Sarbanes-Oxley Research Articles

Board Independence Impact on Insider Trading, Before and After SOX

We investigate the impact of corporate governance mechanisms, particularly board independence, on the incidence and profitability of insider trades before and after the 2002 enactment of Sarbanes-Oxley (SOX). Prior studies indicate that regulation or compliance with regulation may be ineffective in controlling information-driven insider trading. We show how corporate governance mechanisms can compensate the shortcomings of existing regulations or their enforcement mechanisms in reducing the incidents of information-driven trades. We also distinguish the era before and after the enactment of SOX due to its impact on transparency of insider trading and intensified penalties for illegal insider trading. We also find that profitability of information-driven insider trades is associated with corporate governance strength and that the relation was affected by the passage of SOX such that the impacts of corporate governance mechanisms declined in post-SOX era.

Internal Control Weaknesses and Evidence of Real Activities Manipulation

Abstract We examine whether US public firms that file internal control weakness (ICW) disclosure reports with the Securities and Exchange Commission, as part of the reporting requirements under Section 404 of the Sarbanes–Oxley (SOX) Act, exhibit higher levels of real activities manipulation (RM), compared to firms that do not file such reports. Using firm-level data for the post-SOX period, 2004–2010, we find a positive relationship between firms reporting internal control weaknesses and real activities manipulation. Further, those ICW-firms that use RM to beat earnings benchmarks have lower performance in the subsequent year. Our results also show that firms do not use discretionary accruals as a substitute for RM when they report internal control weaknesses. Overall, our findings suggest that ICW-firms are prone to using real activities manipulation as a form of earnings management. Our findings also have implications for audit quality as auditors need to gain a better understanding of how real activities manipulation influences the operations of the firm.

The Effect of Sarbanes-Oxley on Earnings Management Behavior

This paper investigates the impact of Sarbanes-Oxley (SOX) on managers’ earnings management choices (i.e., accrual management and real earnings management). Specifically, I use a large sample of firms from 1987-2004 to investigate whether firms reduce their use of accrual management and increase their use of real earnings management post-SOX. SOX likely increases the cost of engaging in accrual management because of increased legal liability, greater auditor independence, and increased public awareness of aggressive accounting treatments. An increased cost of accrual management is likely to lead managers to use other methods to manage earnings (e.g., real earnings management through sales manipulation, reduction of discretionary expenditures, and overproduction). Consistent with this expectation, this paper finds an increased association between certain types of real earnings management (overproduction and sales manipulation) and the propensity to beat the profit and earnings change benchmarks. Results also indicate that the associations between abnormal accruals and beating the profit and earnings change benchmarks do not change post-SOX.

Effects of Earnings Forecasts and Heightened Professional Skepticism on the Outcomes of Client–Auditor Negotiation

Ethics has been identified as an important factor that potentially affects auditors’ professional skepticism. For example, prior research finds that auditors who are more concerned with professional ethics exhibit greater professional skepticism. Further, the literature suggests that professional skepticism may lead the auditor to more vigilantly resist the client’s position in financial reporting disputes. These reporting disputes are generally resolved through negotiations between the auditor and client to arrive at the final reported amounts. To date, the role that professional skepticism potentially plays in the negotiation process has been relatively unexplored. The literature prior to the enactment of Sarbanes–Oxley (SOX) suggests that auditors are more likely to approve a client position when the matter in dispute is relatively ambiguous and when changing the client’s position will result in the client failing to meet analysts’ expectations. However, changes resulting from SOX have led auditors to be more vigilant and therefore results found in the pre-SOX environment may not hold in the current environment where auditors are held more accountable for their actions. Results from an experiment with experienced audit managers and partners suggest that in the post-SOX climate, auditors’ negotiations do not appear to be substantively influenced by management being able to meet or beat forecasts. Moreover, we find that when auditors exhibit heightened professional skepticism, they are more ethical by being conservative and they stand more resolute than when auditors do not exhibit heightened professional skepticism. Finally, although we do not find a main effect for the influence of earnings forecast, we do find a significant interaction between earnings forecast and heightened professional skepticism. Implications for practice and research are then presented.

