The Disappearance of the Zero-Earnings Discontinuity: SOX, Dotcom Boom or Gradual Decline?
15 Pages Posted: 12 Jul 2021 Last revised: 20 Jun 2022
Date Written: May 2022
Abstract
The zero-earnings discontinuity in the US disappeared around the time when the Sarbanes–Oxley Act (SOX) became effective, suggesting that SOX may have reduced the small loss avoidance by firms. In this paper, we examine a potential confounding effect arising from the dotcom boom at the turn of the millennium. Many newly listed dotcom firms had no revenues but high market capitalizations. Therefore, they mechanically fell into the smallest loss interval, artificially reducing the zero-earnings discontinuity. Once this dotcom effect is accounted for, our results no longer suggest a sharp (causal) effect of SOX on the decline in the zero-earnings discontinuity.
Keywords: Earnings management, Zero-earnings discontinuity, SOX, Dotcom boom, Earnings distribution, Small loss avoidance
JEL Classification: M48, G38, M41
Suggested Citation: Suggested Citation