Headquarters on the Lam

The recent news of General Electric planning to move its headquarters from a small town in Connecticut to Boston is noteworthy yet hardly rare. After all, some two percent of American corporations relocate to a different state or metropolitan area each year, often as a result of a merger. Even the unstated reason for GE’s move — to avoid increased state taxes — is something we’ve heard before.

But, for the sake of argument, let’s consider a related question: Would a publicly-traded corporation operating on the outer edge of the law pack up and leave town in favour of a location that was known for lax regulatory oversight?

Funny you should ask, say researchers Paul Calluzzo, Wei Wang, and Serena Wu. The three Smith School of Business professors developed a novel study that sought to answer just this question. They triangulated corporate head office relocations, firms with a high fraud score, and the locations of Securities Exchange Commission (SEC) offices with a weak record of enforcement. They found that for firms likely to misreport activities or engage in earnings management, relocating headquarters is an attractive option. For them, geography matters a great deal.

“If you’re a child and you’re misbehaving, you don’t want to misbehave in front of your parents,” reasons Calluzzo. “Or the guy with gambling debt who jumps town because he doesn’t want to get his legs broken. In business, you have monitors, shareholders, stock analysts, the SEC office, all trying to make sure you’re behaving well. Our finding definitely aligns with what past research has shown that if you’re not behaving well, you don’t want to be around that monitor.”

Danger in Proximity

The researchers got the idea for the study from research by Rutgers University’s Simi Kedia. Kedia showed that the closer a firm is located to a regional SEC office, the more likely it is to get caught for fraud. (Enforcement actions are mostly conducted by the 11 regional SEC offices.)

“The SEC office only has a certain budget and they want to investigate the most amount of people with that budget,” says Calluzzo. “It’s a lot cheaper to just look at the books of the guy right down the street than fly out to some remote location, stay at a hotel, and spend time there.”

In building their study, Calluzzo, Wang, and Wu had to be inventive, since there is little existing structured information on corporate relocations. First they wrote an algorithm that looked through all annual report filings to the SEC from 1994 to 2012, picking out zip codes. Then they flagged each instance where the zip code changed. With those leads, two research assistants combed the firms’ financial statements and news articles to identify reasons for the moves.

To tag firms likely to engage in shady accounting practices, they used what’s known as the fraud score, which indicates accounting practices by firms that are most predictive of uncaught fraud, such as misreporting activities and aggressive earnings management.

On the regulatory side, the researchers looked at the five-year histories of enforcements at the 11 regional SEC offices in the U.S. to identify those with a high and low volume of investigations. They also collected biographies of all the regional SEC directors.

"Our finding definitely aligns with what past research has shown that if you’re not behaving well, you don’t want to be around a monitor”

Once they crunched the data, the researchers found a statistically significant number of firms with a high fraud score moving to areas with a record of low enforcement. A one standard deviation change in a firm’s fraud score was associated with a 20 percent higher likelihood of relocating headquarters to another SEC jurisdiction state in the following year. And misreported earnings were associated with a 26 percent higher likelihood of a similar relocation.

Their findings were confirmed when they considered corporate relocations in relation to “shocks” in the enforcement activities of a regional SEC office. Examples of shocks would be a sudden boost in resources for enforcement or the arrival of a potentially tough director. If financial misconduct indeed motivates firms to relocate, they reasoned, they should observe firms with higher likelihood of fraud tending to relocate in response to the SEC enforcement shocks. That’s just what the researchers found.

Interestingly, after they relocated, the firms doubled down on their shady ways. “When these firms move to a new region where there’s a relaxed SEC office,” Calluzzo says, “we find that they do commit much more fraud than firms that do not relocate yet they’re not more likely to get caught. That supports the idea that this is actually what’s causing the relocation.”

Calluzzo, Wang, and Wu had a number of additional findings. For one thing, firms that relocate due to potential fraudulent activities are more likely to withhold information from the public and provide no explicit reason for their relocations. And, not surprisingly, firms in industry clusters — banks in New York City or auto makers in Detroit or technology firms in Silicon Valley — are less likely to move in the first place.

Calluzzo says that their findings can potentially help regulators and other monitors deter opportunistic relocations and allocate resources towards firms that are most likely to commit fraud.

But he cautions that he’s not looking to besmirch the reputation of corporations that decide to move their headquarters. “One thing to keep in mind with this research is we’re not saying that everyone that moves is a bad guy. But there are always going to be some bad apples.”

— Alan Morantz