The Sarbanes-Oxley Act, industrial innovation, and real option creation

Waters, James (2013): The Sarbanes-Oxley Act, industrial innovation, and real option creation.

Abstract

We look at the effect of the US Sarbanes-Oxley (SOX) financial regulation on industrial innovation. Our theoretical framework shows it creating immediate uncertainty about its costs and future resolution of cost and managerial performance uncertainty. Real option value is created for investment delay. We construct a panel of patenting data and fit our model to it. We find a dip in patenting after SOX and subsequent medium term recovery, with larger dips for small, risky, and new companies. In the medium term, these companies continue to have relatively lower patenting. Like SOX, the dynamic behaviour is found only to apply to US companies. Our results have implications for policy and analysis.

• Item Type: MPRA Paper
• Language: English
• Keywords: Innovation; Patents; Sarbanes-Oxley; Regulation; Real options
• Subjects: G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; G - Financial Economics > G3 - Corporate Finance and Governance > G38 - Government Policy and Regulation; O - Economic Development, Innovation, Technological Change, and Growth > O3 - Innovation ; Research and Development ; Technological Change ; Intellectual Property Rights > O31 - Innovation and Invention: Processes and Incentives; O - Economic Development, Innovation, Technological Change, and Growth > O3 - Innovation ; Research and Development ; Technological Change ; Intellectual Property Rights > O38 - Government Policy

References

Ahmed, A., McAnally, M., Rasmussen, S. and Weaver, C. (2010) How costly is the Sarbanes Oxley Act? Evidence on the effects of the Act on corporate profitability, Journal of Corporate Finance, 16, 352-69.

Akhigbe, A. and Martin, A. (2008) Influence of disclosure and governance on risk of US financial services firms following Sarbanes-Oxley, Journal of Banking & Finance, 32, 2124-5.

Akhigbe, A., Martin, A. and Newman, M. (2008) Risk shifts following Sarbanes-Oxley: Influences of Disclosure and Governance, The Financial Review, 43, 383-401.

Archibugi, D., Filippetti, A., Frenz, M. (2013) Economic crisis and innovation: Is destruction prevailing over accumulation? Research Policy, 42, 302–14.

Ashbaugh-Skaife, H., Collins, D., Kinney, W. and LaFond, R. (2009) The Effect of SOX Internal Control Deficiencies on Firm Risk and Cost of Equity, Journal of Accounting Research, 47, 1-43.

Bargeron, L., Lehn, K. and Zutter, C. (2010) Sarbanes-Oxley and Corporate Risk-Taking, Journal of Accounting and Economics, 49, 34-52.

Biotechnology Industry Organization (2007a) Greenwood Says More Needs to be Done on SOX Reform, Downloaded from http://www.bio.org/media/press-release/greenwood-says-more-needs-be-done-sox-reform

Biotechnology Industry Organization (2007b) Greenwood to Congress: Proposed Sarbanes-Oxley Reforms, Downloaded from http://www.bio.org/media/press-release/greenwood-congress-proposed-sarbanes-oxley-reforms.

Cameron, A.C. and Trivedi, P.K. (1998) Regression Analysis of Count Data, Cambridge University Press.

Cheng, M., Dhaliwal, D. and Zhang, Y. (2013) Does investment efficiency improve after the disclosure of material weaknesses in internal control over financial reporting? Journal of Accounting and Economics, 56, 1-18.

Chhaochharia, V. and Grinstein, Y. (2007) Corporate Governance and Firm Value: The Impact of the 2002 Governance Rules, Journal of Finance, 62, 1789-825.

Coates, J.C.C. IV (2007) The Goals and Promise of the Sarbanes-Oxley Act, Journal of Economic Perspectives, 21, 91-116

Cohen, D., Dey, A. and Lys, T. (2013) Corporate Governance Reform and Executive Incentives: Implications for Investments and Risk-Taking, Contemporary Accounting Research, accepted article.

