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FINANCIAL REGULATION AND ECONOMIC PERFORMANCE:

A DESCRIPTIVE CORRELATION STUDY OF AMERICAN

FINANCIAL INSTITUTIONS

by

Leslie E. Lynch

A Dissertation Presented in Partial Fulfillment

of the Requirements for the Degree

Doctor of Administration

UNIVERSITY OF PHOENIX

May 2013

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© 2013 by Leslie E. Lynch

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iv

Abstract

The purpose of this descriptive correlation study with a logistic regression analysis was to

examine the relationship between SEC regulatory compliance or malfeasance and the

economic performance of American, publicly traded financial institutions from 2005

through 2010. The research study examined three research questions. The research

questions addressed the relationship between a company’s financial performance and

associated regulatory malfeasance or compliance as well as the type and volume of

regulatory violations. Three predictor variables were operationalized as follows: (a)

regulatory compliance or malfeasance, (b) the type of malfeasance, and (c) the volume of

malfeasance. The study researched 74 publicly traded financial institutions categorized

under SIC 6211. The results demonstrated that (a) neither regulatory compliance nor

malfeasance were statistically related to the financial performance of the financial

institutions, and (b) no significant relationship exists between the volume or type of

regulatory malfeasance and the financial performance of the institutions researched. A

statistically significant relationship (p-value=0.054) was uncovered between one specific

type of regulatory violation and financial performance. Companies with violations

categorized as irresponsible or unfair treatment of customers reported the weakest

financial performance. The results were determined using several statistical methods of

analysis.

v

Dedication

This accomplishment is dedicated to my husband who patiently endured too many lonely

weekends, to my father and mother who taught me that hard work always pays off, and to

my sons who kept me grounded.

vi

Acknowledgements

Thank you to my dissertation chair, Dr. Barbara Fedock for her guidance and

unbelievably positive encouragement throughout this journey. Thank you to my

committee members, Drs. Kofi Amoateng and Gerald Wiesenseel. Special mention is

offered to a fellow doctoral student, Robin Laukhuf, for her collaboration and ‘ear.’

