Forbearance in Oversight - Evidence from SEC Investigations around Natural Disasters

Abstract

This study analyzes and finds that the Securities and Exchange Commission’s (SEC’s) selection and investigation process is guided by a so far unexplored mechanism, namely, forbearance. To empirically test whether the SEC practices selective non-enforcement, we exploit regionally dispersed and time-varying natural disasters that affect firms, but not the responsible SEC regional offices. First, we find that non-disaster-affected SEC regional offices open fewer investigations and increase the length of investigations after firms are hit by a natural disaster. This finding does not appear to be explained by travel limitations in disaster-affected regions. Second, the SEC’s forbearing behavior appears justifiable because natural disasters adversely affect a region’s GDP and the individual firm’s financial health and R&D investments. Third, we find that firms do not seem to abuse the SEC’s forbearing behavior. That is, we only find temporary changes in disclosure quality and accruals and no change in the probability of restatements and AAERs. Overall, our results imply that the SEC applies forbearance and that firms are not taking advantage of the SEC’s welfare stance.