The indirect economic penalties in SEC investigations of underwriters1Our thanks to Sanjai Bhagat, Mo Chaudhury, Andy Chen, Jay Ritter, Wayne Shaw, Cliff Smith (editor), Michael Vetsuypens, an anonymous referee, and workshop participants at Southern Methodist University and Tulane University for valuable comments. The financial support of the Cox School of Business at the Southern Methodist University and the Center for Finance and Accounting Research at UNC-Chapel Hill are gratefully acknowledged.1
We document that an SEC investigation of an underwriter imposes indirect penalties on the underwriter and its past clients, particularly IPO clients. Targeted underwriters experience large declines in IPO market share and increased regulatory scrutiny and client risk after an SEC investigation is announced. Stock prices of clients decline significantly. We attribute these effects to a sudden deterioration in the value of the underwriter's reputation capital, suggesting that the general assumption in prior IPO research that underwriter reputation is stationary may be inappropriate. Our results also suggest that the SEC's power to institute investigations should be considered when designing optimal securities regulation.