The wealth effects of investing in information technology

Abstract

PurposeSection 404 of the Sarbanes‐Oxley Act of 2002 (SOX 404) requires auditors to attest to, and report on, management's assessment and effectiveness of the company's internal control systems. This paper aims to examine investor reaction to companies' announcements of new information technology (IT) or improved existing IT to satisfy requirements of Section 404 of the Sarbanes‐Oxley Act of 2002.Design/methodology/approachUsing a sample of 124 SOX‐related IT announcements from 2003 to 2007, an event study measuring market reactions using average cumulative abnormal return is undertaken. Additionally, the cross‐sectional variation in the marketplace is analyzed to test the effect of firm‐specific factors on market responses.FindingsThe empirical results suggest that the stock market reacts favorably to corporations that invest in SOX 404‐related IT. The reaction is more favorable toward companies without prior reported internal control deficiencies/weaknesses. Additionally, the results marginally support the notion that firms with higher risk and poorer financial reporting quality can demonstrate their commitment to improve internal control over financial reporting by investing in IT for SOX 404 compliance.Originality/valueThe findings will influence companies' IT investment decisions, particularly IT decisions that are SOX Section 404‐related. Potential benefits of SOX 404 IT investments include favorable market returns. Additionally, the study contributes to a deeper understanding of SOX for standard‐setting and regulation bodies examining past rulings and preparing for future regulation.