Ripple Effects: Sarbanes Oxley’s Impact upon Investor Risk in a Global Economy

Abstract

Purpose: This study seeks to evaluate, in a global context, the impact of Sarbanes Oxley Act on a particular risk measure of importance to investors (risk-adjusted returns), and two measures of risk due to asymmetry (upside and downside risk). A unique dataset permits a dual evaluation of the law’s impact upon such measures in leading non-US economies as well (i.e., “ripple effects”).

Design/methodology/approach: Hypotheses are empirically evaluated on a sample (n = 712) of the largest US and European firms (control) using daily return data from 1993 through 2009 — one of the most extensive data sets employed in the literature on this topic to date. The reliability of our risk measures is carefully evaluated using multiple approaches, including Fama-MacBeth regressions. We then employ a series of difference-in-difference analyses to empirically assess Sarbanes Oxley’s impact upon equity risk. Findings: Our findings suggest Sarbanes Oxley decreased both risk-adjusted returns and upside risk, whereas downside risk fails to explain the cross section of returns for the largest US firms. From a global perspective, we suggest that the enactment of Sarbanes Oxley’s in the US motivated leading non-US economies to adopt similar regulatory measures, which caused “ripple effects”— e.g., effects similar to those documented in this paper — in leading non-US economies.

Practical implications: Our findings suggest that comprehensive financial regulations, such as Sarbanes Oxley Act, are properly envisaged at the global level, as their impact is not confined to the home country. In an increasingly globalized economy, investor welfare is likely to be influenced — directly as well as indirectly — by economic and financial regulation(s) enacted in foreign economies. Arguably, this suggests the pivotal importance of effective mechanisms of global governance, such that a purely domestic approach to regulation may be shortsighted. In either case, the findings of this study are entirely relevant if regulators are to consider the broader, global impact of regulation upon investor welfare.

Originality/value: This is the first study to empirically analyze, within a global framework, Sarbanes Oxley’s risk implications without relying upon a series of simple mean variance analyses. Substantive research documents that the methodological approach we employ is more precise, reliable as well as ‘investor relevant’. Furthermore, we seek to assess the law’s impact upon leading non-US equity markets, a first for the literature. Consequently, this study provides a robust evaluation of the law’s (international) impact upon firm (equity) risk, making an important contribution to the literature.

Keywords: Sarbanes Oxley, financial regulation, global financial crisis, ethics in accounting, risk analysis, equity risk, asymmetric risk

JEL Classification: B23, B41, C10, C12, C13, C14, C20, C40, C50, C81, D80, D81, E61, G10, G11, G14, G15, G18, G34, G38