The Effectiveness of the Sarbanes-Oxley Act in Constraining Earnings Management

Widespread concern about earnings management, the management of financial information to mislead investors, was one of the key factors leading to the passage of the Sarbanes-Oxley Act of 2002 (SOX). In this study, I investigate whether SOX is effective in limiting earnings management. Earnings management is a concern because misrepresentation of a company’s financial position and the results of its performance can mislead investors into making poor investment decisions. This study examines earnings changes before and after the passage of SOX to see whether small positive earnings changes were less likely in the post-SOX period, supporting the effectiveness of SOX in constraining earnings management. This study did not find significant improvements in the quality of financial reporting after the passage of SOX. This lack of significant results could reflect the limits of the sample and the data analysis. It is also possible that earnings management was already being constrained prior to the Act, due to new auditing standards and media attention, or that earnings management was not as widespread as the media made it appear to be during the Enron and WorldCom scandals