Securitization and earnings management: evidence from the Sarbanes–Oxley act

Publication Date10 June 2020
Date10 June 2020
SubjectAccounting & Finance,Financial risk/company failure,Financial compliance/regulation
AuthorAnin Rupp
Securitization and earnings
management: evidence from
the SarbanesOxley act
Anin Rupp
Faculty of Business Administration, Chiang Mai University, Chiang Mai, Thailand
Purpose This paper aims to examine whetherthe opportunistic use of assets securitization for earnings
management is systematically widespread. It is hypothesized that with the passage of the SarbanesOxley
(SOX) Act of 2002, which imposed more stringent governance over the f‌inancial reporting process, there
should be a decrease in the opportunistic use of securitization among f‌irms that were not compliantprior to
the passage.
Design/methodology/approach The author use the SOX Act as an exogenous shock to determine
whetherthe act had the intendedeffect of mitigating opportunistic securitization.
Findings The empirical results show that there was a signif‌icant decrease in securitization among the
non-compliant f‌irmsrelative to the compliant f‌irms and this reduction is related to f‌irms using securitization
opportunistically. This evidence suggests that securitization for earnings management was a systematic
phenomenonand that SOX was effective in mitigating such behavior.
Originality/value The contribution of this paper to the literature is twofold. It will identify changes in
the use of asset securitization for earnings management purpose by using the exogenous variation in the
strength of external governance. Furthermore, it will provide additional evidence of the effectiveness of
f‌inancialregulations and have potential implicationsat the policy maker level.
Keywords Securitization, Non f‌inancial f‌irms, SarbanesOxley act
Paper type Research paper
1. Introduction
According to the US f‌low of funds account, assets f‌inanced by issuers of asset-backed
securitization sit at roughly US$1.45tn as of Q4 2014[1]. Securitization allow f‌irms to
generate cash through the sale of asset cash f‌lows such as accounts receivables, to outside
investors. One benef‌it of securitization is the ability for f‌irms to raise cash quicker and
possibly cheaper when compared to traditional methods such as debt f‌inancing. Previous
accounting literature by Dechow and Shakespeare (2009) have demonstrated how
securitization can be accounted for in two ways by the f‌irm. First, it can be treated as a
collateralized borrowing and thus will be ref‌lected in f‌inancial statements as a source of
f‌inancing. Second, it can be treated as a receivable sale to the bankruptcy remote special
purpose vehicle (SPV) where thereceivables are removed from the books and replaced with
cash and a retained asset,which represents the f‌irms ownership stake in the future cash
f‌lows. However, SFAS No. 125/140 stipulates that the retained tranchesbe recorded at fair-
value but does not specify guidelines of how fair-value should be determined. Any value
above the carrying value is recorded as a gain on saleon the income statement. This can
give the appearance of the f‌irm being more prof‌itablewhile having lower leverage.
JEL classif‌ication G18, G23, G28, G30
Received3 February 2020
Revised10 April 2020
Accepted11 May 2020
Journalof Financial Regulation
Vol.29 No. 1, 2021
pp. 44-62
© Emerald Publishing Limited
DOI 10.1108/JFRC-01-2020-0013
The current issue and full text archive of this journal is available on Emerald Insight at:
Thus, there is a potential for f‌irms to use asset securitization for purpose of earnings
management as given by the f‌indings of Dechow et al. (2010) and Dechowand Shakespeare
(2009). They f‌ind that managers use securitization as a means of earnings management
through discount rate manipulation of retained securitized assets. However, any evidence
provided merely suggest a correlation between earnings management and asset
securitization without considering the other potential explanation of why f‌irms may use
asset securitization. It is quite plausible that f‌irms are faced with f‌inancial constraints and
use asset securitization as a means of collateralized borrowing, which potentially explains
the increase in asset securitization.In light of this, it is still unclear whether the use of asset
securitization opportunistically was widespread. This paper offers the identif‌ication of
systematic opportunistic securitization use through the exploitation of the exogenous
governance shocks brought on by the SOX Act, hereby referred to as SOX[2]. If it is the fact
that the opportunistic phenomenon is widespread, it is imperative to understand whether
exogenous f‌inancial regulations such as SOX, which result in governance shocks are
effective in mitigating these types of behavior. In essence, the contribution of this paper to
the literature is twofold. It will identifychanges in the use of asset securitization for earnings
management purpose by using the exogenous variation in the strength of external
governance. Furthermore,it will provide additional evidence of the effectivenessof f‌inancial
regulations and have potentialimplications at the policy maker level.
To answer these questions,the analysis in this paper consists of implementing two event
studies around the initiation of SOX. The sample of f‌irms is divided into two groups,
namely, the control group, which is def‌ined as SOX compliant(based on section 208 and 301
def‌initions) prior to the passage and the treated group, which is def‌ined as non-SOX
complaint prior to the passage. Similar to Cohen et al. (2008), the sample period is divided
into two time periods, namely, theperiod prior to the passage of SOX from 1996 to 2001 and
the period after the passage of SOX from 2002 to 2009. This sample periodis broken further
into a three-year, f‌ive-year and seven-year event windows. The dependent variables is a
dummy variable, which equals to one if the f‌irm securitizes during the year and zero
otherwise. The f‌irst event study is used to test whether there is a signif‌icant decrease in
securitization for noncompliant nonf‌inancial f‌irms as compared to compliant nonf‌inancial
f‌irms[3]. The f‌indings show that f‌irms withoutan independent board of directors decreased
their usage of securitizationafter the passing of SOX and this is robust acrossmultiple event
windows. Further robustness tests are completed through the use of propensity score
matching, as referenced by Rosenbaum and Rubin (1983), to match based on f‌irm
characteristics. Two types of matching techniques are used, namely, nearest neighbor (NN)
matching and radius matching. The analysis shows that the main result is robust when
looking at a matched sample for multiple event windows. For the matched sample, f‌irms
without independent board of directors saw a reduction in securitization with the
implementationof SOX.
It is still unclear, however, whether this reduction in securitization relate specif‌ically to
the opportunistic usenoncompliant f‌irms. It is quite plausible that this reduction in the
number of f‌irms securitizing as a result of SOX is related to noncompliant f‌irms who use
securitization simply as collateralized borrowing. Therefore, to identify the opportunistic
usenoncompliant f‌irms vs collateralized borrowingnoncompliant f‌irms, two f‌inancial
constraint measures, the Whited-WuIndex (WW Index) and the SA Index, are introduced as
proxies. A second event study is performed to test whether the implementation SOX had
any effect on f‌inancial constraints of f‌irms within the sample. The f‌indings show no
signif‌icant changes in noncompliant f‌irmsf‌inancial constraint before and after SOX for
both the WW Index measure and SA Index measure. This result suggests that
Evidence from
the Sarbanes
Oxley act

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