The joint influence of Sarbanes‐Oxley and FAS123R on financial misreporting

Abstract

Prior research reports that a manager's equity risk‐taking incentive (vega) is positively associated with financial misreporting. FAS 123R led to a significant decrease in vega while SOX increased the cost of financial misreporting. Consistent with the original intent of the legislation, we find that SOX contributed to significant decreases in both fraud restatements and AAERs. Importantly, our results suggest that the SOX‐induced decreases in fraud restatements and AAERs have endured to more recent years. On the other hand, while we find evidence that equity‐incentive‐motivated financial misreporting ceased to exist in the immediate years after FAS 123R, we also find that this was only temporary. In particular, we find strong evidence of a significantly positive association between vega and accrual misreporting in more recent years.

When do stock options affect CEO risk‐taking? The moderating role of CEO regulatory focus

“…Using FAS123R as an exogeneous shock Davis et al (2022). find that decreased stock options after FAS 123R lower the probability of misreporting and conclude a positive relation between stock options and misreporting, where misreporting is often considered a managerial risk-taking behavior(Armstrong et al, 2013).…”

“…We continue to find that stock options have a bigger impact on risk‐taking for CEOs with moderate levels of promotion focus and prevention focus than CEOs at the extremes. In another test, we exploit the adoption of FAS 123R as a natural experiment that leads to an exogenous reduction in stock options (Hayes et al., 2012; Davis et al., 2022). We match each CEO with a moderate regulatory focus to a CEO with an extreme regulatory focus.…”