Compliance of the Sarbanes-Oxley Act

¶ … Compliance of the Sarbanes-Oxley Act

Impacts and Compliance of the SOX

The study investigates the impact of the Sarbanes-Oxley Act 2002. The literatures are reviewed to reveal the motive behind the passage of SOX Act. The Act is to protect the investors and improve the accuracy of the accounting practice. With the costs of compliance, many smaller firms migrate to private to escape the costs burden. However, larger firms enjoy abnormal returns at post-SOX. Both primary and secondary data are used to test the hypotheses and satisfy the research objectives. The analysis of data is implemented for the validity and reliability of data.

Research findings reveal that smaller firms leave public and go private because of the costs burden. However, some sophisticated investors initiated LBO going private transactions by buying the entire shares of some firms. Some public firms merge with private firms. While SOX has negative effects on smaller firms, larger firms enjoy abnormal profits after the passage of SOX. Typically, SOX has improved the business efficiency of the public firms and restore the public confidence in the accounting practice.

CHAPTER 1: INTRODUCTION

Accounting and corporate scandals that swept the business circle in the late 2001 seriously eroded the confidence of the capital markets. Many investors suffered the financial losses because of the so-called accounting errors. (Zhang, 2007). One of the examples of the high profile scandals was the misappropriation of accounting records by the Worldcom management. The internal audit revealed that $3.3 billions were improperly recorded in the company financial statements. (Tran, 2002). Similarly, Euron, which was the seventh largest corporation in the United States also publicly admitted of the financial misappropriation of $3 billions. Many investors lost confidence in the U.S. corporate governance, and some international investors were thinking of diverting their investments to other countries. To restore the confidence and integrity in the accounting and financial practices, the senate passed the Sarbanes-Oxley Act (SOX) Act and the law came into force in July 2002. (Gantt, 2007). Main objective SOX Act is to restore the integrity of the financial reporting of the publicly traded companies. Section 302 of the Act requires CEO and CFO of the public companies to certify the company financial statements. To certify the financial statement, the executives must verify the accuracy of the financial data before they are made public. The essence of the certification is to promote sound business process that affects the financial data. (Byrum, 2003).

One of major requirement of SOX is Section 404 that requires the corporate organizations to assess the internal controls while section 409 requires the publicly traded companies to publicly disclose their financial statements. Section 906 requires the corporate organizations to certify their financial data before they are published. (Evans, 2005). Non-compliance with the SOX provisions includes jail term and/or personal fines for the CFO or CEO. To comply with the SOX Act, many small and large companies set aside several millions of dollars. The costs of compliance include the accounting fees, the internal control costs, higher director's fees, and other necessary costs. (Lowengrub, 2005). Survey conducted by the Financial Executives International reveals, "the total cost of compliance with Sarbanes-Oxley Section 404 is now estimated at $3.14 million for the average company." (Hanish, 2004 P. 9).

"The business community has expressed substantial concerns about its costs. Whereas the out-of- pocket compliance costs are generally considered significant they are likely swamped by the opportunity costs SOX imposed on business. Executives complain that complying with the rules diverts their attention from doing Business. Furthermore, the Act exposes managers and directors to greater litigation risks and stiffer penalties. CEOs allegedly will take less risky actions, consequently changing their business strategies and potentially reducing firm value" (Zhang, 2007 P. 75).

With the effects of SOX on publicly traded companies, some large firms and many smaller public companies have converted to privately owned companies to escape the costs of compliance. The impacts of costs of compliance of the Sarbanes-Oxley Act have generated the research problems that the dissertation attempts to address.

1.1: Statement of Problem

The study intends to investigate whether the impact of the Sarbanes-Oxley has influenced the private-owned company to remain private. The study also investigates whether the impact of the SOX has made the publicly traded companies to convert to private-owned company. Evidence has revealed that the cost burden has made many smaller public companies to consider going private. The study conducted by Grant Thornton LLP reveals that 16 months after the enactment of SOX, over 30% of smaller public companies went private. For example, the Bestway, Inc. states that its decision go private is the costs and burden associated with SOX. While many smaller companies go private because of the costs, rather than going private, some smaller firms prefer to be acquired by larger public firm or merge with other larger private firms. (Bova, Minutti-Meza, Richardson et al. 2010).

