Earnings Strings in the Post-SOX Era

Abstract

We investigate whether or not the impact of external firm monitoring on earnings strings is associated with the implementation of the Sarbanes-Oxley Act of 2002 (SOX). Researchers have argued that earnings strings are likely a product of earnings management as earnings strings occur much more often than by chance. External monitors, such as auditors and analysts, may constrain this behavior. We measure the quality of the external monitoring using auditor tenure and number of analysts following the firm. We then examine whether or not this monitoring is more effective post-SOX, given the emphasis of SOX on improving auditing and financial reporting. We find that short and long auditor tenure, indicating lower quality external monitoring, is associated with reduced likelihood and length of earnings strings post-SOX, but the role of analysts as external monitors in relation to earnings strings is only partially affected by SOX. Our results are consistent with stronger auditing and an improved information environment post-SOX.