This paper examines the penalties imposed on 585 firms targeted by SEC enforcement actions for financial misrepresentation from 1978–2002, tracking through November 15, 2005. The legal penalties imposed on firms average only $23.5 million per firm, while the market's penalties are much larger. The authors estimate that the reputational penalty—defined as the expected loss in the present value of future cash flows due to lower sales and higher contracting and financing costs—is over 7.5 times the sum of all legal and regulatory penalties. For each dollar a firm misleadingly inflates its market value, it loses this dollar when its misconduct is revealed, plus an additional $3.08. Of this additional loss, $0.36 is due to expected legal penalties and $2.71 is due to lost reputation. In firms that survive the enforcement process, lost reputation is even greater at $3.83. The reputation loss is positively related to measures of the firm's reliance on implicit contracts. The evidence suggests that financial misrepresentation is heavily penalized through lost reputation, not just legal penalties. The paper also finds that the market reacts strongly to financial misrepresentation, with firms losing 38% of their market value when news of their misconduct is reported. The losses are attributed to market adjustment to accurate financial information, expected legal penalties, and lost reputation. The reputation loss exceeds legal penalties by over 7.5 times and exceeds the amount by which firm value was artificially inflated by more than 2.5 times. The paper also finds that the reputation loss is positively related to measures of a firm's reliance on implicit contracts. The findings have implications for business and public policy, showing that financial misrepresentation can be extremely costly to firms. The paper also contributes to the debate over federal regulation of financial misconduct, showing that legal penalties are only a small portion of the total cost. The most important conclusion is that it is a mistake to consider only prospective legal penalties in making business decisions or setting public policy because most of the financial penalty for cooking the books comes from lost reputation. The paper is organized into sections describing the data, the enforcement process, the share value effects of financial misrepresentation enforcement actions, the legal penalties imposed on firms, the readjustment effect, the reputation loss, and the robustness of the results. The paper finds that the market reacts strongly to financial misrepresentation, with firms losing 38% of their market value when news of their misconduct is reported. The losses are attributed to market adjustment to accurate financial information, expected legal penalties, and lost reputation. The reputation loss exceeds legal penalties by over 7.5 times and exceeds the amount by which firm value was artificially inflated by more than 2.5 times. The paper also finds that the reputation loss is positively related to measures of a firm's reliance on implicit contracts. The findings have implications forThis paper examines the penalties imposed on 585 firms targeted by SEC enforcement actions for financial misrepresentation from 1978–2002, tracking through November 15, 2005. The legal penalties imposed on firms average only $23.5 million per firm, while the market's penalties are much larger. The authors estimate that the reputational penalty—defined as the expected loss in the present value of future cash flows due to lower sales and higher contracting and financing costs—is over 7.5 times the sum of all legal and regulatory penalties. For each dollar a firm misleadingly inflates its market value, it loses this dollar when its misconduct is revealed, plus an additional $3.08. Of this additional loss, $0.36 is due to expected legal penalties and $2.71 is due to lost reputation. In firms that survive the enforcement process, lost reputation is even greater at $3.83. The reputation loss is positively related to measures of the firm's reliance on implicit contracts. The evidence suggests that financial misrepresentation is heavily penalized through lost reputation, not just legal penalties. The paper also finds that the market reacts strongly to financial misrepresentation, with firms losing 38% of their market value when news of their misconduct is reported. The losses are attributed to market adjustment to accurate financial information, expected legal penalties, and lost reputation. The reputation loss exceeds legal penalties by over 7.5 times and exceeds the amount by which firm value was artificially inflated by more than 2.5 times. The paper also finds that the reputation loss is positively related to measures of a firm's reliance on implicit contracts. The findings have implications for business and public policy, showing that financial misrepresentation can be extremely costly to firms. The paper also contributes to the debate over federal regulation of financial misconduct, showing that legal penalties are only a small portion of the total cost. The most important conclusion is that it is a mistake to consider only prospective legal penalties in making business decisions or setting public policy because most of the financial penalty for cooking the books comes from lost reputation. The paper is organized into sections describing the data, the enforcement process, the share value effects of financial misrepresentation enforcement actions, the legal penalties imposed on firms, the readjustment effect, the reputation loss, and the robustness of the results. The paper finds that the market reacts strongly to financial misrepresentation, with firms losing 38% of their market value when news of their misconduct is reported. The losses are attributed to market adjustment to accurate financial information, expected legal penalties, and lost reputation. The reputation loss exceeds legal penalties by over 7.5 times and exceeds the amount by which firm value was artificially inflated by more than 2.5 times. The paper also finds that the reputation loss is positively related to measures of a firm's reliance on implicit contracts. The findings have implications for