Defensive Management

Does the Sarbanes-Oxley Act Discourage Corporate Risk-Taking?

This Article uses a natural experiment to test whether the Sarbanes-Oxley Act of 2002 (“SOX”) may have induced managers to take fewer risks. Because SOX applies to all U.S. public companies, a U.S.-based test cannot rule out other possible causes of changes in risk levels. A cleaner test is available for cross-listed foreign firms: SOX applies to firms cross-listed in the United States on levels 2 and 3 (“level-23”), but not to firms cross-listed on levels 1 and 4 (“level-14”) or to foreign non-cross-listed firms. I use a triple difference methodology to estimate the effect of SOX on risk-taking by level-23 cross-listed firms. I match each cross-listed firm to a similar noncross-listed firm from the same country based on propensity to cross list. I measure the pair risk—the difference between the risk of a cross-listed firm and the risk of its match (first difference). Then, I estimate the after-minus-before SOX change in pair risk (second difference). Finally, I compare the after-minus-before changes in pair risk for level-23 pairs (where the cross-listed company is subject to SOX) to the change for level-14 pairs (where the cross-listed company is not subject to SOX) (third difference). I use four sets of proxies for risk: volatility of returns, balance sheet liquidity, financial leverage, and operating leverage. I find that the risk of level-23 firms declined significantly after SOX on all three measures: volatility and leverage declined, while balance sheet liquidity increased. She finds larger declines in risk for high-growth and high-Tobin’s Q firms, as well as firms whose Tobin’s Q declined more strongly during the period when SOX was adopted. This evidence is consistent with the view that SOX induced cross-listed firms to take fewer risks, and placed a particular burden on riskier and high-growth firms.

The full text of this Article is available to download as a PDF.