vii

Table of Contents

List of Tables …………………………………………………………………………………………………….. xii

List of Figures …………………………………………………………………………………………………… xiv

Chapter 1: Introduction …………………………………………………………………………………………..1

Background of the Problem …………………………………………………………………………………….2

Problem Statement …………………………………………………………………………………………………4

Purpose Statement ………………………………………………………………………………………………….6

Significance of the Study ………………………………………………………………………………………..7

Significance to Leadership ………………………………………………………………………………………8

Nature of the Study ………………………………………………………………………………………………..9

Research Questions and Hypotheses ………………………………………………………………………12

Operational Definition of Variables ………………………………………………………………………..14

Conceptual Framework …………………………………………………………………………………………15

Germinal and Historical Theory ………………………………………………………………….16

Economic Theory ………………………………………………………………………………………16

Public-Choice Theory ………………………………………………………………………………..17

Leadership Theory …………………………………………………………………………………….17

Current Theory ………………………………………………………………………………………….18

Definition of Terms………………………………………………………………………………………………19

Assumptions ………………………………………………………………………………………………………..23

Scope, Limitations, and Delimitations …………………………………………………………………….24

Limitations ……………………………………………………………………………………………….25

Delimitations …………………………………………………………………………………………….26

viii

Summary …………………………………………………………………………………………………………….27

Chapter 2: Review …………………………………………………………………………………28

Overview …………………………………………………………………………………………………………….28

Background …………………………………………………………………………………………………………29

Related Legislation ………………………………………………………………………………………………30

Securities Act of 1933 and Securities Exchange Act of 1934 ………………………….32

Glass-Steagall Act of 1933 …………………………………………………………………………35

Investment Company Act of 1940 ……………………………………………………………….36

Securities Acts Amendments of 1964 …………………………………………………………..37

Sarbanes-Oxley Act of 2002 ……………………………………………………………………….38

Dodd-Frank Consumer Protection Act of 2010 ……………………………………………..40

Regulatory Malfeasance………………………………………………………………………………………..41

U.S. Securities and Exchange Commission …………………………………………………..42

Public Company Restatements and Misstatements…………………………………………43

Mandatory Disclosures ………………………………………………………………………………45

Financial Statement Malfeasance and Securities Fraud …………………………………..47

Ethics ……………………………………………………………………………………………………47

Individuals………………………………………………………………………………………………..48

Normative Constructs ……………………………………………………………………..48

Descriptive Constructs …………………………………………………………………….49

Prescriptive Constructs ……………………………………………………………………50

Leadership ………………………………………………………………………………………………..51

ix

Organizational Factors ……………………………………………………………………………….52

Culture…………………………………………………………………………………………..52

Governance ……………………………………………………………………………………53

Miscellaneous Factors ……………………………………………………………………..53

Economic Performance …………………………………………………………………………………………54

Earnings Management ……………………………………………………………………………….55

Valuation Measures …………………………………………………………………………………..56

Conclusion ………………………………………………………………………………………………………….56

Summary …………………………………………………………………………………………………………….57

Chapter 3: Methodology ……………………………………………………………………………………….60

Research Method …………………………………………………………………………………………………60

Research Design…………………………………………………………………………………………………..62

Research Questions and Hypotheses ………………………………………………………………………64

Operational Definition of Variables ………………………………………………………………………..66

Sample and Setting ………………………………………………………………………………………………67

Sampling Frame ………………………………………………………………………………………..68

Archived Data Sample ……………………………………………………………………………….69

Geographic Location ………………………………………………………………………………….69

Data Collection ……………………………………………………………………………………………………69

Archival Data ……………………………………………………………………………………………69

Reliability and Validity …………………………………………………………………………………………70

Data Analysis ………………………………………………………………………………………………………73

Screening………………………………………………………………………………………………….74

x

…………………………………………………………………………………………………..74

Canonical Correlation ……………………………………………………………………..74

Multiple Regression ………………………………………………………………………..75

Summary …………………………………………………………………………………………………………….76

Chapter 4: Presentation and Analysis of Data ………………………………………………………….78

Data Collection Process ……………………………………………………………………………………….78

Appropriateness of Statistical Tests ……………………………………………………………………….82

Data Analysis Procedure ………………………………………………………………………………………83

Step 1: Correlation between Gross Profit Margin and After-tax Profit Margin …84

Step 2: Repeated ANOVA …………………………………………………………………………84

Step 3: RQ1 Logistic Regression ………………………………………………………………..85

Step 4: RQ 2 Logistic Regression ……………………………………………………………….86

Step 5: RQ 3 Poisson Regression ………………………………………………………………..88

Step 6: Additional Chi-squared Analysis ……………………………………………………..89

Critical Values ………………………………………………………………………………………….90

Summary ……………………………………………………………………………………………………………91

Chapter 5: Conclusions and Recommendations ………………………………………………………92

Summary of Findings …………………………………………………………………………………………..94

Theme 1(RQ2): Type of Regulatory Violations ……………………………………………95

Theme 2 (RQ1): Regulatory Compliance or Malfeasance ……………………………..96

Theme 3 (RQ3): Volume of Regulatory Violations ………………………………………97

Theme 4: Top-performing Companies …………………………………………………………97

Restatement of Limitations …………………………………………………………………………………..98

xi

Other Limitations ……………………………………………………………………………………..99

Conclusions and Implications ……………………………………………………………………………..100

Implications to Leaders ……………………………………………………………………………101

Implications to the Study of Leadership …………………………………………………….101

Recommendations for Further Study ……………………………………………………………………102

Timeframe ……………………………………………………………………………………………..102

Sector ……………………………………………………………………………………………………102

Research Design ……………………………………………………………………………………..102

Research Reflections ……………………………………………………………………………….103

Summary ………………………………………………………………………………………………………….104

References …………………………………………………………………………………………………………106

Appendix A. Companies for SIC 6211 …………………………………………………………………139

Appendix B. Sample of Securities and Exchange Commission Enforcement
Actions ………………………………………………………………………………………….144

Appendix C. Twenty-First Century Corporate Scandals …………………………………………146

Appendix D. Data Analysis Procedure Step 1 Results …………………………………………….147

Appendix E. Data Analysis Procedure Step 2 Results ……………………………………………..148

Appendix F. Data Analysis Procedure Step 3 Results ……………………………………………..149

Appendix G. Data Analysis Procedure Step 4 Results …………………………………………….151

Appendix H. Data Analysis Procedure Step 5 Results …………………………………………….153

Appendix I. Data Analysis Procedure Step 6 Results ………………………………………………155

xii

List of Tables

Table 1 Criterion and Predictor Variables Ordered by Hypothesis…………………………….65

Table 2 Types of Regulatory Infractions ………………………………………………………………….81

Table 3 Parameter Estimates: Violation Type 2 ……………………………………………………….87

Table 4 Critical Values Synopsis ……………………………………………………………………………90

Table D1 Correlations between Gross Profit Margin and After-tax Profit Margin …….147