Predicting Bankruptcy After The Sarbanes-Oxley Act Using Logit Analysis

<span style="font-family: Times New Roman; font-size: small;"> </span><p style="margin: 0in 0.5in 0pt; text-align: justify; mso-pagination: none;" class="MsoBodyText"><span style="font-family: Times New Roman;"><span style="color: black; font-size: 10pt; mso-themecolor: text1;">Our study proposes </span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-language: KO;">firm bankruptcy prediction using </span><span style="color: black; font-size: 10pt; mso-themecolor: text1;">logit analysis a</span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-language: KO;">fter the passage of the Sarbanes-Oxley (SOX) Act </span><span style="color: black; font-size: 10pt; mso-themecolor: text1;">using </span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-language: KO;">2008-2009 U.S. </span><span style="color: black; font-size: 10pt; mso-themecolor: text1;">data.<span style="mso-spacerun: yes;"> </span>The results of our logit analysis show an 80% (90% with one year before bankruptcy data) prediction accuracy rate using financial </span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-language: KO;">and other </span><span style="color: black; font-size: 10pt; mso-themecolor: text1;">data from the 10-K report in the post-SOX period.</span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-language: KO;"><span style="mso-spacerun: yes;"> </span>This prediction rate is comparable to other data mining tools.<span style="mso-spacerun: yes;"> </span>Overall, our results show that, as compared to the </span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-font-family: Batang; mso-fareast-language: KO;">prediction rates documented by other bankruptcy studies before SOX,</span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-language: KO;"> firm bankruptcy prediction rates have improved since the passage of SOX.</span><span style="color: black; font-size: 10pt; mso-themecolor: text1; mso-fareast-font-family: Batang; mso-fareast-language: KO;"> Our findings shed light on the benefits of SOX by providing evidence that legislation makes the financial reporting more informative. This study is important for regulators to implement public policy.<span style="mso-spacerun: yes;"> </span>Investors may be interested in our findings to better assess company risk when making portfolio decisions.<span style="mso-spacerun: yes;"> </span></span></span></p><span style="font-family: Times New Roman; font-size: small;"> </span>

What drives delistings of foreign firms from U.S. Exchanges?

We examine time dependency in the factors motivating delistings of foreign firms from major U.S. Exchanges over the period 1962–2006. For firms listing before Sarbanes-Oxley (SOX), we find that governance has no significant effect on delisting but after SOX, it becomes one of the main forces driving delisting. For firms whose delisting decision is most likely attributable to SOX, we find they realize low benefits from listing – they originate from countries with strong home market governance, and from listing onward realize low trading volume, analyst coverage, and make little use of capital raising. Our results suggest that SOX has had a large influence on the benefits seek from a U.S. listing, leading firms from well governed countries and low capital raising needs to delist.

Indicators of audit fees and fraud classification: impact of SOX

PurposeThe purpose of this paper is to compare the effect of corporate governance variables and fraud litigation on audit fees both before and after the implementation of the Sarbanes‐Oxley (SOX) Act in 2002.Design/methodology/approachThe paper utilizes a sample of firms that had litigation proceedings filed against them for fraudulent financial reporting, and compare these firms to a sample of non‐fraud firms in the pre‐and post‐SOX period. First, the authors examine indicators of audit fees using the Simunic model. Next, the authors develop a logistic regression model with corporate governance variables and other financial control variables in order to identify the characteristics of firms that are accused of fraud in the pre‐and post‐SOX period.FindingsThe paper identifies specific components of corporate governance that are positively related to audit fees and which subsequently aid in classifying companies subject to fraud litigation. The most successful logistic regression model for 2005 (post‐SOX) is 64.4 per cent accurate in distinguishing firms litigated for fraud, while the most successful model for 2001 (pre‐SOX) is 61.4 per cent accurate in distinguishing such firms.Originality/valueThe research design and findings assist in providing additional evidence about the association between the effectiveness of the corporate governance structure and the external auditor in assessing the risk of fraud.

