Sarbanes Oxley's impact upon investor‐relevant risk types
| Pages | 254-270 |
| DOI | https://doi.org/10.1108/13581981111147883 |
| Published date | 26 July 2011 |
| Date | 26 July 2011 |
| Author | Nicholas V. Vakkur,Zulma J. Herrera |
| Subject Matter | Accounting & finance |
Sarbanes Oxley’s impact upon
investor-relevant risk types
Nicholas V. Vakkur
TUI University, Venice, California, USA, and
Zulma J. Herrera
Herrera-Vakkur Consulting, Venice, California, USA
Abstract
Purpose – The purpose of this study is to empirically analyze, with a greater degree of accuracy than
is currently presented in the literature, the comprehensive risk impact of the Sarbanes Oxley Act of
2002. Research to date is based upon a series of simple mean-variance analyses and is therefore
unreliable.
Design/methodology/approach – Rigorous statistical methodology to include a highly
representative dataset, difference-in-difference analysis, comprehensive controls, and fixed effects
(firm as well as longitudinal). As a reliability check, the authors also employ several pre- and
post-tests.
Findings – In support of Bargeron et al., the authors find that the Sarbanes Oxley Act of 2002
significantly reduced firm risk. In particular, the law reduced firms’ risk-adjusted returns as well as
“upside” risk. This is not a mere repeat of prior research, but a detailed analysis of the law’s risk impact.
Research limitations/implications – As a study of corporate risk, there are inherent limitations,
as contained in every study of this type. First, the authors are unable to account for every single factor
that might influence firm risk. However, their methodology represents a significant improvement over
the current literature, and therefore produces more comprehensive, detailed, and reliable findings.
Practical implications – The main practical implication is that Sarbanes Oxley, the most important
and comprehensive US financial regulation since the New Deal, reduced firm (equity) risk. This
represents a finding of enormous importance: comprehensive accounting regulation was never
intended to alter firm risk, yet this study strongly suggests that it has in two specific ways.
Social implications – As a result of this study, the cost to investors – the “social” cost – of this
important regulation can now be analyzed more conclusively. In particular, the authors suggest
Sarbanes Oxley reduced “upside” risk as well as firms’ risk-adjusted returns. This is of enormous
potential importance to investors of all types.
Originality/value – This study is original and hence important in several ways: the dataset is
arguably an improvement – in terms of the degree to which it is representative of the US economy –
over Bargeron et al., the most conclusive study of its type to date; the methods are a significant
improvement over the current published studies in the literature; the risk measures analyzed are also
entirely distinct and new from prior research in a manner that is important. Prior research, as based
upon simple mean-variance analyses, is unreliable.
Keywords Regulation, Financial regulation, Accounting regulation, SarbanesOxley, Firm risk,
Equity risk, Financialrisk
Paper type Research paper
1. Introduction
After the collapse of Enron and reports of accounting fraud at WorldCom, HealthSouth,
and other leading firms, the US Congress enacted the Sarbanes Oxley Act of 2002. It is
widely considered the most comprehensive economic regulation since the New Deal.
However, the precise impact of the law upon firms has proven somewhat controversial:
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1358-1988.htm
JFRC
19,3
254
Journal of Financial Regulation and
Compliance
Vol. 19 No. 3, 2011
pp. 254-270
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581981111147883
Braendle and Noll (2004) su ggest that “self-induced ” disclosure would have
proven more effective than rigorous mandates in promoting transparency; Colasse
and Standish (2004) note the powerful socio-political influences that typically skew
the development and implementation of comprehensive accounting measures. More
recently, a growing body of research finds that the hastily designed law proved
unable to address the root causes of the subprime crisis (Nordberg, 2008), has failed to
improve corporate performance or value (Basu and Dimitrov, 2010), and is likely to
produce serious negative consequences (Vakkur et al., 2010; Engel et al., 2008; Zhang,
2007; Chhaochharia and Grinstein, 2007).
A growing area of research has been the law’s (risk) impact with contradictory
findings. Whereas Bargeron et al. (2010) report a decrease in corporate risk taking,
Akhigbe et al. (2009) and Akhigbe and Martin (2006) suggest an increase immediately
following the law’s enactment. Such research suggests that Sarbanes Oxley impact
upon firm (equity) risk remains unsettled[1]. Adding to the complexity, research
suggests more nuanced effects: Litvak (2008) reports a discriminatory impact upon
high-risk and well-governed firms; Cohen et al. (2007) reports an increase in managerial
risk aversion, while Vakkur et al. (2010) suggest a variety of unintended consequences.
Methodological limitations, as present in the research to date, make it difficult to
ascertain Sarbanes Oxley’s impact upon (equity) risk – the focus of this study. Not
only has the literature produced contradictory findings, the methodology employed,
e.g. simple mean-variance analyses – fails to fit the data and is fraught with
imprecision[2]. This study seeks to overcome these limitations, by being the first to
rigorously evaluate the law’s influence upon equity returns per unit of risk as well as
firm (equity) risk due to asymmetries – issues which have never previously been
subject to empirical analysis in spite of their documented importance to investors
(Kahneman and Tversky, 1979).
Data limitations represent an issue in any study, especially one seeking to isolate
the risk impact of a comprehensive regulation[3]. In this regard, we employ a
comprehensive dataset supporting daily data over a 16-year period, and covering
nearly three-fourths of all US (and EU) economic activity. Three basic research
questions are examined:
RQ1. Is up/downside risk empirically distinct from the unconditional beta?
RQ2. What is Sarbanes Oxley’s impact upon firm risk?
RQ3. What firm covariates moderate this influence?
2. Evaluation framework
Research to date, e.g. most recently Bargeron et al. (2010), has sought to evaluate
Sarbanes Oxley’s risk impact exclusively via a series of simple mean-variance analyses.
However, such a reliance produces several crucial limitations (Sortino and Vandermeter,
1991). Equity return distributions tend not to be symmetric (Sharpe, 1964; Ross, 1976;
Bookstaber and Clarke, 1985), so the approach does not fit the data. Furthermore, the
standard deviation fails to account for noted investor diversity in terms of risk
perception (Kahneman and Tversky, 1979)[4]. Within the CAPM framework, upside and
downside risks are equally distasteful – in actual practice, investors loathe downside
risk (Kraus and Litzenberger, 1976; Grinblatt and Titman, 1989; Dybvig and Ingersoll,
1982). Consequently, simple mean-variance analyses produce imprecise risk estimates
Sarbanes Oxley’s
impact upon
risk types
255
To continue reading
Request your trial