The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices
The Effect of SOX Section 404: Costs, Earnings
Quality, and Stock Prices
Introduction
The Securities and Exchange Commission (SEC) Responsible for the application of the law THE SARBANES–OXLEY ACT (SOX) was passed in 2002 after a string of high profile corporate scandals. The law’s main goal was to improve the quality of financial reporting and to increase investor confidence, which requires companies to put in place and periodically test procedures that monitor the internal systems ensuring accurate financial reports Section 404 requires that managers report their findings in a special management’s report, and that an outside auditor attest to management’s assessment of the company controls.
The objective of the study
The objective of this paper is to measure the costs, benefits, and overall value impact of SOX, focusing on small firms. The costs are likely to be found in additional costs of compliance, partly measurable as audit fees. The benefits are likely to be found in changes in how firms report earnings. And the net effect is most likely found in firms’ stock returns. Accordingly, the authors investigate audit fees as a direct measure of the costs of Section 404, changes in reporting behavior proxied by firm accruals as a measure of the benefits of compliance, and stock returns around Section 404–related announcements as a measure of the net effect of compliance.
Contribution of the study
Looking at the contribution of this paper, the author use a regression discontinuity design that compares the companies that were just above the rule cutoff and had to file the report to companies that were just below the cutoff and did not have to file the report. This is a good quasi-natural experiment because the exact cutoff is not related to firm fundamentals. In addition, one must consider whether firms actively manipulated their public float to escape compliance. This paper uses the public float rule in 2002 to predict (instrument) the actual compliance in
Quality, and Stock Prices
Introduction
The Securities and Exchange Commission (SEC) Responsible for the application of the law THE SARBANES–OXLEY ACT (SOX) was passed in 2002 after a string of high profile corporate scandals. The law’s main goal was to improve the quality of financial reporting and to increase investor confidence, which requires companies to put in place and periodically test procedures that monitor the internal systems ensuring accurate financial reports Section 404 requires that managers report their findings in a special management’s report, and that an outside auditor attest to management’s assessment of the company controls.
The objective of the study
The objective of this paper is to measure the costs, benefits, and overall value impact of SOX, focusing on small firms. The costs are likely to be found in additional costs of compliance, partly measurable as audit fees. The benefits are likely to be found in changes in how firms report earnings. And the net effect is most likely found in firms’ stock returns. Accordingly, the authors investigate audit fees as a direct measure of the costs of Section 404, changes in reporting behavior proxied by firm accruals as a measure of the benefits of compliance, and stock returns around Section 404–related announcements as a measure of the net effect of compliance.
Contribution of the study
Looking at the contribution of this paper, the author use a regression discontinuity design that compares the companies that were just above the rule cutoff and had to file the report to companies that were just below the cutoff and did not have to file the report. This is a good quasi-natural experiment because the exact cutoff is not related to firm fundamentals. In addition, one must consider whether firms actively manipulated their public float to escape compliance. This paper uses the public float rule in 2002 to predict (instrument) the actual compliance in