Unintended Consequences of Granting Small Firms Exemptions from Securities Regulation: Evidence from the Sarbanes-Oxley Act

Abstract:     
This paper provides evidence about the unintended consequences arising when small companies are exempted from costly regulations - these firms have incentives to stay small. Between 2003 and 2008, the SEC postponed compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (SOX) for "non-accelerated filers" (firms with public float less than $75 million). We hypothesize and find that some of these firms had an incentive to remain below this bright line threshold. Moreover, we document that these firms remained small by undertaking less investment, making more cash payouts to shareholders, reducing the number of shares held by non-affiliates, making more bad news disclosures and reporting lower earnings than control firms. Finally, there is no evidence that firms remaining small are doing so to maintain insiders' private control benefits. These findings have implications beyond SOX because numerous federal and state regulations exempt small firms via bright line size thresholds.

Keywords: unintended consequences, regulations, Sarbanes-Oxley Act, Section 404

JEL Classifications: G18, G31, G32, G35, K22, M41

Accepted Paper Series