Changes in Discretionary Financial Reporting Behavior Following the Sarbanes-Oxley Act

Abstract

We examine the effect of the Sarbanes-Oxley Act (SOX) on the extent of aggressive/conservative reporting behavior of public companies. SOX imposes considerably greater potential penalties on CEO/CFOs who engage in financial wrongdoing; therefore, risk averse managers are likely to report lower earnings by reducing discretionary accruals following SOX. Our results, based on a matched sample of dual-listed Canadian firms and their domestically-listed counterparts, indicate that (1) firms subject to SOX are more conservative in financial reporting in the post-SOX period as evidenced by lower signed discretionary accruals, the differential earnings persistence conditional conservatism measure, and the Penman and Zhang (2002) unconditional conservatism measure, and (2) the impact of SOX on firms' conservative reporting through discretionary accruals in the post-SOX period is not homogeneous; it is more pronounced for firms that were aggressive in the pre-SOX period.