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Abstract
We employ an event study analysis to examine the market reaction to congressional agreement on the passage of the Sarbanes-Oxley Act of 2002. We find that as firm size increases, the negative impact of Sarbanes-Oxley's passage decreases. The results show that the difference in abnormal returns between the smallest and largest firms is 3.91 %.
The Corporate Context of Sarbanes-Oxley
In a volatile world, burdened by corporate scandals and a decline in investors' confidence, lawmakers crafted the Sarbanes-Oxley Act of 2002 (hereafter abbreviated as SOX) with an enthusiastic desire for corrective action. Passed by Congress as a reaction to financial scandals such as Enron, WorldCom, Adelphia, Global Crossing, and Tyco, SOX enhanced standards for corporate accountability and penalties for corporate wrongdoing. SOX contains 11 extensive titles, ranging from extra responsibilities for audit committees to tougher criminal penalties for white-collar crimes such as securities fraud. In plain English, the objective of the law was to make financial reporting more transparent and executives more accountable, changes that were ultimately planned to restore investors' confidence in financial markets and enhance corporate governance.
SOX requires executives, boards of directors, and independent auditors to take specific actions that are intended to produce more reliable, timely, and useful financial information to the public. Greater transparency and more reliability in corporate reporting means that companies function in a moral and ethical environment that enhances their credibility. This is a key benefit that should lower the firm's cost of capital, which may improve growth. Thus, at least theoretically, SOX could provide a win-win situation for both companies and investors.
Although many agreed that the changes to the corporate governance system in the U.S. were necessary, some now believe that SOX has imposed an unnecessary burden on companies because of its high compliance costs. A challenging issue is Section 404 of SOX, Management Assessment of Internal Controls, which requires publicly held firms to identify financial reporting risks, establish related controls, assess their effectiveness, fix any material control deficiencies, and then re-test and re-document all of the above. A March 2005 survey by Financial Executives International shows that the first year compliance costs on Section 404 of SOX alone averaged $4.36 million per company, and large companies with more than $5 billion...