The Impact of Securities Regulation on New Keynesian Firms

Abstract

Borrowing firms resetting output prices infrequently are less able to insulate their profits from economic shocks, the impact of which on performance is costly for lenders to verify. If securities regulation is lenient, sticky-price firms might face greater financial frictions due to managerial misreporting. We document that S&P 500 firms with stickier prices paid lower loan spreads and provided collateral less often following the passage of Sarbanes-Oxley Act (SOX), and the results are robust to using staggered implementations of Section 404 to isolate the effects that were uniquely due to SOX. Firms with stickier prices are negatively associated with daily returns around the Enron scandal but positively associated with returns around the SEC's approval of the change in listing requirements. We develop a New Keynesian model of an economy in which firms feature differential output-price stickiness. The model mirrors both pre- and post-SOX scenarios and shows that when paying higher credit spreads, firms with stickier prices have lower debt capacity, are endogenously more volatile in equity returns, and display higher capital-investment and stock-price sensitivities to monetary policy shocks. Our further empirical analyses yield results that are in line with these model predictions.