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Abstract:
In this paper we study the effect of Section 404 of the Sarbanes-Oxley Act on earnings quality. Using a difference-in-differences method we find that firms that were required to comply with Section 404 during the first two years of its implementation improved the quality of their financial reporting more than control firms that were not required to comply. Our testing results also provide some evidence that the reduction in intentional misstatement contributes to the improvement in financial reporting quality of complying firms. Investor confidence appears to be restored, in that they react more strongly to earnings surprises of complying firms than to those of the control firms in the post-404 period. These results are robust to various sensitivity tests. Our results suggest that Section 404 helped to achieve the main goal of the Act: protecting investors and restoring their confidence in the stock market by improving the accuracy and reliability of corporate disclosure.

Section 404 of the Sarbanes-Oxley Act, Earnings Quality, Internal Control, Investor Confidence

Abstract:
This study examines firms surrounding the Sarbanes-Oxley Section 404 market value compliance threshold. We predict that management will behave opportunistically to affect their firm's market value in order to temporarily fall below the threshold. We find evidence that sample firms reduce their market value only during threshold measurement quarters, while control firms experience increasing market value. For threshold firms, dampened stock returns and insider trading function to reduce float. We consider this evidence of regulatory avoidance, confirming managers' beliefs regarding the net costs of the regulation. Additionally, we find that firms with the ability and incentives to avoid Section 404 do so.

Sarbanes-Oxley Section 404, Regulatory Avoidance, Small Firms

Abstract:
We study the immediate and delayed market response to SEC EDGAR 10-K filings. Unusual trading volumes and stock price movements are documented during the days around the 10-K filing dates. The abnormal price movements are positively associated with future accounting profitability, indicating that 10-K filings contain useful information about future firm performance. In addition, investors' reaction to 10-K information seems sluggish, as evidenced by the stock price drift during the twelve month period after 10-K filing. We find that investors' under-reaction tends to be stronger for firms with more complex 10-K filings.

Abstract:
Analysts who lack information on a company are likely to round their forecasts to the nearest multiple of five (10, 15, 20, etc). As information flow improves this rounding tendency is likely to dissipate. Information flow improved for analysts after 1995 with the advent of web browsers and the increase use of conference calls. Consistent with a structural change in information flow, we find that the proportion of analysts rounding their short-term EPS forecasts declines monotonically from 60 percent prior to 1995 to 28 percent by 2006 (the expected percentage is 20). We also document an improvement in the relative accuracy of rounded forecasts after 1995. We argue that changes in information flow after 1995 will have less impact on long-term growth forecasts since most information revealed in conference calls is short-term in nature. Consistent with this view, we find that the proportion of long-term growth forecasts rounded to the nearest multiple of five stays at around 40 percent with little improvement in accuracy over time. We document that when analysts round to the nearest multiple of five, they tend to round up (be optimistic). We examine investor response to rounded forecasts and find that investors are not fully aware of this optimism.

Abstract:
Earnings announcements and 10-K filings are two important channels through which companies release financial information to the public. Earnings announcements, particularly for large firms, are often accompanied by intensive media coverage. In contrast, 10-K filings are usually of much lower profile, attracting little investor attention. Limited attention hypothesis suggests that investors’ failure to devote enough attention to an economic event leads to underreaction, and the degree of underreaction should decrease with the amount of investor attention. In this paper we document evidence consistent with this hypothesis. First, we show that among large firms, investors under-react more to the information contained in 10-K filings than earnings announcements. Second, underreaction to earnings announcements tends to be stronger for small firms than large firms. In contrast, investor underreaction to 10-K information is similar between the two groups of firms. Third, we find that companies report their earnings and 10-Ks earlier when there is a higher demand for such information, and document a negative relationship between the degree of underreaction and the timeliness of such information release. Finally, we show that the recent ruling by SEC to accelerate 10-K filing has little impact on the degree of investors’ underreaction to 10-K information.

stock price drift, earnings, 10-K, limited attention

Abstract:
Altamuro and Beatty (2009) examine financial reporting quality before and after the Federal Deposit Insurance Corporation Improvement Act (FDICIA). They document increases in the validity of the loan loss provision, earnings persistence, predictability of future cash flows and reductions in benchmark-beating for banks complying with FDIC’s internal control regulations relative to non-complying banks. Our discussion focuses on Altamuro and Beatty’s interpretation of the results, specifically that the internal control provision of FDICIA improved financial reporting quality. In this paper, we provide a brief overview of FDICIA in an attempt to assess the importance of FDIC’s internal control regulations. We then review the findings of other studies on internal control regulations with the goal of evaluating what new insights we gain from Altamuro and Beatty. Next, we report new evidence relating to the subgroups driving the changes in financial reporting quality surrounding FDICIA. Finally, we discuss the results in the context of the current financial crisis and suggest avenues for future research.

FDICIA, Internal Control, Financial Reporting Quality