The Role and Function of PCAOB and AS 5

This paper examines the role and the function of the Public Company Accounting Oversight Board (PCAOB) and AS 5. Recently, the need to improve auditing standards has increased as the public's demand for corporate accounting has increased. This paper discusses the nature and the functions of auditing standards and how these standards are applied to financial, operational, and compliance audits. This paper will also examine the effects of Sarbanes-Oxley (SOX) and PCAOB and how it has affected the audits of publicly traded companies. The need for improved regulation has forced new laws to be passed and new procedures to be set forth for both management and auditors to follow. Most of the required standards used today by auditors were put in place by the Generally Accepted Auditing Standards (GAAS), SOX, and PCAOB. These standards contain auditing requirements that will aid users and investors of financial statements to make informed decisions and assist in restoring the confidence that was lost during the Wall Street corporate scandals.

The Impact of Information Technology Internal Controls on Firm Performance

Since the introduction of the Sarbanes-Oxley (SOX) Act in 2002, companies have begun to place more emphasis on information technology (IT) internal controls. IT internal controls are policies that provide assurance that technical systems operate as intended, provide reliable data, and comply with regulations. Research suggests that firms with strong internal controls perform better than those with internal control weaknesses. In this study, the authors evaluate the impact of IT internal controls on firm performance. The sample includes 72 publicly traded firms, 36 that reported IT internal control weaknesses and 36 that did not. The results of ordinary least squares (OLS) regression indicate that substantive IT internal control weaknesses negatively impact firm performance. Results and implications for research and practice are discussed.

The Whonka Chocolate Company: Corporate governance and controls over financial reporting

► Improvements to thinking and writing are meager in college but vital for success. ► This case provides a resource that successfully addresses these issues. ► Students create a written appraisal of the internal controls and corporate governance. ► Complex reasoning is used to apply knowledge regarding Sarbanes–Oxley and COSO. ► The case is appropriate for graduate and undergraduate accounting and auditing students. Whonka Candy Company (Whonka) is a case study dealing with internal control and corporate governance. The company has grown rapidly over the last few years and achieved a large share of the wholesale chocolate market. The growth has caused many changes to corporate operations and financial reporting. Your responsibility as a new member of Whonka’s board of directors is to evaluate the company’s current system of control. Use the knowledge you have obtained regarding the Sarbanes–Oxley (SOX) Act (2002) (Sarbanes-Oxley Act of 2002. 2002, July 30. Available at http://www.sec.gov/about/laws/soa2002.pdf ) and the COSO Internal Control–Integrated Framework (1992 and 2012) (Committee of Sponsoring Organizations of the Tre. (1994). INTERNAL CONTROL – INTEGRATED FRAMEWORK . Jersey City, NJ: AICPA. Retrieved on June 12, 2012 from http://www.snai.edu/cn/service/library/book/0-framework-final.pdf ) and best business practices of accounting system design and operation to develop a report to the board. This case will challenge your ability to think critically and practice your written communication skills.

Unintended consequences of regulatory reporting requirements for small and medium size construction entities: Australian evidence

The Queensland Building Services Authority (QBSA) regulates the construction industry in Queensland, Australia, with licensing requirements creating differential financial reporting obligations, depending on firm size. Economic theories of regulation and behaviour provide a framework for investigating effects of the financial constraints and financial reporting requirements imposed by QBSA licensing. Data are analysed for all small and medium construction entities operating in Queensland between 2001 and 2006. Findings suggesting that construction licensees are categorizing themselves as smaller to avoid the more onerous and costly financial reporting of higher licensee categories are consistent with US findings from the 2002 Sarbanes-Oxley (SOX) regulation which created incentives for small firms to stay small to avoid the costs of compliance with more onerous financial reporting requirements. Such behaviour can have the undesirable economic consequences of adversely affecting employment, investment, wealth creation and financial stability. Insights and implications from the analysed QBSA processes are important for future policy reform and design, and useful to be considered where similar regulatory approaches are planned.

