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    The Sarbanes-Oxley Act and Exit Strategies of Private Firms.
    research summary posted July 28, 2015 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx 
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    Title:
    The Sarbanes-Oxley Act and Exit Strategies of Private Firms.
    Practical Implications:

    While there are ex ante societal benefits to SOX-type reforms, in terms of reduced fraud, better financial reporting, and the resulting reduction of negative externalities, the regulator must consider the total societal costs of SOX-type reforms, including real costs to society resulting from smaller private firms opting to be acquired rather than going public. The authors leave a consideration of the costs and benefits of SOX-type regulations up to the global regulatory community, with the hope that the stylized facts presented in this study inform the ongoing debate about the socially optimal level of mandatory investment in internal and external monitoring.

    Citation:

    Bova, F., M. Minutti-Meza, G. Richardson, and D. Vyas. 2014. The Sarbanes-Oxley Act and Exit Strategies of Private Firms. Contemporary Accounting Research 31 (3): 818-850.

    Keywords:
    auditing, Sarbanes-Oxley, government policy, consolidation & merger of corporations, compliance
    Purpose of the Study:

    There may be real costs to society if private firms opt to be acquired rather than pursue an IPO. The authors assess whether SOX has had an impact on both the exit strategy preferences of private firms and the deal proceeds achieved by private firms when selling to a public buyer. The authors assess SOX’s impact on the decision of private firms to either be acquired by a public firm or to pursue an IPO. SOX’s implementation has forced publicly traded firms to incur costly new layers of financial reporting controls to monitor internal transactions. These costs have proven to be one of the more controversial elements of SOX’s implementation. As the evidence suggests that there are larger SOX-related costs for IPO firms, fewer firms should meet the threshold over which the benefits of going public outweigh the benefits of being acquired, and as a result fewer U.S. private firms should choose the U.S. IPO option as an exit strategy, post-SOX. SOX might limit private firms’ options for financing in general, and stifle opportunities for private companies to grow.

    Design/Method/ Approach:

    The study was conducted using data collected during the 1994-2009 time period. The combination of U.S. IPO and takeover firms results in a sample of 3,738 observations. The combination of U.K. IPO and takeover firms results in a sample of 1,515 observations. Data from COMPUSTAT and the Center for Research and Public Securities (CRSP) was used to calculate the industry-related factors in the model.

    Findings:
    • SOX appears to have shifted U.S. private companies’ exit strategy preferences from pursuing an IPO to being acquired by a public firm. This shift in preferences is particularly prominent for smaller U.S. firms.
    • In over 85% of the cases, the IPO firms discuss concerns over the substantial costs to becoming SOX compliant, prior to going public.
    • The findings imply that the adoption of SOX has both changed the propensity for firms to choose an IPO relative to being acquired and negatively impacted the proceeds obtained by acquired targets.
    • Private deal proceeds are lower in the post-SOX era if a seller is not fully SOX compliant. The target either incurs the SOX compliance costs or the proceeds are reduced to reflect the fact that the public buyer has to incur these costs. Either way, the private target is forced to incur SOX compliance costs.
    • The authors rerun the tests in a U.K. setting. As the United Kingdom did not adopt concurrent SOX-like regulations with the United States, they find no evidence that SOX affected U.K. private companies’ exit strategy preferences.
    Category:
    Independence & Ethics
    Sub-category:
    Impact of SEC Rules Changes/SarBox