Impact of Sarbanes Oxley Act on initial public offerings: new evidence from reverse leveraged buyouts

Purpose This paper aims to investigate how the passage of the Sarbanes Oxley Act (SOX) impacted the likelihood and timing of the decision of leveraged buyout (LBO) firms to exit via initial public offering (IPO) (reverse-LBO) and the mediating effect of reputed private equity (PE) firms. Design/methodology/approach The sample comprises firms that went private via LBO between 1990 and 2018. The authors use logistic and ordinary least square regression models to compare the effect of SOX on the re-listing decision and the time taken to re-list. Findings LBO firms were less likely to exit via public offering after SOX, and the time from LBO to IPO was significantly longer for exiting firms post-SOX. PE firm reputation partially reversed the reluctance to exit via IPO and shortened the time to exit. Research limitations/implications The primary focus is RLBOs; the authors do not directly examine other methods of LBO exit. The findings have policy implications for unintended impacts of SOX. Despite the benefits of increasing transparency and protecting investors, SOX reduced the likelihood of going public and increased the time to IPO, potentially reducing product market competition. Originality/value RLBOs present a unique experimental setting as the authors can test the impact of SOX on both the likelihood and time to go public, whereas prior literature using first-time IPO samples are able to test only the likelihood. The authors also show that the reputation of the advising PE firm attenuates the reluctance and time taken for RLBOs to re-list. The authors are, thus, able to provide a new perspective on the impact of SOX on the going public decision.

How did the Sarbanes–Oxley Act affect managerial incentives? Evidence from corporate acquisitions

We examine the impact of incentive compensation on the riskiness of acquisition decisions before and after the passage of the Sarbanes–Oxley Act (SOX). Before SOX, equity-based compensation was positively related to changes in risk around acquisition decisions, but this relationship weakened after the introduction of SOX. The drop in post-SOX acquisition-related risk stems from how managers respond to compensation-based incentives in the new regulatory environment. We show that executive stock options and pay-risk sensitivity drive post-SOX managerial responsiveness to risk-taking incentives. We also document a post-SOX value-enhancing effect on long-term stock-price performance and total factor productivity through these same incentive compensation mechanisms. The results are robust to selection bias, simultaneity, measurements of risk, and the definition of incentive compensation.

The Adoption and Consequences of COSO 2013

COSO has developed frameworks for firms to improve their internal controls with the objective of reducing fraud and managing enterprise risk. The frameworks are widely used by firms and their auditors to comply with the internal control requirements of the Sarbanes-Oxley Act (SOX). We investigate two issues involving the most recent COSO internal control framework (COSO 2013): the determinants of a firm's decision to adopt it in a timely manner; and the consequences of adoption on internal controls. In our sample, firms that report internal control problems under SOX 404, especially firms with information technology (IT) problems, are likely to be late adopters. Regarding the consequences of adoption, for late adopters, we find that firms using the revised COSO framework have a lower probability of reporting weaknesses in IT-related controls. We also find evidence that COSO 2013 adoption is helpful in remediating internal control weaknesses.

Uncovering Real Earnings Management: Pay Attention to Risk-Taking Behavior

We examine the impact of corporate risk-taking on firm-level real earnings management. We find that firms with higher risk-taking engage in higher real earnings management. Our results are robust to a series of robustness tests, including simultaneous least squares approach, firm fixed effect, change analysis, and pseudo difference-in-difference analysis. Additional analyses reveal that the impact of risk-taking on real earnings management is more pronounced among firms that experience prior-year loss and are run by top-echelons who are risk lovers. Sarbanes-Oxley Act (SOX) regulation does not attenuate the positive effect of risk-taking on real earnings management. However, external monitoring by institutional investors and takeover susceptibility curb the relation between risk-taking and real earnings management. Our study highlights that outsider, such as investors and regulators, should pay close attention to a firm’s risk-taking behavior to unravel the extent of real earnings management in the firm.

