Real and Accrual-Based Earnings Management in the Pre- and Post-Sarbanes-Oxley Periods

Abstract

We document that accrual-based earnings management increased steadily from 1987 until the passage of the Sarbanes Oxley Act (SOX) in 2002, followed by a significant decline after the passage of SOX. Conversely, the level of real earnings management activities declined prior to SOX and increased significantly after the passage of SOX, suggesting that firms switched from accrual-based to real earnings management methods after the passage of SOX. We also find evidence that the accrual-based earnings management activities were particularly high in the period immediately preceding SOX. Consistent with these results, we find that firms that just achieved important earnings benchmarks used less accruals and more real earnings management after SOX when compared to similar firms before SOX. Finally, our analysis provides evidence that the increases in accrual-based earnings management in the period preceding SOX were concurrent with increases in the fraction of equity based compensation.1

Audit quality and accrual persistence: evidence from the pre‐ and post‐Sarbanes‐Oxley periods

“…We note, that like many other empirical studies that investigate the impact of SOX era reforms (Carcello et al 2009;Cohen et al 2008; that we cannot definitively state that the changes we document in financial reporting behavior are solely from the passage of SOX and the other changes in the auditing environment in that period. Many other factors (e.g., increased auditor and investor prudence) were in a state of fluctuation during the post SOX period that might influence decisions affected reported financial statements.…”

“…Many have been quick to dismiss SOX as unnecessary and overly burdensome, even going so far as to deem it "quack corporate governance" (Romano 2005). Concurrent research finds that opportunistic earnings management, proxied using absolute levels of abnormal accruals, declined in the post-SOX period (Carcello, Hollingsworth, and Mastrolia 2009;Cohen, Dey, and Lys 2008;. This behavior was accompanied in the post-SOX period by a reduced propensity of reported earnings to just meet or beat analysts' forecasts (Bartov and Cohen 2009), potentially indicating companies are less likely to engage in opportunistic earnings management.…”

“…This behavior was accompanied in the post-SOX period by a reduced propensity of reported earnings to just meet or beat analysts' forecasts (Bartov and Cohen 2009), potentially indicating companies are less likely to engage in opportunistic earnings management. However, Cohen et al (2008) and Bartov and Cohen (2009) find a concurrent increase in the use of real earnings management techniques to adjust reported financial statement balances after the passage of SOX. They note that these techniques are more costly to implement, yet less likely to be considered opportunistic if detected by investors and auditors.…”

Can a securities law improve investor rationality in processing earnings information?

“…Therefore, the SOA is expected to create a new market system in which financial statements become more credible and convey less biased corporate information. Studies about the economic impact of new securities laws and regulations for enhancing shareholder protection and improving disclosure and transparency in general provide evidence of positive effect of such reforms on the market system and value (Lo, 2003;Jain and Rezaee, 2006;Cohen et al, 2008;Li et al, 2008;Hochberg et al, 2009;Burks, 2011;Singer and You, 2011). Some studies, however, question the intended effect of the SOA.…”

Evitar Divulgar Perdas: Um Estudo Empírico do Gerenciamento de Resultados por Meio de Decisões Operacionais

“…This coefficient should be negative in Equations 4 and 5 and positive in Equation 6, since companies that manipulate financial results in order to improve them and thus avoid reporting losses will probably have abnormally low ACFO and/or ASG&A (Roychowdhury, 2006;Cohen, Dey, & Lys, 2008;Martinez & Cardoso, 2009;Cohen & Zarowin, 2010;Gunny, 2010;Zang, 2012;Cupertino, 2013). For Equation 7, consistent with Gunny (2010), an aggregate measure for the three REM proxies is constructed, and is shown in Equation 8.…”