The Effect of SOX on the Predictability of Future Cash Flows in Litigious and Non-litigious Industries

Chang, Hsihui; Suh, Sang-Hyun; Werner, Edward M.; Zhou, Jian

doi:10.2139/ssrn.1267464

Cited by 3 publications

(3 citation statements)

References 35 publications

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“…Cohen et al () present similar evidence over a much longer period and find that accrual‐based earnings management increased steadily from 1987 to 2001, followed by a significant decline in 2002–2005 and that the converse is true for real‐activity manipulations, which are not subject to SOX regulations. Chang et al () study the predictive ability of discretionary accruals and report that they have become more important in predicting future cash flows during the post‐SOX period, compared to the pre‐SOX period. Chambers and Payne () focus on accrual persistence and conclude that it increases significantly in the post‐SOX period.…”

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

Does Accrual Management Impair the Performance of Earnings‐Based Valuation Models?

Courteau¹,

Kao²,

Tian

2015

Business Fin & Account

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This study examines how accrual manipulations affect firm valuation in the years surrounding the passage of the Sarbanes-Oxley Act (SOX). We compare the absolute percentage pricing errors of RIM and DCF valuation models for a group of US firms suspected to have engaged in accrual manipulations to avoid a small loss or a small earningsdecline vs. "Normal" firms matched on industry, year and size.We find that RIM can better estimate intrinsic value than DCF for the matched Normal firms in the pre-SOX period, but not so for accrual manipulators, and that SOX mitigates the harmful effect of accrual manipulations, completely eliminating the difference in RIM"s accuracy advantage over DCF between Normal firms and accrual manipulators. As a further analysis, we redefine Suspect firms as real-activity manipulators and find a significant across-group difference in accuracy wedge in both sample periods, implying that SOX has prompted firms to favour real-activity manipulations over accrual manipulations. JEL Classification: M41

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Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

Does Accrual Management Impair the Performance of Earnings‐Based Valuation Models?

Courteau¹,

Kao²,

Tian

2015

Business Fin & Account

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“…Panel A of Table 2 presents the papers that studied the relationship between earnings management and predictability. Most of them defended that earnings management decreases predictability, because it adds noise to the reported earnings (Chang et al, 2012;Dechow and Dichev, 2002;Huang et al, 2014). Their results corroborate this expectation, showing a negative relationship between earnings management and predictability.…”

Section: Papers That Study the Empirical Relationships Among Earningsmentioning

confidence: 75%

A Review on the Multidimensional Analysis of Earnings Quality

Licerán-Gutiérrez

Rodríguez

2017

SSRN Journal

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“…Tong and Miao (2011) find that firms with higher litigation risk demonstrate better earnings quality. Chang et al (2012) show that litigation risk improves the informational content of discretionary accruals. Frankel et al (2002) document a significantly positive impact of shareholder litigation risk on income-decreasing discretionary accruals, but no effect on income-increasing discretionary accruals.…”

Section: Shareholder Litigationsmentioning

confidence: 92%

Shareholder litigation risk and real earnings management: a causal inference

Liao

Ouyang

2019

RAF

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Purpose The authors study how shareholder litigation risk impacts a firm’s decision of real earnings management (REM). This paper aims to shed light on how shareholder litigation risk impacts REM. The authors further explore how the intensifying effect varies systematically conditioning on the degree of information asymmetry and the strength of internal corporate governance. Design/methodology/approach In this study, the authors use the 1999 Ninth Circuit Court ruling as a quasi-experiment that reduces shareholder litigation risk to address endogeneity and establish a causal inference. Findings The difference-in-difference tests suggest lower shareholder litigation risk intensifies REM. In other words, higher litigation risk mitigates REM. Cross-sectional test results suggest the negative effect of decreased shareholder litigation is more pronounced when monitoring difficulty is higher, when information environment is more impoverished and when internal corporate governance is weaker. The negative effect is also stronger in firms with higher sensitivity to legal threats. Originality/value Protection of investors’ interest is the focus of corporate governance. Designed as an important corporate governance mechanism, shareholder litigation enables investors to pursue legal actions to recover their losses in the event of corporate misbehaviors. However, whether shareholder litigation is an effective corporate governance tool and beneficial to shareholders and firms is not without controversy. The authors contribute to the debate by providing evidence that supports the argument that shareholder litigation threat significantly disciplines REM, a form of costlier earnings management technique and myopic investment behavior.

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The Effect of SOX on the Predictability of Future Cash Flows in Litigious and Non-litigious Industries

Cited by 3 publications

References 35 publications

Does Accrual Management Impair the Performance of Earnings‐Based Valuation Models?

Does Accrual Management Impair the Performance of Earnings‐Based Valuation Models?

A Review on the Multidimensional Analysis of Earnings Quality

Shareholder litigation risk and real earnings management: a causal inference

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