DP8058 | Regulatory Sanctions and Reputational Damage in Financial Markets

Publication Date

18/10/2010

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Abstract

We study the impact of the announcement of enforcement of financial and securities regulation by the UK?s Financial Services Authority and London Stock Exchange on the market price of penalized firms. Since these agencies do not announce enforcement until a penalty is levied, their actions provide a uniquely clean dataset on which to examine reputational effects. We find that reputational sanctions are very real: their stock price impact is on average ten times larger than the financial penalties imposed. Furthermore, reputational losses are confined to misconduct that directly affects parties who trade with the firm (such as customers and investors). The announcement of a fine for wrongdoing that harms third parties has, if anything, a weakly positive effect on stock prices. Our results have significant implications for understanding both corporate reputation and regulatory policy.