The effect of Sarbanes-Oxley Act and managerial-entrenchment on earnings management and the value relevance of earnings


Student thesis: Doctoral Thesis

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  • Anthony C Y NG

Related Research Unit(s)


Awarding Institution
Award date15 Feb 2007


This thesis examines the effects of the passing of Sarbanes-Oxley Act (SOX) of 2002 as well as managerial entrenchment of corporations (a proxy for corporate governance) on (1) earnings management and (2) the value relevance of earnings. Following the scheme used in Cohen et al. (2005), this study partitions the sample period into three sub-periods – the Pre-Scandal (January 1, 1990 – June 30, 2001), Scandal (July 1, 2001 – June 30, 2002) and Post-SOX sub-periods (after July 1, 2002) – based on Enron’s collapse and the passing of SOX. Data analyses using 10711 (which consists of 7029 firm-year observations during the Pre-Scandal sub-period, 1251 firm-year observations during the Scandal sub-period and 2431 firm-year observations during the Post-SOX sub-period) firm-year observations show the following. First, it is found that discretionary accruals (a proxy for earnings management) are of the highest magnitudes during the Scandal sub-period, consistent with the Cohen et al. (2005) study. Based on such findings, Cohen et al. (2005) conclude it is mainly the large magnitudes of absolute discretionary accruals during the Scandal sub-period that lead to the passing of SOX. However, my analysis shows that the large magnitudes of accruals during the Scandal sub-period are mostly income-decreasing in nature. This finding suggests that the conclusions in the Cohen et al. (2005) study might not be appropriate since income decreasing accruals are more likely to be conservative application of GAAP. In addition, this thesis also takes into account firm-level corporate governance when investigating the nature of earnings management. Firm-level corporate governance in this thesis is proxied by the aggregate of six anti-managerial-entrenchment mechanisms that are in place. The anti-managerial-entrenchment mechanisms are extracted from the Investor Responsibility Research Center (IRRC) takeover database. Taking into account nature of corporate governance, this thesis shows that corporations are more likely to engage in income-decreasing earnings management if they have more anti-managerial-entrenchment mechanisms in place during the Scandal sub-period. Besides the relationship between earnings management and anti-managerial-entrenchment mechanisms, this thesis also examines the value relevance of earnings during the different sub-periods. It is shown that value relevance of earnings is significantly different for the three sub-periods. Strong anti-managerial-entrenchment mechanisms have a positive impact on the value relevance of earnings, but only during the Scandal sub-period. In addition to the effect of strong anti-managerial-entrenchment mechanisms, this thesis also shows that such positive impact only apply to firms that engage in income-decreasing earnings management during the Scandal sub-period. Investors seem to take into account corporate governance characteristics, and place more confidence on the reported earnings for firms that are managing earnings downward when corporate governance characteristics are stronger during the Scandal sub-period. The results suggest that there is a substitution effect between firm-specific corporate governance mechanism and macro corporate governance improvement like the passing of SOX in general.

    Research areas

  • Financial statements, Accounting, Corrupt practices, Corporations, Law and legislation