Defensive Management: Does the Sarbanes-Oxley Act Discourage Corporate Risk-Taking?

Abstract

Prior studies find that foreign firms subject to the Sarbanes-Oxley Act ("SOX") suffered significant declines in market valuation; these declines are too large to be fully explained by the increased costs of direct compliance. This paper investigates one possible source of losses - the charge that SOX discourages corporate risk-taking. I use a triple difference methodology to estimate the effect of SOX on risk-taking by SOX-exposed foreign firms. I match each foreign cross-listed firm to a similar non-cross-listed firm from the same country based on propensity to cross-list. I measure the "pair" risk - the difference between the risk of a cross-listed firm and the risk of its match (first difference). I then estimate the after-minus-before SOX change in pair risk (second difference). Finally, I compare the after-minus-before changes in pair risk for SOX-exposed pairs (where the cross-listed company is listed on level 2 or 3 and is thus subject to SOX) to the change for SOX-unexposed pairs (where the cross-listed company is listed on level 1 or 4 and is thus not subject to SOX) (third difference). I use three sets of proxies for risk: volatility of returns, financial leverage, and cash hording. I find that the risk of SOX-exposed foreign firms declined significantly after SOX on all three measures. High-Tobin's Q firms suffered larger declines in risk. Firms that were riskier before SOX lost more of their value after SOX. This evidence is consistent with the view that SOX induced cross-listed firms to take fewer risks, and placed a particular burden on riskier and better-governed firms.

Keywords: Sarbanes-Oxley, cross-listing, risk-taking, corporate law, securities law

JEL Classification: F23, G18, G30, G38, K00, K20, K22