Table E1 Test of Model Effects ……………………………………………………………………………148

Table E2 Omnibus Test ………………………………………………………………………………………148

Table E3 Mauchley’s Test of Sphericity ……………………………………………………………….149

Table E4 Test of Within-subjects Effects ………………………………………………………………149

Table F1 Omnibus Test: Regulatory Compliance or Malfeasance ……………………………150

Table F2 Parameter Estimates: Regulatory Compliance or Malfeasance …………………150

Table G1 Omnibus Test: Violation Type 1 ……………………………………………………………151

Table G2 Parameter Estimates: Violation Type 1 ………………………………………………….151

Table G3 Omnibus Test: Violation Type 2 ……………………………………………………………151

Table G4 Omnibus Test: Violation Type 3 ……………………………………………………………151

Table G5 Parameter Estimates: Violation Type 3 ………………………………………………….152

Table G6 Omnibus Test: Violation Type 4 ……………………………………………………………152

Table G7 Parameter Estimates: Violation Type 4 ………………………………………………….152

Table H1 Frequency Table of Total Volume ………………………………………………………….153

Table H2 Omnibus Test: Volume …………………………………………………………………………154

Table H3 Parameter Estimates: Volume ………………………………………………………………154

Table I1 Mean Gross Profit Margin Percentiles ……………………………………………………155

xiii

Table I2 Descriptive Crosstabs: Gross Profit or Loss to Malfeasance ……………………..155

Table I3 Chi-squared Tests: Malfeasance …………………………………………………………….155

Table I4 Descriptive Crosstabs: Gross Profit or Loss to Type 1 Violations ………………156

Table I5 Chi-squared Tests: Type 1 Violations ……………………………………………………..156

Table I6 Descriptive Crosstabs: Gross Profit or Loss to Type 2 Violations ………………157

Table I7 Chi-squared Tests: Type 2 Violations ……………………………………………………..157

Table I8 Descriptive Crosstabs: Gross Profit or Loss to Type 3 Violations ………………158

Table I9 Chi-squared Tests: Type 3 Violations ……………………………………………………..158

Table I10 Descriptive Crosstabs: Gross Profit or Loss to Type 4 Violations …………….159

Table I11 Chi-squared Tests: Type 4 Violations ……………………………………………………159

Table I12 Frequency Table: Gross Profit Margin to Top-10, Profit, and Loss
Companies ………………………………………………………………………………………….159

Table I13 Descriptive Crosstabs: Top 10, Profit, and Loss to Malfeasance ………………160

Table I14 Descriptive Crosstabs: Top-10, Profit, and Loss to Type 1 Violations ……….161

Table I15 Chi-squared Tests: Type 1 Violations ……………………………………………………161

Table I16 Descriptive Crosstabs: Top-10, Profit, and Loss to Type 2 Violations ……….162

Table I17 Chi-squared Tests: Type 2 Violations ……………………………………………………162

Table I18 Descriptive Crosstabs: Top-10, Profit, and Loss to Type 3 Violations ……….163

Table I19 Descriptive Crosstabs: Top-10, Profit, and Loss to Type 4 Violations ………..164

Table I20 Fisher’s Exact Test: Malfeasance and Type 3 Violations …………………………164

xiv

List of Figures

Figure 1. Accessed Financial Statements by Year ……………………………………………………80

Figure E1. Variance Boxplot of the Sample Companies’ Gross Profit Margins …………148

Figure H1. Total Volume Distribution …………………………………………………………………153

1

Chapter 1: Introduction

The 2008 financial crisis and subsequent failure of American financial institutions

were the result of global liquidity concerns and a poor regulatory framework (Blundell-

Wignall, Atkinson, & Lee, 2008). In 2008, a global investment bank based in New York

ceased to exist as acquisition by one of the oldest global financial services firms in the

United States was completed. Executives of the fourth largest investment bank in the

United States filed the largest bankruptcy in history. The board of directors of one of the

world’s largest financial institutions approved the acquisition of a financial-management

and advisory company, and leaders of an American multinational insurance company

accepted an $85 billion federal loan (Dolmetsch, 2008). In response to this economic

scenario, members of Congress passed new laws. Regulatory agencies concurrently

began the development of new governmental-malfeasance policy.

Financial executives anticipate forthcoming regulations and experience pressure

to maximize profits and meet earnings projections (Berrone, Surroca, & Tribo, 2007).

Regulatory advocates have argued that compliance with governmental policy generates

the trust and commitment of stakeholders, which ensures long-term performance

(O’Brien, 2010). Regulatory antagonists have contended, however that governmental

policy is burdensome and offers no validated payoff for stakeholders (Berrone et al.,

2007). These two adversaries may find the results of the quantitative study helpful in the

assessment of regulatory-compliance value.

Chapter 1 introduces the background of the problem and the purpose of the study.

The chapter continues with an analysis of the study’s significance. Research questions

are presented that guide the study and reflect the intent of the research (Salkind, 2009).

2

Hypotheses are stated to communicate the expected findings of the investigation (Leedy

& Ormrod, 2010). The research assumptions and the scope of data collected in the study

are examined, and the chapter concludes with a discussion of the study’s limitations and

delimitations.

