The Effect of Sarbanes-Oxley on the Debt Contracting Value of Accounting Information



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This paper investigates whether and how the Sarbanes-Oxley Act (SOX) changed the way that banks use accounting information to price corporate loans. SOX reformed corporate governance and disclosure, intending to improve reporting transparency. The targeted beneficiaries of this improved reporting transparency were investors and shareholders, but SOX also may have affected the decision usefulness of accounting information to private lenders, such as banks. I refer to accounting information’s usefulness to creditors, i.e. its ability to indicate the level of credit risk, as its debt contracting value (DCV) and proxy it with loan interest spread’s sensitivity to key accounting metrics, such as ROA, interest coverage, leverage, and net worth. The tests show that, on average, the DCV of key accounting metrics, most notably ROA, declined in the period following a borrower’s compliance with the requirements of SOX Section 404. Investigation of this decline finds that it cannot be explained by borrowers that disclose deficiencies in internal control over financial reporting, but is instead primarily driven by changes in how borrowers manage earnings. The study also finds that a reduction in auditor-provided tax services is related to lower DCV of ROA and leverage. Conversely, a reduction in other unspecified nonaudit services is related to higher DCV of net worth. These findings suggest that SOX has mixed implications for accounting information’s usefulness to private lenders.



Debt contracting value, Sarbanes-Oxley (Act), Internal control weakness, Bank loans, Real earnings management, Nonaudit services, Auditor-provided tax service