The Effect of SOX on the Predictability of Future Cash Flows in Litigious and Non-litigious Industries

Abstract

In this paper, we investigate whether the role of discretionary accruals in predicting future operating cash flows changes after the passage of the Sarbanes-Oxley Act (hereafter SOX). We also examine the information content of discretionary accruals in industries where litigation is more common. We find that discretionary accruals are positively associated with future operating cash flows. More importantly, we find that discretionary accruals become even more important to predict future cash flows during the post-SOX period. In addition, our findings indicate that litigious firms impart greater information content relative to non-litigious firms prior to the issuance of SOX and that the SOX effect on discretionary accruals is weaker for such firms as a result. Our results suggest that managers improve earnings quality after SOX by reducing discretionary accruals and reporting more conservatively. Our study contributes to the understanding of the impact of SOX on the use of discretionary accruals to convey firm value.