All the news on SOX that's fit to print

Floyd Norris writing in today’s NYT has decided that the evidence has wrapped up the debate on SOX:

It has become received wisdom on Wall Street that the Sarbanes-Oxley Act has damaged American competitiveness. It made listing in the American market less attractive to foreign companies and drove initial public offerings overseas. It raised costs for American companies without providing any significant benefit. But do the facts support that wisdom? No.

Norris gets that remarkable conclusion from a single study by Doidge, Karolyi and Stulz based on 59 firms that delisted after the adoption of SEC Rule 12h-6, which allowed firms to deregister from the 1934 Act and SOX based on their average daily trading volume in the US. Norris summarizes the study as follows:

• the market did not react favorably when companies got out from under American regulation.
• share prices suffered in the few cases where foreign companies with good growth prospects left the American market.
• the study finds no evidence to support the thesis that companies that leave the United States are rewarded by investors, and some evidence to indicate that those who could benefit from an American listing are punished.

Yes, the study did find, according to the abstract, “weak evidence that firms experience negative stock returns when they announce deregistration and stronger evidence that the stock-price reaction is worse for firms with higher growth” (emphasis added).  Why is the evidence "weak"?

First, it’s only 59 firms that self-selected by reacting to 12h-6. Although it’s reasonable to hypothesize that these were the firms that suffered most from SOX, there could be a lot of other things going on with this small sample of all of the foreign firms affected by SOX.

Second, in terms of the stock price effect, the authors concede that it may be "that investors partially anticipated the actions of the deregistering firms." In fact, the authors do look at stock price effects after announcement dates relating to adoption of 12h-6. While they find no positive stock price reactions, which suggests SOX isn't driving firms away,

at the same time, however, the estimates are not supportive of the bonding theory [that SOX is good for firms] either. With that theory, we would expect a negative announcement return for the rule change since allowing firms to renege more easily on the bonding provided by adherence to U.S. laws and regulations would decrease the value of a U.S. listing.

Moreover, the authors find that for 18 of the 59 firms which made statements in their press releases about deregistration that they were reacting to SOX, there was a positive stock price reaction. This wasn't statistically significant, but, then, we do have that small sample size.

The authors’ self-assessment of their work [in contrast to Norris's] is appropriately modest:

we find some results supportive of the bonding [Sox-is-good] hypothesis. At the same time, however, not all results are supportive of that hypothesis. Since our results do not contradict the bonding hypothesis, there may well be an issue of the power of our tests due to the limited size of our sample.

So Norris has used his bully pulpit at the NYT to inflate the importance of this rather modest paper.

If you want a balanced assessment of SOX, the NYT is not the place to look. There have been numerous studies of SOX, both in terms of direct effects (see, e.g., Bargeron, et al, reporting that "overall, the evidence supports the proposition that SOX discourages risk-taking by public U.S. companies) and stock price effects (see, e.g., Litvak , reporting that "the overall evidence is consistent with the view that SOX negatively affected cross-listed premia, and particularly hurt riskier firms and firms from well-governed countries, while perhaps helping high-growth firms from poorly-governed countries”).  Norris misleadingly reports on evidence showing a short-term effect. 

Comments

[michael webster]

You might be interested in this series of links about Sox:

http://www.sequence-inc.com/fraudfiles/2008/08/09/but-sarbanes-oxley-hasnt-actually-reduced-fraud/