The study explores the decision of the publicly traded companies to convert to private companies. The quantitative technique is used to investigate the reasons public traded firms go private, and the impacts of SOX on firms. The study formulates the research objectives for the greater understanding on the impact of SOX and the reasons firms go private.

1.2: Research Objectives

To show the impact of the Sarbanes-Oxley Act on the net increase of the private smaller businesses.

To show that the impact of the Sarbanes-Oxley Act leads larger publicly traded corporations to migrate to private company due to the adherence of Section 404.

1.3: Rationale of the Study

Since the enactment of SOX, there are hot debates in the academic and business communities whether firms has benefited from the enactment of SOX. Evidence has shown that fewer firms have gone into the capital markets since the enactment of SOX. There is general believe that the rising costs of the SOX compliance has made large number of smaller firms to go private. The rational behind this study is to investigate whether the impact of SOX has made the smaller and larger publicly traded companies to go private due to the associated costs of compliance. The research employs the quantitative technique for the research design. The financial valuation of the impact of the SOX Act on the smaller and larger companies is established. To enhance the greater understanding on the difference between smaller and larger companies, the definitions of smaller and larger corporations are established. Organizations are ranked as larger corporation if they are included in the 1000 Fortune lists. (Fortune Datastore 2011). However, smaller companies are defined as those having values of $15M in their current fiscal years. The dissertation only focuses on the smaller and larger companies having headquarters in the Unite States. To quantify the effects of SOX on smaller and larger companies, their market values at both pre-SOX and post-SOX are evaluated. The rational is to examine whether there are statistical significant in the difference in the market values before and after the SOX enactment.

1.4: Research Questions

1. What are the factors leading publicly traded companies to go private?

2. What are the impacts of the Sarbanes-Oxley Act on publicly traded companies?

3. What are the effects of converting from a publicly traded company to a private owned company?

4. What are the consequences of staying private ?

5. What are the long-term economic effects of migration from publicly traded companies to private owned companies ?

By answering the research questions, the study provides several significance.

1.5: Significance of the Study

The significant of the study is as follows:

First, the study will make the U.S. regulators to be mindful of the impact of costs of compliance on smaller companies.

Moreover, the study will be relevant to the foreign regulators outside the United States who are attempting to improve on their corporate governance to fully understand the costs of compliance and its effects on smaller and larger firms.

The study will also enhance the greater understanding of the privately owned companies attempting to go public the significant effects of costs of compliance especially costs associated with Section 404.

Finally, the study will be relevant to the foreign companies attempting to enter into the U.S. capital markets to have fully understanding of the SOX Act and the costs associated with its compliance before ventures into the U.S. capital markets.

1.6: Inductive and Deductive Approach.

Business and social science researchers employ generally deductive approaches to test the hypothesis. The deductive approach move from the general to specific. Sometimes, deductive reasoning is called the top-down approach. For example, a researcher might choose a theory and narrow the theory down to test the hypothesis. Typically, deductive approach collects specific data to test the hypothesis. Pattern of deductive reasoning are as follows: Theory ?Hypothesis ?Observation ?Confirmation.

On the other hand, inductive approach distances itself from deductive approach by moving from the specific to the general observation. The inductive approach, which also called bottom-up approach begins with the observation and measurement, then formulates the hypotheses and finally draws general conclusion or theories. Pattern of inductive reasoning is as follows: Theory ?Tentative Hypothesis ?Pattern ?Observation. While inductive approach is concerned with the open-ended explanatory, deductive reasoning chooses a narrow perspective by testing or confirming the hypothesis. (Trochim, & Donnelly 2007). Typically, inductive reasoning chooses qualitative approach to test the hypothesis. However, the deductive approach employs quantitative method to test hypothesis before arriving at confirmation. In qualitative research, it is not necessary to generate hypothesis to begin research, however quantitative studies make use of hypothesis to begin research. One of the advantages of deductive approach is that the researcher is able to test the hypothesis by using data. The limitation of quantitative approach is that the hypothesis could only be tested when there is enough data. (Ali, & Birley, 1998).

