| While prior research suggests that firms have primarily switched from accrual to real earnings management strategies since the passage of the Sarbanes-Oxley Act of 2002 (Cohen, Dey, and Lys 2008), SOX hereafter, there has been limited research on the effects that this switch might have on firm performance and market pricing. Accrual earnings management simply shifts income recognition without affecting cash flows, whereas real earnings management implies suboptimal decisions that directly affect the underlying cash flows. Thus, this shift in earnings management techniques could have important consequences for investors. Consistent with increased real earnings management post-SOX, I find that abnormal operating decisions are less informative about future ROA and have a more negative effect on firm value relative to pre-SOX. Alternatively, consistent with less accrual earnings management post-SOX, I find that discretionary accruals are more informative about future ROA. Further, there is less evidence of market mispricing relative to pre-SOX. Finally, I examine the net effect that SOX has had on earnings management and find evidence consistent with earnings management in the post-SOX period leading to lower future returns and firm performance. |
