The Disappearance of the Zero-Earnings Discontinuity: SOX, Dotcom Boom or Gradual Decline?
20 Pages Posted: 12 Jul 2021
Date Written: June 30, 2021
The zero-earnings discontinuity in the United States disappeared around the time when the Sarbanes-Oxley Act (SOX) became effective, suggesting that SOX might have had a real and lasting impact on earnings management. In this research note, we examine a potential confounding effect of the dotcom boom at the turn of the millennium. Many firms that went public in this period had no sales revenues and therefore invariably incurred losses. When the stock market valuation was high, the losses scaled by the market value of equity often fell into the smallest loss interval, reducing the discontinuity in the overall sample. However, these observations do not indicate a decline in earnings management. We find that the dotcom effect is nonnegligible. When filtering out the firms without sales, our results no longer suggest a sharp decline in the zero-earnings discontinuity after SOX. Rather, our findings are consistent with a gradual decline in earnings management over time.
Keywords: Earnings management, Zero-earnings discontinuity, SOX, Dotcom boom, Earnings distribution, Small loss avoidance
JEL Classification: M48, G38, M41
Suggested Citation: Suggested Citation