THE INDIRECT ECONOMIC PENALTIES IN SEC INVESTIGATIONS OF UNDERWRITERS

We document that an SEC investigation of an underwriter imposes indire ct penalties on the underwriter and its past clients, particularly IPO clients. Targeted underwriters experience large declines in IPO marke t share and increased regulatory scrutiny and client risk after an SEC investigation is announced. Stock prices of clients decline significa ntly. We attribute these effects to a sudden deterioration in the valu e of the underwriter's reputation capital, suggesting that the general assumption in prior IPO research that underwriter reputation is stati onary may be inappropriate. Our results also suggest that the SEC's po wer to institute investigations should be considered when designing op timal securities regulation. (C) 1998 Elsevier Science S.A. All rights reserved.