In accounting research, testing the hypothesis with the use of the statistical analysis is the common method to arrive at confirmation. The validity of the accounting research is to relate various components in a logical manner. The deductive approach is able to test the hypothesis using the data collected to arrive at the confirmation. (Schroeder, Clark, & Cathey, J.M. 2010).With the benefits of deductive approach for the confirmation of the hypothesis, the study employs deductive reasoning to test the hypothesis.

Reviewing of the related literatures is essential to explore the impacts of SOX on the smaller and large companies.

CHAPTER 2: LITERATURES REVIEW

This chapter reviews the previous studies on the theoretical frameworks that lead firms to go private. The literatures are also reviewed to reveal the SOX acts and its impacts on smaller and larger corporations. Review of the literatures elaborates some concepts such as publicly traded companies, privately owned companies, smaller companies and large companies. In the literatures review, the hypotheses are developed and the costs of SOX compliances and its burdens on smaller and larger firms are examined. The literatures are also reviewed to provide greater understanding on the reasons firms migrate from publicly traded companies to privates owned companies.

2.1: Theoretical Framework

There are many theories surrounding the reasons firm go private or stay public. Chemmanur, and Fulghieri, (1999) formulate the theory of the going-public decision. The authors argue that the decision of firms to stay in public is to raise capital rather than using its private equity to finance a project. Decision to go public allows firms' shares to become more liquid. However, Boot, Gopalan, and Thakor, (2004) argue that going private or staying public is explained by the theory of entrepreneurial choice. In the capital market, corporate governance plays a major role in the firm's decision to stay public or remain private. Although, firm may face disadvantages of illiquidity by staying private, however, the ownership structure plays a major role in the firm's decision to stay public or go private. Firm with the public ownership is characterized with control from multiple shareholders, however, in private contracting, ownership is concentrated among the fewer large investors. Market-imposed discipline is the feature of public ownership, while in the private contracting; few powerful investors are monitoring firms. In the public ownership "much of the governance structure and disciplining mechanisms are externally imposed by the financial market regulators and investors" (Boot, Gopalan, and Thakor, 2004 P4).

However, theory of firm does not agree that firm's decision to stay in public or private is from the firm's ownership. Theory of firms argues that profit maximization plays a major role in a corporate decision. In a contemporary business environment, firms interact with the markets to maximize profits. Firm's decision to stay in public or private depends on firm's capacity to maximize profits. In 1990s, many companies went public because firms made superprofits by staying in public. However, in the late 1990s, many publicly traded firms decided to delist and went private because there were decline in the stock markets. In 1999, scores of U.S. companies delisted, 83 U.S. companies delisted. In 2002, 86 companies delisted. 262 in 2003 and 188 in 2004.

"Many have conjectured that the decline in stock prices after 2000 has induced firms to go private, a sort of flip side of the observation that initial public offerings (IPOs) are largely a bull market phenomenon." (Boot, Gopalan, & Thakor 2008 pp 2013-2014).

Although, there are increase in the number of firms that go private after SOX, modern theory of firm argues that the behavior of firms is natural since many firms believe that going private will make them reducing direct and indirect costs and maximize the profits.

On other hand, the financial theory suggests that efficiency is the root cause of the advantage buoyant (LBO) going private transactions where small group of investors and often management of firms buy shares of firms from the investing public. (Houston, & Howe 1987). Financial theory argues that the LBO or going private transaction is an important method of corporate restructuring. Typically, LBO method of going private will make firm to create more wealth because of the efficient ownership structuring. Although, this hypothesis has been criticized on the ground that LBO only affect the wealth transfer rather than creating wealth transfer.

These above-discussed theories help to explain the decision of firms from delisting from the stock exchanges and go private. Although, there are changes in corporate governance at post -- SOX, where it has been suggested that high costs of being public discourage firms from staying public, and large proportion of firms delisted and go private. "however, no formal theory that provides any link between a firm's decision to go private, investor participation in public capital markets, the level of its stock price, and the stringency of its corporate governance " (Boot et al. 2008 P. 2013). At post-SOX, many smaller firms go private because of the associated costs burden; the case is different with the larger firms. Many sophisticated investors take the advantages of the abnormal profits after the SOX.

