The Wealth Change and Redistribution Effects of Sarbanes-Oxley Internal Control Disclosures

36 Pages Posted: 25 Apr 2005

See all articles by Gus De Franco

Gus De Franco

Tulane University - A.B. Freeman School of Business

Yuyan Guan

University of Toronto - Rotman School of Management

Hai Lu

University of Toronto - Rotman School of Management

Date Written: April 17, 2005

Abstract

This article provides evidence about the wealth change and redistribution effects of Section 404 of Sarbanes-Oxley (SOX), which requires that management assess and publicly report on the effectiveness of their firm's internal controls, and that auditors publicly provide an opinion on management's assessment, as well as the effectiveness of the internal controls. This section is the most expensive, burdensome and contentious part of SOX - mainly because the benefits are elusive, and according to some critics, non-existent. We analyze a sample of 102 firms that report a deficiency in their internal controls between November 1, 2003 and December 31, 2004 and that have no confounding news during the event window. We find that the cumulative size-adjusted abnormal returns are -1.8% during the three-day event window for firms that report internal control deficiencies. This economically-significant wealth change supports the idea that investors value internal control news and that they are not (at least fully) aware of these deficiencies prior to the disclosures. We confirm these results for a small sample of firms reporting deficiencies in the first calendar quarter of 2005. More importantly, using trading data from the NYSE TAQ database, we find that small- (large-) investor net buying is positively (not) associated with returns. More specifically, it is small-investor net selling that is driving the negative returns. These results are consistent with the redistribution of wealth from large to small investors during the announcement period. In summary, our results support the conjectures made by regulators underlying the regulation and show that small investors benefit more from these disclosures than large investors.

Keywords: Internal Control, Sarbanes-Oxley Act, trading volume, corporate disclosure

JEL Classification: G14, G28, G34, M41

Suggested Citation

De Franco, Gus and Guan, Yuyan and Lu, Hai, The Wealth Change and Redistribution Effects of Sarbanes-Oxley Internal Control Disclosures (April 17, 2005). Available at SSRN: https://ssrn.com/abstract=706701 or http://dx.doi.org/10.2139/ssrn.706701

Gus De Franco (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Yuyan Guan

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
416-978-3813 (Phone)

Hai Lu

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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