Organizational Non-Compliance: A Study of FDA-Regulated Industries

In this paper, we investigate compliance deficiencies across multiple business functions. Specifically, in the medical device and pharmaceutical industries, we examine the association between: (1) error-related restatements of financial reports [financial reporting non-compliance], and (2) adverse outcomes from the U.S. Food and Drug Administration’s (FDA) plant inspections [operational non-compliance]. Consistent with the argument that an organizational common cause influences the culture of compliance across multiple business functions, we observe a contemporaneous relationship between the two types of non-compliance issues, but no such relationship when operational non-compliance is lagged. We also demonstrate multiple, economically meaningful implications of this cross-functional non-compliance. First, we document a more negative stock market reaction to error-related accounting restatements in the presence of operational non-compliance. Second, we find that likelihood of CEO turnover following an error-related restatement is higher if there is also operational non-compliance. Taken together, we infer from our findings that a culture of organizational non-compliance influences compliance behavior across the entire firm, and that both financial markets and corporate boards recognize this, resulting in significant consequences for firms and their CEOs.