Political connections, SEC enforcement and accounting quality

My dissertation examines whether firms and executives who have built political connections through political contributions and lobbying face lower enforcement costs by the Securities and Exchange Commission (SEC). I discuss model alternative mechanisms that could produce such a result. There may be an exchange of favors between firms and politicians, where firms provide politicians with the political contributions they need in order to be re-elected and, in exchange, these politicians exert pressure on the SEC to avoid investigation and prosecution of these firms. Political expenses may also lead to a lower probability of investigation and prosecution in the absence of this interference by politicians on the agency's activities. In fact, in a context where the benefits from financial misreporting are unknown to the SEC and firms with larger benefits fight the agency's decisions harder to avoid disgorgement, firms may use political contributions to signal these benefits. I show that these two alternative mechanisms lead to similar predictions: a positive association between political contributions and low accounting quality and misreporting and lower probabilities of investigation and prosecution for politically connected firms. Consistent with these predictions, I find that firms with low accounting quality have greater political expenditures on average. They increase these expenditures during the period of the misreporting and are more likely to target them to the Congressional Committees with stronger ties to the SEC during this period. This evidence suggests that these firms may be using lobbying and political contributions to lower enforcement costs. Moreover, the behavior of political expenditures may improve our ability to predict misreporting. In order to test the effectiveness of these payments, I examine three different stages of the enforcement process: the review of filings by the Division of Corporation Finance and the subsequent issuance of comment letters, the decision to begin an enforcement action against the firm or its executives and the monetary and non-monetary regulatory penalties faced by respondents in the enforcement action. I find some evidence that politically connected firms are less likely to have a restatement initiated by a comment letter from the SEC, are less likely to be involved in an SEC enforcement action and face lower penalties on average.