The Earnings Quality of High Growth Firms Before and after the Sarbanes-Oxley Act

Abstract

Here we examine whether earnings quality improved after the Sarbanes-Oxley Act of 2002 (SOX) in the context of high growth and lower growth firms. Our examination is based on the notions that high growth creates unique management and reporting challenges that can contribute to lower earnings quality and that the period of increased attention to accounting and reporting issues initiated by SOX has been particularly relevant for high growth firms. Our earnings quality measures include modified Jones performance-matched discretionary accruals and absolute value book tax differences. Our results indicate that earnings quality for high growth firms improved in the period after SOX relative to lower growth firms. We also find that the relation between accounting returns and market returns weakened in the period after SOX. However, we find that the returns relations are significantly lower only for lower growth firms. We interpret these results as indicative of dual and potentially conflicting effects from improvements in financial reporting.