I study the impact of an SEC investigation (as captured by Accounting and Auditing Enforcement Releases, or AAERs) on a firm's cost of equity capital. AAERs are often used in accounting literature as a proxy for fraudulent financial reporting. Fraudulent financial reporting should lead to an increase in cost of equity capital as a firm's future cash flows become less certain. Several factors could contribute to the increase in risk surrounding future cash flows, such as renegotiation of contracts with the firm's suppliers and lenders, or a decrease in the reliability of management disclosures. Cross-sectional variation likely exists in the relation between receiving an AAER and firms' cost of equity capital. One attribute of that variation may be the 'severity' of the AAER. Using shareholder lawsuits, management turnover, core earnings and auditor censure, I attempt to correlate the severity of the AAER with changes in cost of equity capital. The economic consequences of accounting-related enforcement actions as captured by my study should be of interest to analysts selecting a discount rate to apply to future earnings in determining target prices, regulators interested in the impact of regulatory action and the effectiveness of the SEC, and academics interested in measuring the impact of accounting-related government regulation and the performance of cost of equity capital measures in capturing expected changes in discount rates.;Overall, I find that my study provides evidence of changes in cost of equity capital for firms targeted by an SEC AAER on the date the investigation is first made public. Multivariate tests of changes in cost of equity capital surrounding AAER issue dates do not yield changes in cost of equity capital that differ from the corresponding change for a matched sample of firms. Furthermore, I do not find an association between the 'severity' of an AAER and the change in cost of equity capital for sample firms.
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