Financial Reporting After the Sarbanes-Oxley Act: Conservative or Less Earnings Management?

Abstract

One of the goals of the Sarbanes-Oxley Act (hereafter SOX) was to restore confidence in financial reporting by providing incentive for firms to report financial results that reflect the underlying economic performance. Early findings are inconclusive on the success of the Act. Cohen, Dey and Lys (2005) show that firms engage in less earnings management post-SOX, but Lobo and Zhou (2006) find that firms report earnings more conservatively. Reporting more conservatively could be consistent with greater earnings management. We simultaneously examine conservatism using discretionary accruals and earnings management using the absolute value of discretionary accruals Our findings suggest that firms are reporting more conservatively (i.e., reporting lower discretionary accruals), but also engaging in less overall earnings management (i.e., reporting lower absolute value of discretionary accruals). Our paper contributes to the literature by investigating the impact of SOX on financial reporting and reconciling potentially conflicting findings in other studies.

Keywords: Sarbanes-Oxley Act, Earnings Management, Accounting Conservatism

JEL Classification: G38, M41, M43, M44