The Sarbanes-Oxley Act and Managerial Risk Taking: A Structural Assessment

Abstract:     
This paper examines the impact of the Sarbanes-Oxley Act of 2002 (SOX) on managerial risk taking behavior in a structural investment framework. We apply the Generalized Method of Moments (GMM) estimation to the model. Based on the estimated structural parameters, we compute the hurdle rate perceived by the managers to decide investment spending, and use it as a measure of managerial risk preference. We identify robust evidence that the hurdle rates inferred from actual investment data and perceived by managers increase significantly in the post-SOX period. The increase in managerial hurdle rate is asymmetric and is mainly driven by value firms and less risky firms. We also find that managers of the firms with better corporate governance, higher credit ratings, and smaller degrees of information asymmetry become more cautious in their investment decisions after the passage of SOX.

Keywords: the Sarbanes-Oxley Act, investment Euler equation model, managerial hurdle rate, corporate governance

JEL Classifications: G3, G1

Working Paper Series