Stock market reactions to regulatory investigations: Evidence from options backdating

Option backdating practices have resulted in broad regulatory scrutiny, formal inquiries by federal authorities, and internal investigations by companies. In this paper, we investigate stock market reactions to option backdating probe announcements. For the 245 implicated companies, we detect negative abnormal stock returns, which are modest for internal investigation, larger for SEC probes, and the most severe for Department of Justice investigations. We also find that the market reaction is more negative for companies with higher stock price volatility, less effective corporate governance, and lower quality of financial statements. Results suggest that option backdating practices demonstrate weak corporate governance and financial reporting, and regulatory investigations of such practices are value-relevant as reflected in stock prices.