Critic Paper

Submitted By raenef110
Words: 911
Pages: 4

In the paper “The Financial and Market Effects of The Securities and Exchange Commission’s (SEC) Accounting and Auditing Enforcement Releases”, Feroz, Park, and Pastena examined 188 firms that have disclosed financial disclosure violations from April 1982 to April 1989 (Feroz, Park & Pastena, 1991). The authors analyzed the impacts resulted from the financial disclosure violations. In this review of the paper, I provided a summary of the original paper followed by critical review of the paper using the follow criteria: the validity of framework, the validity of assumptions and the appropriateness of evidences.

The authors explored three questions related to the SEC’s account enforcement program: (1) what accounting and auditing issues SEC enforce on, (2) what consequences did the SEC’s action brought to the market, 3) how did investors and other market agents react to the SEC’s investigations? Based on the documents examined by the authors, the “goals of the SEC’s accounting-based enforcement activities are to anticipate emerging reporting problems and to maintain the credibility of the disclosure system” (Feroz, Park & Pastena, 1991). The disclosure of reporting financial violations has negative effect on target firm’s market performance and managements often suffered negative consequences. Additionally, the largest accounting firms suffered less penalties than the small firms based on the documents analyzed from April 1982 to April 1989. The authors concluded that the SEC enforcements are viable actions to achieve its goals of “maintaining the credibility of financial statements and preventing the erosion of accounting principles” (Feroz, Park & Pastena, 1991).

The framework the authors used in the paper by Feroz, Park, and Pastena was first they identified the objectives of SEC’s enforcement program. Second, they described the process of enforcement. Then, they analyzed the effects of the investigations on targets’ financial statements, executives, auditors, and stock market responses. Based on the effect of the investigations, they concluded that SEC’s investigations were effective in ensuring credibility of financial statement and preventing erosion of accounting principles. Throughout the paper, the authors demonstrated effective logical flow of the process and supported their arguments statement with strong documented evidence. However, the framework over focused on the effect of SEC’s investigations, which leads to authors’ invalid assumption of SEC’s investigations dictating the market prices of targeted firm.

In Feroz, Park, and Pastena’s paper, the following phase was stated: “the ability of SEC investigations to affect targets’ market prices indicates that the agency possesses a viable sanction because managers have market-based incentives to avoid investigations.” This demonstrated the critical assumption of the target’s negative stock performance during investigation was because of SEC’s investigations. Although the impacts of SEC investigation on targets’ organization and stock performance was significant, the impacts can also be caused by other market factors such as recession or political conflict. Without comparing the targets’ decline to overall market, it is invalid to conclude that negative market performance was resulted from SEC’s investigation. Therefore, the conclusion that SEC’s enforcement can maintain credibility and prevent the erosion of accounting principles is improper.

The evidences provided in the paper are insufficient to support authors claim. In the paper the authors stated that largest accounting firms suffered less penalties than the small firms based on the experiment tested from April 1982 to April 1989. However, the outcome of empirical test is not reasonable to apply today’s world. For example, Arthur Andersen LLP was one of the big five accounting firms, and they became bankrupted in 2002 due to criminal charges related to the auditing the company of Enron. For