Did the Sarbanes-Oxley Act Affect Corporate Risk-Taking? The Study of Cross-Listed Companies

Abstract:     
This paper uses a triple difference approach to test a popular hypothesis that the Sarbanes-Oxley Act induced firms to lower their risk levels. Because SOX applies to all US public companies, a US-based test cannot rule out other possible causes of changes in risk levels. A cleaner test is available for cross-listed firms: SOX applies to firms cross-listed in the US on levels 2 and 3, but not to firms cross-listed on levels 1 and 4; it also does not apply to foreign non-cross-listed firms. I match each cross-listed firm to a similar non-cross-listed firm from the same country, and measure the pair-level risk - the difference between the risk of a cross-listed firm and the risk of its match (first difference). I then estimate the after-minus-before SOX changes in pair-level risk (second difference). Finally, I compare the after-minus-before changes in pair risk levels of pairs where the cross-listed company is listed on level 2 or 3 (and thus subject to SOX) and pairs where the cross-listed company is listed on level 1 or 4 (and thus not subject to SOX) (third difference). I use three sets of proxies for risk: volatility of returns, balance sheet liquidity, and leverage. I find that the volatility of returns of level-23 firms declined significantly after SOX, compared to non-cross-listed firms and level-14 firms. Liquidity of level-23 firms increased (and therefore risk declined), compared to non-cross-listed firms and level-14 firms. High-growth and high-Tobin's Q firms, as well as firms whose Tobin's Q declined more strongly during the period when SOX was adopted, experienced the largest decreases in volatility and increases in liquidity. Leverage declined significantly only for high-growth companies. Firms that were more volatile before the adoption of SOX experienced significantly stronger declines in their Tobin's Q than less volatile firms. This evidence is consistent with the view that SOX placed particular burden on riskier firms and induced firms to take less risk, especially high-growth and already well-governed firms.

Keywords: Sarbanes-Oxley Act, cross-listing, corporate governance, risk, volatility, securities regulation

JEL Classifications: K00, K22, G3, G15, G34, G38

Working Paper Series