When do corporate penalties for financial misreporting enhance long-term firm value?

Abstract

Securities regulators frequently punish firms for their managers’ misreporting. They argue that this would enhance firms’ long-term value by mitigating underinvestment in compliance mechanisms, such as internal controls over financial reporting. Opponents of corporate penalties argue that the penalties would harm the very same investors already harmed by misreporting. We evaluate these arguments in a model with a capital market-oriented misreporting manager and a board of directors that invests in internal control quality. We identify governance transparency and board dependence as key factors that moderate the firm-value effects of corporate penalties. Internal control underinvestment occur..