Investor Perceptions of Government Deregulation: Evidence from Section 404 of the Sarbanes-Oxley Act

Accounting Horizons, forthcoming.

50 Pages Posted: 21 Sep 2017 Last revised: 1 Feb 2022

See all articles by Benjamin W. Hoffman

Benjamin W. Hoffman

Cleveland State University

John L. Campbell

University of Georgia - J.M. Tull School of Accounting

Jason L. Smith

University of Nevada, Las Vegas

Date Written: September 1, 2020

Abstract

We investigate the stock market’s reaction to events leading up to the Securities and Exchange Commission’s (SEC) and Public Company Accounting Oversight Board’s (PCAOB) 2007 regulatory changes that reduced the scope of and documentation requirements for assessments of firms’ internal controls over financial reporting (ICFR), as required by Section 404 of the Sarbanes-Oxley Act. The stated goal of these regulations was to reduce firms’ and auditors’ compliance costs with mandatory ICFR assessments, while maintaining the effectiveness of these assessments. We examine abnormal returns surrounding key dates leading to the passage of these regulations and offer two main findings. First, investors reacted negatively on key event dates, suggesting that investors viewed the regulations as likely to reduce financial reporting quality rather than to drive firm and audit efficiencies. Second, this negative market reaction is larger when ICFR effectiveness should matter most – when firms are more complex, have higher litigation risk, and greater fraud risk. In additional analysis, we find that restatements increase in the post-regulation time period, consistent with investors’ concerns that the effect of the legislation would be a reduction in ICFR effectiveness. Overall, our results may imply that investors prefer stronger government regulation when it comes to the assessments of a firm’s internal controls over financial reporting.

Keywords: regulation; internal control effectiveness; financial reporting quality; audit quality

Suggested Citation

Hoffman, Benjamin W. and Campbell, John L. and Smith, Jason L., Investor Perceptions of Government Deregulation: Evidence from Section 404 of the Sarbanes-Oxley Act (September 1, 2020). Accounting Horizons, forthcoming., Available at SSRN: https://ssrn.com/abstract=3040098 or http://dx.doi.org/10.2139/ssrn.3040098

Benjamin W. Hoffman

Cleveland State University ( email )

2121 Euclid Ave
Cleveland, OH 44115
United States
2166874723 (Phone)

John L. Campbell (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States
706.542.3595 (Phone)
706.542.3630 (Fax)

Jason L. Smith

University of Nevada, Las Vegas ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States

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