Did the Sarbanes-Oxley Act of 2002 lead to More Optimal Financing Decisions?

Abstract

This study empirically examines whether the adoption of the Sarbanes-Oxley Act of 2002 (SOX) led to subsequent improvements in financing decisions of firms. The provisions in SOX are likely to improve the corporate governance of firms which, consistent with the entrenchment hypothesis, should result in firms increasing leverage and reducing debt maturity. While I find that market leverage falls after the enactment of SOX, firms non-compliant with the board and committee independence provision significantly increase leverage more than compliant firms. Furthermore, firms non-compliant with the related party transaction and financial reporting provisions significantly reduce their debt maturity more than compliant firms. These findings are consistent with the premise that the mandated tightening of governance was the greatest benefit to those firms with the weakest governance structures. In contrast I find some evidence of the substitution hypothesis, as firms that are non-compliant with the financial reporting provision significantly reduce leverage more than compliant firms. However this relatively larger leverage decrease of non-compliant firms is concentrated among small firms, that I contend are seeking to reduce firm risk post-SOX through leverage reductions.