The theoretical factors arising from Becker’s economic approach to crime are measured empirically by estimating
managers’ assessment of the potential future costs of private and public enforcement. To do so, I construct two models that
provide estimates of the probabilities of class action lawsuits and SEC Accounting and Auditing Enforcement Releases
(AAER). The dependent variables in the models are indicator variables for whether a class action lawsuit or an AAER were
filed, and the explanatory variables consist of factors, presumably known to managers, likely to affect the two outcomes.
This approach provides instruments of managers’ assessment of litigation and SEC enforcement risks that vary over the
sample depending on the firm’s attributes. The financial benefit from trading is estimated by the market reaction to the
restatement announcement, which can be interpreted as the magnitude of managers’ private information about the GAAP
violations. Non-financial factors, such as the firm’s corporate environment and managers’ traits and preferences are
proxied by the presence of fraud. Finally, to investigate the effect of a potential change in the economic environment,
I separate the sample into two periods based on Enron’s first disclosure of its problems, which marked the beginning of the
massive accounting scandals that led to calls for reforms and the enactment of SOX.