The impact of governance characteristics on the stock price of cross listed companies

The study examines the relationship between the country-specific governance characteristics of the origination country and the post-listing returns of cross-listed firms. In addition, the study researches the relative impact of those governance indicators on the abnormal returns of cross-listed stocks following the passage of the Sarbanes-Oxley (SOX) Act. The positive abnormal returns experienced by foreign companies around their listing in the U.S. are shown to be driven by the governance indicators of their home countries, i.e., the worse the governance characteristics of the origination country are, the higher the abnormal return for a cross-listed firm is. The governance indicators that influence abnormal returns to the highest degree are director liability, rule of law, control of corruption, political and economic development, and the integrity of the legal system. The abnormal returns generated by cross-listed foreign firms after the adoption of SOX are higher than those experienced by cross-listed foreign firms in the pre-SOX period. This outcome is pronounced for companies which score the worst on the combined set of country-specific governance characteristics. Thus, the main implication of the study is that foreign companies with a specific set of governance characteristics should consider listing on the U.S. stock markets. To be specific, companies from countries with lower governance standards, as reflected in low scores on director liability and control of corruption, are likely to derive the highest benefits from cross- listing on the NYSE or NASDAQ exchanges.

SOX and the regulated firm

We investigate the initial and long-term market reactions in three regulated industries to the debate and ultimate passage of Sarbanes–Oxley (SOX) legislation. We argue that market reactions may differ for regulated industries relative to the broad market based on perceived differences in the costs and benefits from the legislation. Our results indicate that the initial reaction to the passage was more positive for regulated firms compared with non-regulated firms. These results are generally consistent with a compliance cost based explanation, although the underlying motivation for the results differs across industries. However, over longer post-SOX holding periods, the regulated samples outperformed the S&P 500 but underperformed their matched samples. Lower longer-term accounting profits in terms of ROA argue against significantly lower compliance costs associated with SOX.

The Impact of Enterprise Resource Planning (ERP) Systems on the Effectiveness of Internal Controls over Financial Reporting

ABSTRACT: Software vendors that market enterprise resource planning (ERP) systems have taken advantage of the increased focus on internal controls that grew out of the Sarbanes-Oxley (SOX) legislation by emphasizing that a key feature of ERP systems is the use of “built-in” controls that mirror a firm’s infrastructure. They argue that these built-in controls and other features will help firms improve their internal control over financial reporting as required by SOX. This study tests that assertion by examining SOX Section 404 compliance data for a sample of firms that implemented ERP systems between 1994 and 2003. The results suggest that ERP-implementing firms are less likely to report internal control weaknesses (ICW) than a matched control sample of non-ERP-implementing firms. It also finds that this difference exists for both general (entity-wide), and individual (account-level) controls.

Competitiveness In A Post Sarbanes-Oxley Economy And Its Impact On Small And Mid-Size Companies

With the increase in the number of people who had a stake in the Stock market coupled with 9/11 and Enron (which created a climate of uncertainty); a need was created for more assurance in the Stock market. Sarbanes-Oxley (SOX) was created to answer the need for accuracy and reliability of financial reporting. SOX imposed unprecedented close government oversight of publicly traded companies through rigid internal control of corporate processes.

SOX And ERP Adoption

The objective of this paper is to examine the relationship between the implementation of the Sarbanes-Oxley (SOX) legislation and Enterprise Resource Planning (ERP) systems, and to investigate the impact that the passage of this legislation has had on the decision for companies to adopt ERP technology. The legislation itself is discussed, along with an analysis of ERP systems, including their components, their advantages and disadvantages, and the critical factors and crucial components which must be present for the successful deployment of such systems. This paper explores the contributory effect of SOX on ERP adoption. The authors concluded that SOX merely accelerated an inevitable process. The best managers will always find and use the best tools to maximize benefits to their organizations. The requirements of Sarbanes-Oxley forced companies to rethink their processes and technology, and therefore may have provided the final incentive for companies to commit to ERP.

