

(2.36) (0.56)

(-0.14)

Panel C: Corruption Index

Corruption 0.235** ? -0.078* 0.078 ? -0.088*** -0.002 ? 0.001*

(2.36)

(-1.64) (1.28)

(-2.82) (-1.57)

(2.06)

Panel D: Country Fixed

Effects Regressions

R2 0.0041

0.0076 0.0029

0.0043 -0.001

0.016

F 2.06***

2.4*** 2.48***

2.58*** 0.870

2.59***

Significant Effects 3/40

2/47 0/37

33/48 0/38

1/48

N 9,968

8,618 18,631

17,094 5,384

4,728 *, **, ***

denotes significance at the 10%, 5%, and 1% level for a two-tailed test, respectively.

42

Table 4: Declining CAR Magnitude This table provides the results of Wilcoxon rank sum nonparametric tests

for the equivalence of the temporal first and second (equally numbered)

halves of portfolio returns by type of enforcement.

Early Late Difference p-value

Insider Trading 0.46% 0.28% 0.18% .35

Restatements 1.32% 0.65% 0.67% .07

Miscellaneous 0.86% 1.44% -0.58% .28

All 0.77% 0.66% 0.11% .38