BOFIT Seminar - Daniel Berkowitz (University of Pittsburgh): Can Trade Sanctions Deter Illegal Financial Transactions?

Co-authors: Guillermo Lezama (University of Pittsburgh) and Laura Liu (University of Pittsburgh)

The Office of Foreign Assets Control (OFAC) has the authority to issue civil penalties to companies for engaging in business transactions with foreign countries sanctioned by the US government. These penalties are generally unanticipated because they are announced only after OFAC had completed its investigation and settled. Using data for listed financial companies, we find there were no announcement effects for firms that engaged with “bad” countries such as Russia and Iran. However, consistent with the prediction that large penalties can deter illegal activity (Gary Becker, 1968), we find that the upper quartiles of penalties imposed “reputation costs” where the loss in market value exceeded legal costs. Additional predictors of reputation costs include penalties jointly enforced by OFAC and the Department of Justice, activities that are considered “egregious” and vague preannouncement signals.

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