Does Equity-Based Compensation Really Have a 'Dark Side'? The Influence of Regulatory Discretion

Using a recent sample of firms subject to SEC litigations for fraud and employing a detection-controlled estimation technique, we find that equity-based executive compensation (EBC) is positively related to both the probability of fraud commission and the probability of being prosecuted by the SEC. Moreover, EBC usage significantly decreased post Sarbanes-Oxley (SOX), but only in high-growth industries. Finally, post SOX, fraud commission dramatically declined by 60-70%, and this appears to be driven by the increased fraud penalties in SOX. These empirical results highlight the influence of potential regulatory discretion on fraud commission, fraud detection, and the usage of EBC.

Market Reaction to Auditor Switching from Big 4 to Third-Tier Small Accounting Firms

SUMMARY: After the demise of Arthur Andersen, the public accounting industry has witnessed a significant migration of public clients to second-tier (Grant Thornton and BDO Seidman) and smaller third-tier accounting firms. While prior literature documents that smaller auditors are perceived by the stock market as an inferior substitute for a Big 4 auditor, this perception appears to have changed in recent years. In this paper, we analyze market responses to auditor switching from Big 4 to smaller accounting firms during 2002 to 2006. We break our sample period into two separate periods (Periods 1 and 2) based on when regulatory changes occurred. These changes included Sarbanes-Oxley (SOX) 404 implementation, Public Company Accounting Oversight Board (PCAOB) inspections, and a tightened Form 8-K filing deadline. We find a relatively more positive stock market reaction to clients switching from a Big 4 to a smaller third-tier auditor in Period 2. This relatively more positive reaction in Period 2 reflects companies seeking better services rather than a lower audit fee, when an audit quality drop is less likely. Overall, our results suggest that companies and investors have become more receptive to smaller accounting firms.

Object Migration Tool for Data Warehouses

Data warehouses contain numerous software applications and thousands of objects that make those applications work. Many companies maintain multiple data warehouses depending on business requirements for example development, testing and production. Installing objects and keeping them synchronized across all environments can be a challenging task due to the sheer number of objects and complexity. Software objects stored in a Source Control system must be installed on target warehouse environments. Manual copy procedures are possible but very inefficient. Developers spend much time preparing installation and migration scripts that are prone to syntax errors. This paper proposes an Object Migration and Apply Tool (OMAT) that automates software installation across all warehouses for anyone using manual procedures. An automated tool can help eliminate error prone manual procedures, increase flawless object installation and reduce installation time. The OMAT tool is easy to use through a web browser and includes many useful features that support the development life cycle, the Sarbanes-Oxley (SOX) Act requirements and enforce numerous business requirements. OMAT is designed to support the construction and maintenance of an enterprise-wide, strategic data warehouse faster and better.

Perceptions of preparers, users and auditors regarding financial statement audits conducted by Big 4 accounting firms

This study includes the most diverse stakeholder population integrated into one research study regarding perceptions of financial statement audits conducted by Big 4 accounting firms. Whereas prior studies almost exclusively used either archival data or experiments to implicitly derive the stakeholders’ perceptions, this study employed focus groups with financial statement (1) preparers; (2) users consisting of bankers, financial analysts and non-professional investors; and (3) auditors to explicitly solicit perceptions regarding the financial statement audits conducted by Big 4 accounting firms. Some stakeholders opined that Big 4 audit quality has decreased because of the rush to hire staff because of increased Sarbanes–Oxley (SOX) work. However, stakeholders generally agreed that for organizations that are some combination of large, complex and/or multinational, the Big 4 accounting firms will be superior. For other organizations, second- and third-tier accounting firms will provide the same quality audit as the Big 4 firms. One factor as to why there are fewer differences between the firms is that many of the non-Big 4 auditors are Big 4 firm alumni. Regardless of whether a Big 4 audit is actually superior, the stakeholders generally agreed that the Big 4 audit has a cachet that has a monetary value in the financial marketplaces. In terms of differences between the Big 4 firms, the auditors believe there is little difference in how they interpret GAAP or GAAS because there is open communication between the Big 4 firms. Alternatively, the preparers have witnessed differences, particularly, in GAAP interpretations. However, both the auditors and the preparers generally agreed that interpretation differences are wider between Big 4 and non-Big 4 firms.