Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

The politics of SEC enforcement or is it data mining?

Last month, Jonas Heese published a paper on “Government Preferences and SEC Enforcement” which purports to show that the US Securities and Exchange Commission (SEC) refrains from taking enforcement action against companies for accounting restatements when such action could cause large job losses particularly in an election year and particularly in politically important states. The results show that:

  • The SEC is less likely to take enforcement action against firms that employ relatively more workers (“labour intensive firms”).
  • This effect is stronger in a year in which there is a presidential election
  • The election year effect in turn is stronger in the politically important states that determine the electoral outcome.
  • Enforcement action is also less likely if the labour intensive firm is headquartered in a district of a senior congressman who serves on a committee that oversees the SEC

All the econometrics appear convincing:

  • The data includes all enforcement actions pertaining to accounting restatements over a 30 year period from 1982 to 2012: nearly 700 actions against more than 300 firms.
  • A comprehensive set of control variables have been used including the F-score which has been used in previous literature to predict accounting restatements.
  • A variety of robustness and sensitivity tests have been used to validate the results

But then, I realized that there is one very big problem with the paper – the definition of labour intensity:

I measure LABOR INTENSITY as the ratio of the firm’s total employees (Compustat item: EMP) scaled by current year’s total average assets. If labor represents a relatively large proportion of the factors of production, i.e., labor relative to capital, the firm employs relatively more employees and therefore, I argue, is less likely to be subject to SEC enforcement actions.

Seriously? I mean, does the author seriously believe that politicians would happily attack a $1 billion company with 10,000 employees (because it has a relatively low labour intensity of 10 employees per $1 million of assets), but would be scared of targeting a $10 million company with 1,000 employees (because it has a relatively high labour intensity of 100 employees per $1 million of assets)? Any politician with such a weird electoral calculus is unlikely to survive for long in politics. (But a paper based on this alleged electoral calculus might even get published!)

I now wonder whether the results are all due to data mining. Hundreds of researchers are trying many things: they are choosing different subsets of SEC enforcement actions (say accounting restatements), they are selecting different subsets of companies (say non financial companies) and then they are trying many different ratios (say employees to assets). Most of these studies go nowhere, but a tiny minority produce significant results and they are the ones that we get to read.


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