Fraudulent Financial Reporting and the Consequences for Employees

Abstract

We examine employment effects, such as wages and employee turnover, before, during, and after periods of fraudulent financial reporting. To analyze these effects, we combine U.S. Census data with SEC enforcement actions against firms with serious misreporting (“fraud”). We find, compared to a matched sample, that fraud firms’ employee wages decline by 9% and the separation rate is higher by 12% during and after fraud periods. Employment growth at fraud firms is positive during fraud periods and negative afterward. We explore the heterogeneous effects of fraudulent financial reporting, including thin and thick labor markets, bankruptcy and non-bankruptcy firms, worker movements, pre-fraud wage levels, and period of hire. Negative wage effects are particularly severe in thin labor markets, for bankrupt, fraud firms, and lower wage employees. However, some negative wage effects occur across these sample cuts, indicating that fraudulent financial reporting appears to create meaningful and prevalent consequences for employees. We discuss how our results can be consistent with channels such as labor market disruptions, punishment, and stigma.