The foreign corrupt practices act: How investors respond when violation severity and corresponding penalty (mis)match

The Foreign Corrupt Practices Act (FCPA) has become a major focus for corporations, the Securities and Exchange Commission (SEC), and the Department of Justice (DOJ), as indicated by the dramatic increase in the number of FCPA enforcement actions and the level of civil and criminal penalties. Prior regulatory practice shows that the SEC and the DOJ struggle not only to evaluate the severity of a company's FCPA violation, but also to establish the penalty amount. Given the difficulty in assessing penalties, the severity of a company's FCPA violation at times appears mismatched with the size of the penalty. Leveraging signaling theory, this study predicts and finds that when a company's FCPA violation severity and the size of the penalty imposed are mismatched, investors experience ambiguity in assessing the company's future prospects and, in effect, are more likely to give the company the benefit of the doubt. In this case, investors' company risk assessments are dampened, and they show a higher willingness to maintain their investment in the company. However, when the severity of the company's FCPA violation and the penalty amount match, investors are less likely to experience ambiguity, which leads to higher company risk assessments and a lower willingness to maintain their investment in the company. In addition, the combination of a more severe FCPA violation and high penalty amount results in the highest risk assessment and lowest willingness to maintain the investment. These results provide ethical and practical considerations that regulatory bodies should weigh in evaluating sanctions.