2.2: Overview of SOX Act

Several literatures have revealed the motive behind the action of the U.S. regulators to enact the Sarbanes-Oxley Act (SOX) in 2002. The U.S. regulators enacted the Sarbanes-Oxley Act (SOX) in the July 2002 to protect investors from the high profile accounting irregularities that was very common among the bigger organizations in the United States. (Ahmed, McAnally, Rasmusse et al. 2010).

"The auditing profession came under intense scrutiny following the collapse of Enron and several other leading ?rms. To protect investors from the financial scandals, legislators responded swiftly with the Sarbanes-Oxley Act of 2002. A stringent rules-based system is enacted which is widely considered the most comprehensive economic regulation since the New Deal." ( Vakkur, McAfee, & Kipperman, 2010 P. 18).

The main objectives of SOX are to improve the reliability of corporate disclosures where firms are obliged to publicly disclose their financial statements. "Section 404 of Sarbanes-Oxley Act (Sarbanes-Oxley) requires management of public companies to include in their annual reports an assessment of the effectiveness of their financial controls." (FEI, 2004 P. 1). The public disclosures are to enhance the accuracy of the corporate financial accounting and protect the investors from the accounting misappropriation.

Five main provisions of SOX Acts are as follow:

First, SOX demands CEO and CFO to certify the financial report with regard to balance sheet transactions and special-purpose entities.

Second, SOX mandates public company to maintain internal control, management should evaluate the effectiveness of annual report, and the external auditor must attest to the evaluation.

Moreover, SOX mandates that all the audit committees must be independent, and at least one of them must be a financial expert.

In addition, SOX mandates the corporate insiders to benefit from the firm shares.

Finally, the SOX impose fines or jail terms for non-compliance with the SOX Acts. (Spedding, 2009).

Likewise all regulations, the SOX impose costs and benefits on corporate organizations. Major benefits of SOX are to improve transparency of the financial accounting of the publicly traded companies in the United States. Ahmed et al. (2010) argues that SOX imposes new requirements on firm to improve on the deteriorated internal controls, auditing, accountability and governance. However, to accomplish the SOX requirements, firms need to spend significant direct costs to implement or redesign the internal controls. Firms also needs to borne additional audit fees to adhere with the new controls. Although, SEC estimates that the direct costs of complying with SOX would be up to $91,000 on an average firm, however, the Financial Executives International estimates the costs of SOX compliance is closer to $4.4 million per ?rm. (FEI, 2006). On the other hand, Charles River Associates International (CRA, 2005) estimates the direct costs burden to be about $8.50 millions for firms with market capitalization greater than $700 million, while the direct costs burden is about $1.24 millions for firms with market capitalization of between $75 and $700 million. To comply with the SOX requirements, a firm needs to hire the services of management consultants, lawyers, and financial experts. All these are direct burdens on firms. There are other less observable costs, which could be termed indirect costs. The addition costs burden may include the costs of hiring competent staff to assist in the compliance. For example, many firms hire Chief Compliance Officers, and there is increase in the accounting department personnel, higher salary for the directors because of the increased in the directors' responsibilities. With elaborate discussion on direct and indirect costs of compliances, the study reviews the previous studies on the impact of SOX on firms.

2.2: Impact of SOX on Smaller and Larger Firms

There are mixed reactions on the impacts of SOX on the firms' returns. Lee (2007) believes that it is difficult to attribute firm market returns to SOX. Zhang (2007) supports this argument by comparing the returns of the U.S.-exchange-listed foreign ?rms with the returns of the U.S. firms after the SOX. The results reveal that U.S. firms are performing better than foreign firms listed in the U.S. stock exchanges are. The author reveals the improvement in the returns is due to the other factors outside SOX. On the other hand, Bova et al. (2011) disagree with Zhang by pointing out that firms that adopt SOX initiatives perform better than firms that that do not implement SOX initiatives do. The authors substantiate their argument by referring to the survey conducted by PricewaterhouseCoopers. From the PwC publication,

"many private companies have something to gain by embracing the spirit, if not the letter, of SOX. In certain cases, buyers might be willing to pay a premium for companies that have brought their system of internal controls into line with standards in Section 404." (Bova et al. 2011 P. 9).