Background of the Problem

Before the stock-market crash of 1929, the securities markets were governed by

minimal federal regulation (Li & Xu, 2008; Securities and Exchange Commission [SEC],

2008). The demand for public financial disclosure to prevent the fraudulent sale of stock

was not yet seriously pursued. American investors still believed in the promise of easy

credit and the American dream (SEC, 2008). However, public confidence in the

securities markets was destroyed by the 1929 crash (Securities Advisory, 2011).

Members of the U.S. Congress passed the Securities Act of 1933 and the Securities

Exchange Act of 1934 (Li & Xu, 2008; SEC, 2008). Collectively, this legislation

intended to restore public confidence in the capital markets by providing investors access

to reliable publicly traded securities information (State of Wisconsin Department of

Financial Institutions, 2010). Policy related to honest business practice was introduced,

and rules were written to protect investors against fraud and misrepresentation (SEC,

2008).

The Securities Exchange Act of 1934 facilitated creation of the U.S. SEC. The

mission of the SEC was designed to protect investors and maintain efficient markets as

well as to facilitate capital formation (SEC, 2008). The Commission was assigned the

law-enforcement authority to serve as the regulatory agency overseeing adherence to the

mandates of the Securities Act of 1933 and the Securities Exchange Act of 1934. Public

3

disclosure of financial and other information by executives of publicly listed companies

is required by the SEC (2008).

SEC regulators investigate violations of the rules and regulations established by

members of the Commission (SEC, 2008). Reporting managers of an organization may

misrepresent or omit important information related to securities, manipulate stock-market

price, or violate insider trading rules as established by those comprising the SEC.

Company executives have been found guilty of violating their responsibility to treat

customers fairly or of stealing customer funds or securities (Rhee, 2009). When

violations are committed, questions are raised if business ethics can be legislated

(O’Brien, 2010; Pellerin, Walter, & Wescott, 2009).

On July 21, 2010, members of the U.S. Congress enacted the Consumer

Protection Act, also known as Dodd-Frank (Anderson et al., 2011). Dodd-Frank is

considered to include the most sweeping securities law since the Securities Act of 1933

and the Securities and Exchange Act of 1934. Financial institutions are significantly

affected by this broad expansion of regulatory oversight and corporate governance

mandates (Anderson et al., 2011; Raidy, 2011). The increase in regulatory reform and

government oversight was introduced in response to the failure of American financial

institutions and the subsequent global financial crisis (Blundell-Wignall et al., 2008).

Sherman (2009) referred to the enactment of the new law and subsequent

regulations as providing greater transparency in business practice and hence more rapid

revelation of corporate fraud than prior policy. Edgar (2009) confirmed the need for

efficient and effective corrective regulation. A need has also been identified for greater

transparency of publicly traded companies (Burr, 2010). Few researchers have linked

4

increased government regulation with improved economic performance (Burr, 2010;

Edgar, 2009). Executive leadership may devalue long-term regulatory compliance to

meet short-term earnings estimates (Choi & Jung, 2008; Heneghan, 2010).

The quantitative study was conducted to examine the relationship between

regulatory compliance or malfeasance and the economic performance of publicly traded

financial institutions. New data was revealed that may serve as the basis for SEC

compliance by financial executives. Public policy makers may undertake further study to

extend this research.

Problem Statement

The problem is that chief executives of publicly traded financial institutions

encounter significant pressure to maximize profits within a legal and regulatory

framework (Heneghan, 2010). Overlooked by the investigators of existing empirical

research is evidence of the influence of regulatory compliance or malfeasance on

economic performance (Choi & Jung, 2008). O’Brien (2010) asserted that published

researchers have failed to show empirical evidence demonstrating a statistically

significant or insignificant relationship between regulatory compliance or malfeasance

and the economic performance of financial institutions. Lin and Hwang (2010) claimed

that published researchers have presented little consistent evidence on the relationship

between the type or volume of regulatory violations and the economic performance of

financial institutions.

Burton and Goldsby (2010) presented a philosophical basis for the connection

between ethics and business practice. No quantitative evidence was put forth. Svensson

and Wood (2008) advanced a conceptual framework for business ethics with no empirical

5

validation. This lack of evidence is problematic (Lin & Hwang, 2010). Tamny (2010)

recommended that government regulators create complex and restrictive financial

regulations ignoring the reality of failure as a critical economic input. Francis (2009)

postulated that financial executives oppose what is perceived to be government control of

free markets. Financial regulatory agents dispute the notion that increased government

oversight ends free-market capitalism (Rivlin, 2009). Regulatory agents and financial

executives fail to collaborate, which frequently results in ineffective and delayed

legislation and excessive cost (Sherman, 2009).

The relationship between …