Doyle, J., Ge, W., and McVay, S. (2007) Determinants of weaknesses in internal control over financial reporting, Journal of Accounting and Economics, 44,193–223.

Gao, F., Wu, J. and Zimmerman, J. (2009) Unintended Consequences of Granting Small Firms Exemptions from Securities Regulation: Evidence from the Sarbanes-Oxley Act, Journal of Accounting Research, 47, 459{506.

Griffin, A. (1997) The Effect of Project and Process Characteristics on Product Development Cycle Time, Journal of Marketing Research, Vol. 34, pp. 24-35.

Hall, B. (2002) The financing of research and development, Oxford Review of Economic Policy 18, 35–51.

Hall, B.H., Griliches, Z., and Hausman, J.A. (1986) Patents and R and D: Is There a Lag? International Economic Review. Vol. 27, pp. 265-83

Hausman, J., Hall, B.H., and Griliches, Z. (1984) Econometric Models for Count Data with an Application to the Patents-R & D Relationship, Econometrica, 52, 909-38

Jaffe, A.B. and Trajtenberg, M. (2002). Patents, citations, and innovations: a window on the knowledge economy. MIT Press

Kalelkar, R. and Nwaeze, E. (2011) Sarbanes-Oxley Act and the quality of earnings and accruals: Market-based evidence, Journal of Accounting and Public Policy, 30, 275-94.

Kamar, E., Karaca-Mandic, P. and Talley, E. (2007) Sarbanes-Oxley’s Effects on Small Firms: What is the Evidence?, USC CLEO Research Paper C07-9, University of Southern California Law School.

Kang, Q., Liu, Q. and Qi, R. (2010) The Sarbanes-Oxley Act and Corporate Investment: A Structural Assessment, Journal of Financial Economics, 96, 291-305.

Leuz, C., Triantis, A. and Wang, T. (2008) Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations, Journal of Accounting and Economics, 45, 181-208.

Li, H., Pincus, M. and Rego, S. (2008) Market Reaction to Events Surrounding the Sarbanes-Oxley Act of 2002 and Earnings Management, Journal of Law and Economics, 51, 111-34.

Linck, J., Netter, J. and Yang, T. (2009) The Effects and Unintended Consequences of the Sarbanes-Oxley Act on the Supply and Demand for Directors, Review of Financial Studies, 22, 3287-328.

Litvak, Kate (2007a) The effect of the Sarbanes-Oxley act on non-US companies cross-listed in the US, Journal of Corporate Finance, 13, 195-228.

Litvak, K. (2007b) Sarbanes-Oxley and the Cross-Listing Premium, Michigan Law Review, 105, 1857-98.

Paunov, C. (2012) The global crisis and firms' investments in innovation, Research Policy, 41, 24-35.

Prentice, R.A. and Spence, D.B. (2007). Sarbanes-Oxley as Quack Corporate Governance: How Wise is the Received Wisdom? Georgetown Law Journal. Vol. 95, pp. 1843-909

Sarbanes-Oxley (2002) Sarbanes-Oxley Act of 2002, Public Law 107-204, 107th Cong., 30 July 2002.

Singer, Z. and You, H. (2011) The Effect of Section 404 of the Sarbanes-Oxley Act on Earnings Quality, Journal of Accounting, Auditing & Finance, 26, 556-89.

Waters, J. (2013) The effect of the Sarbanes-Oxley Act on industrial innovation – evidence from patenting of stem cell technologies, Nottingham University Business School Working Paper

Wintoki, M. (2007) Corporate Boards and Regulation: The Effect of the Sarbanes-Oxley Act and the Exchange Listing Requirements on Firm Value, Journal of Corporate Finance, 13, 229-50.

Zhang, I. (2007) Economic consequences of the Sarbanes-Oxley Act of 2002, Journal of Accounting and Economics, 44, 74-115.