The Sarbanes-Oxley Act and Exit Strategies of Private Firms

Abstract

The costs and benefits of the Sarbanes-Oxley Act of 2002 (SOX) have been oft-debated since the inception of the Act. Much of the extant literature has assessed the costs and benefits of SOX to publicly-traded companies. We focus on the costs of SOX compliance for private firms wanting to exit the private market via either an acquisition by a public firm or an IPO. Consistent with our predictions we establish three principal findings. First, SOX appears to have shifted the incentive for firms to exit the private market via IPO to exit via acquisition by a public acquirer. Second, private target deal multiples are increasing in variables that proxy for a private target’s level of pre-acquisition SOX compliance. For our median-sized private target, the estimated dollar value decrease in deal proceeds when one moves from a high level to a low level of pre-acquisition SOX compliance is $1.3 million. Finally, public target deal multiples are not affected by a public target’s level of pre-acquisition SOX compliance. These findings suggest that SOX-related costs have both restricted the action space of possible exit strategies for private firms and led to lower deal multiples for those private acquisition targets that are less likely to be SOX compliant prior to acquisition. We believe that the implications from our tests will be relevant to regulators in the U.S. and many countries outside the U.S. that are attempting to improve their country’s governance and listing standards and potentially seeking alternatives to SOX-like standards, especially with respect to internal controls. International regulators need to assess the total costs of SOX, including costs imposed on private company shareholders, when contemplating the net benefits of SOX-like regimes.

Keywords: Sarbanes-Oxley, SOX, M&A, IPO, Private Firms

JEL Classification: G30