Punish one, teach a hundred? A study on the failure of the indirect deterrence effects of regulatory punishments

Abstract

The supervision of listed firms plays an important role in improving the quality of listed firms and the efficiency of resource allocation in the capital market. We study the effectiveness and realisation mechanisms of the indirect deterrence effects of regulatory punishments from the perspective of executives’ interlock. We find that the financial misstatement decreases for punished firms while increases for innocent firms which interlock with punished ones through punished executives after regulatory punishments. Further analyses indicate that punished executives are more likely to leave these innocent firms after being punished. But independent directors actively saying ‘no’ are more likely to resign from these innocent firms and auditors do not make adjustment to audit decisions for the rising engagement risk. Therefore, the aforementioned negative adjustments exceeding positive adjustments of corporate governance results in the failure of the indirect deterrence effects of regulatory punishments, finally leading to these innocent firms’ value being impaired.