Accounting Conservatism and Income Smoothing after the Japanese Sarbanes–Oxley Act

Abstract

Research aims: The Japanese Sarbanes-Oxley Act (J-SOX) was implemented for the fiscal years ending on or after March 31, 2009 to ensure the reliability of financial reporting by listed firms. This study examines the effect of J-SOX on financial reporting quality, proxied by accounting conservatism and income smoothing.
Design/Methodology/Approach: This study conducts empirical analyses using a sample of Japanese listed firms with fiscal year-ends of March 31 from 2007 to 2010. We obtain financial data and stock price data from the Nikkei NEEDS Financial QUEST, stock return data from NPM Monthly Stock Return Data, and auditor data from eol. The sample consists of 7,752 and 7,594 firm-years regarding accounting conservatism and 7,380 firm-years regarding income smoothing. We perform multiple regression analyses with a dummy variable for the post-J-SOX period to compare the levels of accounting conservatism and income smoothing between the pre- and post-J-SOX periods.
Research findings: We find that accounting conservatism increased and income smoothing decreased immidiately after J-SOX implementation. In additonal analyses, we extend the sample period to 2012 and find the evidence indicating that the increasing effect of J-SOX on accounting conservatism may have persisted, but the decreasing effect on income smoothing have not persisted. These findings suggest that financial reporting quality in Japanese firms may have increased following J-SOX implementation through increased accounting conservatism (timely loss recognition).
Theoretical contribution/Originality: This study adds new evidence to the literature regarding the effect of internal control regulations on managerial accounting behaviour.
Practitioner/Policy implications: Our findings suggest that J-SOX may be effective in improving financial reporting quality although the procedures are relatively concise. Therefore, policy makers and accounting standard setters should consider not only strictness but also cost-effectiveness.
Research limitation: We cannot rule out the possibility that factors occurred during our study period other than J-SOX affected our results.

Keywords: Accounting Conservatism, Income Smoothing, Internal Control Regulation, Japan, Sarbanes–Oxley Act

JEL Classification: G38, M41, M48