The Effects of Stock-Based Incentives on Inventory Management

Classic inventory theories typically focus on the operational trade-offs to optimize inventory decisions. However, managers of public firms who obtain stock-based incentives may alter inventory operations to influence the stock price. We develop a stylized model, which shows that, in the presence of an interest in the stock price, managers over-install inventory when it can either inflate sales or deflate the reported cost of goods sold even if the market anticipates such actions. We analyze the joint and marginal effects of the stock-based incentives and the cost of using inventory to manage earnings, which may provide useful implications for the detection of inventory distortion and the design of management incentive plans. We then conduct an empirical analysis based on the financial data of U.S. publicly listed retailers and manufacturers. We find positive (negative) correlation between firms’ abnormal excess inventory and the stock-based incentives of their top executives (the inventory manipulation cost). Moreover, the marginal effect of the stock-based incentives on the abnormal excess inventory is the strongest when the inventory manipulation cost is intermediate. Our empirical analysis also shows that this effect becomes statistically weaker after the passage of the Sarbanes–Oxley Act. This is in line with the prediction of our analytical model about the effect of the accuracy of financial reporting. This paper was accepted by Vishal Gaur, operations management.

The effect of firm-specific litigation risk on independent director conservatism

PurposeThe purpose of this study is to examine whether firm-specific litigation risk affects independent director conservatism in the oversight of financial reporting.Design/methodology/approachThis study considers the enactment of Sarbanes–Oxley Act and the main US stock exchanges' corresponding corporate governance regulations in 2002–2003 as an exogenous shock event to increase board independence. OLS regressions with fixed effects are conducted to test the hypothesis.FindingsChanges in discretionary accruals from the pre-event year (2001) to the post-event year (2004) are more negatively associated with an exogenous increase in board independence for firms with high litigation risk than for firms with low litigation risk.Originality/valueThe results suggest that independent directors are more conservative in overseeing financial reporting when they face higher litigation risk, consistent with the notion that they are still concerned about liability risk although they seldom have to pay damages or legal fees out of their own pockets.

Director Compensation in the Banking Industry Around the Dodd-Frank Act

Directors’ monitoring and advising activities as agents were supposed to increase after the Dodd-Frank Act in 2010. The Dodd-Frank Act significantly increases the pressure on the board of directors to be more effective agents of the stockholders even after the Sarbanes-Oxley Act (2002) became effective. Director compensation, especially incentive-based compensation, is intended to align with the interests of shareholders and motivate director behavior. This paper empirically tests how banks respond to the Dodd-Frank Act by redesigning their director compensation plans. Our findings suggest that banks recognize the need for improved board monitoring by highlighting the importance of director workload and qualifications through the design of director compensation packages in the post-Dodd-Frank Act period. We also find that the negative impact of excessive director equity compensation on firm performance was attenuated after the passage of the Dodd-Frank Act. The findings of this study shed light on the rationale of director compensation policies for banking firms.

An exploratory study of US acquirers’ market performance: pre- versus post-Sarbanes–Oxley act of 2002

Purpose Motivated by the findings of Bhabra and Hossain (2017) that highlight an improvement in US market performance in the post-Sarbanes–Oxley (SOX) period, this paper aims to investigate how this change varies with the methods of payment used for the deals. Design/methodology/approach Deductive in nature and using an event study approach, this paper uses a sample of 675 deals between 1999 and 2006 to test three research hypotheses in a pre-post setting. Findings Results show that at the aggregate level, there is a significant improvement in the market performance of US acquirers around the announcement day in the aftermath of the passage of SOX 2002. Considered separately, both US stock acquirers and cash acquirers did not experience any significant improvement in market performance in the post-Sarbanes–Oxley period. These results are robust to controlling for governance, firm and deal variables, as well as industry and year fixed effects. Research limitations/implications Exploratory in nature, the results are to be interpreted in light of the sample size and the period under investigation. Practical implications The results provide evidence for regulators and legislators on the contribution of SOX 2002 to curbing managerial misconduct. Significant improvement in the market performance also signals more confidence in managerial decisions and a reduction in agency problems. The insignificant change in stock acquirers’ market performance can be an indication that policymakers should exert more efforts to improve shareholders' confidence in the quality of disclosure. Originality/value This investigation provides unique insights on whether SOX has been effective in mitigating mispricing concerns associated with stock-financed acquisitions and whether it was effective in moderating the governance mechanism associated with cash-financed acquisitions.