Securitization and earnings management: evidence from the Sarbanes–Oxley act

Abstract

PurposeThis paper aims to examine whether the opportunistic use of assets securitization for earnings management is systematically widespread. It is hypothesized that with the passage of the Sarbanes–Oxley (SOX) Act of 2002, which imposed more stringent governance over the financial reporting process, there should be a decrease in the opportunistic use of securitization among firms that were not compliant prior to the passage.Design/methodology/approachThe author use the SOX Act as an exogenous shock to determine whether the act had the intended effect of mitigating opportunistic securitization.FindingsThe empirical results show that there was a significant decrease in securitization among the non-compliant firms relative to the compliant firms and this reduction is related to firms using securitization opportunistically. This evidence suggests that securitization for earnings management was a systematic phenomenon and that SOX was effective in mitigating such behavior.Originality/valueThe contribution of this paper to the literature is twofold. It will identify changes in the use of asset securitization for earnings management purpose by using the exogenous variation in the strength of external governance. Furthermore, it will provide additional evidence of the effectiveness of financial regulations and have potential implications at the policy maker level.