Regulators, investors, and academics generally agree on the main goal of strong SEC oversight: to improve financial reporting, which helps markets allocate capital and promotes market efficiency. But this goal prompts a question that matters for corporate governance and long-run growth. Does stronger SEC oversight and better financial reporting constrain managers from “managing the numbers” and their willingness to take risks? In a new paper, we examine that question.

Why the Effect Could Go Either Way

Risk-taking, such as investing in R&D, is central to value creation. Yet managers do not experience risk the same way diversified shareholders do. A failed project can damage a manager’s reputation, compensation, job security, and career.

On the one hand, strong oversight could improve governance by limiting opportunism and making measures of company performance more reliable. Complete and accurate information reduces agency problems and may lead to more efficient risk-taking because outsiders can better distinguish between a good strategy that had bad luck and a poor decision by management.

On the other hand, scrutiny can reduce accounting flexibility. Managers often value risk buffers, such as the ability to smooth volatility, meet short-term reporting benchmarks, or avoid outcomes perceived as failures. If reporting discretion functions as an implicit insurance policy for managers, constraining it may make risk-taking costlier for them personally, even if shareholders view projects as having positive net present values.

A Shift in Enforcement Intensity

To study the effect of heightened SEC scrutiny on corporate risk-taking, we examine an internal SEC reorganization in 2007. Before 2007, the SEC operated a two-tier structure in which five regional offices oversaw six district offices. In April 2007, the SEC eliminated that hierarchy and elevated each district office to regional status, aiming to strengthen local monitoring and enforcement by giving those offices more autonomy and resources. The newly upgraded offices had higher budgets, gained staff, and opened more cases. Companies in the jurisdictions of these offices now appear more likely to be  investigated and have reduced their earnings management.

This reorganization lets us compare firms in jurisdictions where SEC offices have more authority (treated firms) with firms in other jurisdictions, before and after the 2007 change, to isolate the effect of greater expected scrutiny. Importantly, our design captures expected enforcement intensity, rather than just the behavior of firms after being targeted for wrongdoing.

Companies Take Fewer Risks

We find that heightened SEC scrutiny reduces corporate risk-taking, and the effect is strongest when managers face greater personal costs from risky outcomes.

Using a difference-in-differences framework, we show that after the 2007 reorganization, treated firms  score lower than other firms in idiosyncratic stock-return volatility – a broad market-based measure of firm risk.  We also find that treated firms reduce R&D spending and innovate less.

We next examine whether the effects are caused by greater concern among managers for their careers and their loss of reporting discretion as a risk buffer. The reduction in risk-taking is concentrated where managers’ career concerns are higher, and it is stronger when earnings management declines more. Taken together, our evidence suggests that when reporting is becomes more tightly monitored, managers avoid riskier projects.

Implications for Corporate Governance and Enforcement

Our results do not imply that stronger SEC oversight is harmful. High-quality reporting and deterrence of misconduct are fundamental to market integrity, and prior work consistently links scrutiny to lower misreporting and reduced earnings management.

The point is more nuanced. How the SEC deploys resources and how it designs enforcement can shape corporate behavior, including R&D investment and innovation. Our evidence suggests that strengthening oversight can inadvertently tilt managers toward playing it safe, especially when career concerns are salient and when reduced reporting flexibility makes downside outcomes harder to absorb.

In short, enforcement is not merely a back-end response to wrongdoing. It is part of the governance environment that shapes management incentives. For those thinking about SEC budgets, staffing, and regional organization, the broader message is that enforcement choices can have significant effects, and those effects should be part of the cost–benefit analysis when designing how, where, and to what extent the SEC monitors public companies.

David Weber is a professor, and Nina Xu is an assistant professor, at the University of Connecticut. Kangkang Zhang is an assistant professor at the University of Illinois at Urbana-Champaign. This post is based on their recent paper, “SEC Scrutiny and Corporate Risk-Taking,” available here.