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A Lobbying Approach to SOX

By Harvard Law School Program on Corporate Governance

(Editor?s Note: This post comes from Yael V. Hochberg, Paola Sapienza and Annette Vissing-Jørgensen of Northwestern University.)

In our forthcoming Journal of Accounting Research paper entitled A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002, we evaluate the impact of the Sarbanes-Oxley Act (SOX) on shareholders by studying the lobbying behavior of investors and corporate insiders in order to affect the final implemented rules under the Act.

Following the passage of SOX in 2002, Congress delegated the drafting and implementation of the principles outlined by SOX to the Securities and Exchange Commission (SEC). The various sections of SOX were divided into separate rules by the SEC, which then solicited public comments regarding the proposed rules, prior to adopting the final releases. Letters to the SEC commenting on the proposed rules were publicly available on the SEC website or through its public reference office. Following the main compliance-related titles of SOX, we classify the rules on which the SEC solicited comments into groups. We focus on three major sets of rules: provisions related to enhanced financial disclosure (including the much-discussed Section 404 assessment of internal controls), provisions related to corporate responsibility, and provisions related to auditor independence.

Our review of these comment letters revealed that Investors lobbied overwhelmingly in favor of strict implementation of SOX, while corporate insiders and business groups lobbied against strict implementation. In addition, we find that the firms most likely to lobby were firms in mature industries, with relatively low forecasted earnings growth, high profitability and poor governance. These are precisely the types of firms that Jensen?s [1986] theory of free cash flow would predict are likely to provide more opportunities to management for expropriation, perquisite consumption or mismanagement of firm resources. In contrast, our analysis of audit fees indicates that lobbying firms are unlikely to be those that expect a large relative increase in compliance costs. Rather, lobbyers on average had lower audit fees relative to initial market value pre-SOX, and their audit fees relative to size increased by less, post-SOX, than those of non-lobbying firms.

Our portfolio analysis of returns reveals that during the period leading up to passage of SOX (February to July of 2002), cumulative returns were approximately 7 percentage points higher for corporations whose insiders lobbied against one or more of the SOX ?Enhanced Disclosure? provisions than for non-lobbying firms of similar size, book-to-market and industry characteristics. In contrast, we find no significant evidence of higher cumulative returns for those corporations whose insiders lobbied against one or more of the SOX ?Corporate Responsibility? provisions or for those corporations whose insiders lobbied against one or more of the SOX ?Auditor Independence? provisions than for comparable non-lobbying firms. Our analysis of returns in the post-passage implementation period suggests that investors? positive expectations with regards to the effects of the ?Enhanced Disclosure? provisions were warranted.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on November 29, 1999 (boomark / email).