Catch Me If You Can: Financial Misconduct Around Corporate Headquarters Relocations
Queen’s School of Business
Queen’s School of Business; HKUST
July 7, 2015
We find that misreporting activities and aggressive earnings management positively associate with the probability of headquarters relocation, after controlling for economic factors and high dimensional fixed effects. Firms with higher probability of conducting financial fraud are more likely to move to a location where the regional SEC office has less intense scrutiny against local firms, and such firms tend to provide no explicit reason for relocations. Moreover, using shocks to local SEC enforcement intensity, we find that the probability of headquarters relocation increases after the shock for firms with higher likelihood of financial misconduct. Finally, a propensity matching estimation shows that relocated firms are more likely to continue conducting fraud and restate previously reported earnings than firms that do not relocate. However, they are not more likely to be caught by either regulators or shareholders. Our results provide new evidence on the fraudulent motives for headquarters relocations and suggest that the intensity of local SEC scrutiny has a direct impact on firm’s financial misconduct and location decisions.
Catch Me If You Can: Financial Misconduct Around Corporate Headquarters Relocations – Introduction
Approximately two percent of public firms relocate their headquarters to a different state or Metropolitan Statistical Area (MSA) each year. These infrequent corporate actions have immense consequence for a company’s short-term continuity and attract the attention of the business world and the company’s key stakeholders. In spite of this, headquarters relocation has been generally overlooked in the finance and accounting literature.
Economic geography literature suggests that the choice of headquarters location is a tug-of-war between the corporate need to be in proximity to customers, high-level professional services and infrastructure, and motives for cost and tax savings. Headquarters relocation can thus add value to a firm and falls into a firm’s value creation agenda. Moving headquarters also entails substantial costs. Major costs range from property acquisition and business interruptions to employee relocation, hiring, and training.2 A value-maximizing manager should weigh benefits against costs to strategically locate headquarters. However, agency theories suggest that managers, at times, make corporate decisions not to maximize firm value but to extract private benefits. Therefore, headquarters location may not be an outcome of optimal corporate action but rather a result of managers’ self-serving motives. There is evidence that locations for corporate events such as shareholder meetings are chosen in reflection of opportunistic behavior of managers (Li and Yermack, 2014). We are interested in whether firms relocate for reasons that relate to financial misconduct.
A number of studies examine the origins and causes of corporate financial misconduct, and find that they are related to incentive-based compensation (Cheng and Warfield, 2005; Burns and Kedia, 2006; Efendi, Srivastava, and Swanson, 2007), investor beliefs about industry prospects (Povel, Singh, and Winton, 2007; Wang, Winton, and Yu, 2010), and peer effects and social norms (Koh, Kedia, and Rajgopal, 2015; Parsons, Sulaeman, and Titman, 2015). Economic theories of crime and punishment suggest that intense regulatory monitoring and enforcement actions should deter corporate executives from committing misconduct (e.g. Becker, 1968). Empirical studies document that detected financial misconduct imposes tremendous costs to the management and the board of directors (Srinivasan, 2005; Desai, Hogan, and Wilkins, 2006; Fich and Shivdasani, 2007; and Karpoff, Lee, Martin, 2008). Consistent with this, Kedia and Rajgopal (2011) suggest that SEC enforcement by regional offices has a deterrence effect on corporate misconduct. The focus of this paper is not to necessarily add to the debate on the causes and incentives for managers to commit misconduct. Instead we ask the question: are firms potentially committing financial misconduct more likely to relocate headquarters to avoid being caught by regulators?
If regulatory enforcement intensity creates dis-utility to corporate managers, incentives for headquarters relocation may arise from scrutiny avoidance. However, a firm’s strategy of avoiding enforcement actions through relocations only works if there are frictions associated with regulatory monitoring. Such frictions could arise from two sources. The first is that enforcement actions are mostly conducted by SEC regional offices overseeing the firms’ jurisdiction states. The cross-sectional variation in enforcement intensity across regional offices provides opportunities for firms to gain through relocation. The second is that enforcement is costly and regulators are constrained by their budget and staffing resources. The SEC home and regional offices need to strike a balance between their resource constraints and enforcement activities undertaken. Headquarters relocations disrupt the equilibrium of monitoring and increase the costs for regulators to detect and investigate fraudulent activities, and thus create an opportunity for firms to alter the likelihood of getting caught by regulators. We therefore posit that firms committing financial misconduct are more likely to move, especially away from local regulators that impose intense enforcement to areas with fewer enforcement actions by the local SEC office.
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