Firms that adopt SOX initiatives tend to enjoy larger sales than firms not involving in the SOX initiatives. However, Li, Pincus, & Rego (2008) reveal the costs and the benefits of SOX to firms and the market reactions after the enactment of the SOX. The authors argue that there are abnormal stock returns after the SOX enactment. Although, firms recorded negative returns shortly after the announcement Worldcom financial scandal. The reason may be associated with the disinterest of the investors to invest; however, it was revealed that sampled publicly traded firms recorded cumulative abnormal returns after the SOX. Typically, 78.8% of sample firms have positive abnormal returns with cumulative abnormal returns of 11.0%. The reasons may be associated with the improvement in firms' internal control as being stipulated by Section 404. Although, it is expected that SOX acts imposed costs burden on firms, however, it is revealed that firm has been able to reduce the agency cost after the Act. The agency cost theory is the internal cost that arises because agent is acting on behalf of the principal. Section 404 of the Act imposes some internal costs on firms. Given the post-SOX evidence, the agent costs on firm are negative because many publicly traded firms enjoy positive returns. Li, et al. (2008) argues that the reason may be due to the improvement in the management internal control. The increase in the firm's earnings is due to the improvement in the accuracy of their financial statements.

However, Engel, Hayes, and Wang (2007) do not believe that all firms enjoy abnormal returns after the SOX. The abnormal returns enjoyed by many firms are due to the firm's size and economic of scale. Many smaller firms are unable to support the costs burden associated with the SOX. To avoid the cost burden, many smaller firms convert to privately owned companies at post-SOX. Typically, the number of smaller firms going private is higher at post-SOX than pre-SOX. The authors argue that the "SOX compliance costs weighed more heavily on smaller firms." (P 116). Many smaller firms announce going private after the SOX because they believe that they stand to enjoy little benefits by staying public.

The review of the literatures has revealed that smaller firms feel the impact of the SOX than larger firms. With smaller firms going private because of the impact of the SOX, the study develops following hypotheses:

H1: Costs burdens associated with SOX has more impact on smaller firms than larger firms

H0: Costs burdens associated with SOX has more impact on larger firms than smaller firms.

2.3: Long-Term Effects of Migrating from the Public to Private

Firms choose different strategies to go private. Going private transaction occurs when a private firm acquires all the public shares of the publicly traded firms, and this strategy is by merging the operations of the two firms. In other case, a publicly traded firm may merge with the private equity firm with the sole purpose of executing going private transaction. Sometimes, incumbent management may buy the entire shares of a public corporation and merge the entire assets of the target firm to a privately held corporation. This type of going private is called advantages buyouts (LBOs). Whether financial buyer or strategic, going private transaction entails buying up entire shares of public holding companies. (Bartlett, 2008, Muscarella, & Vetsuypens, 1990). Publicly traded companies that go private are no more obliged to present their financial data to SEC because they have chosen to terminate with the SEC reporting. . Evidence has revealed that it is very risky to go private because the stocks of the private firms will be less attractive because of the reduction in shareholders litigation. Leu, Triantis, & Wang, (2008) argues going private is more risky than being in public. Firms that go private are likely to be involved in the long-term debts because of their inability to raise capital from the public. The consequences are that the firm will not be sufficiently attractive to the affiliated parties, and the firms may not be attractive to the competent managers. Typically, the firms that go private are likely to have fewer growth opportunities because of the poorer operating performances.

Bartlett (2008) reveals that migration of smaller firms to private have doubled after the SOX enactment. While many firms belief that by going private, they are likely to be immune to SOX's compliance costs, the detrimental effects of going-private is that these private firms will be ready to finance their obligations with cash. Large percentages of the small and medium firms that go private are unlikely to meet the costs of complying with the SOX especially costs of complying with Section 404. However, the consequences of going private are that the firm growth rate is declined because of the inability to raise capital from the public.

Engel (2007) also argues that majority of the firms that go private after the SOX are the firms general illiquid at pre-SOX. These firms believe that they will not be able to raise enough capital to comply with the SOX. Rather than staying in public and face the consequences of non-compliance, they prefer to go private to escape the SOX costs burden.

On the other hand, Holmstrom and Kaplan (2003) believe that going private transaction after the SOX will have detrimental effect on the economy. Ahmed et al. (2010) reveal that there is no correlation that firms have lower net profit at post-SOX. Typically, the firm's profitability improves after the SOX. The effect of SOX is that there are improvement in the firm internal controls and the result lead to more efficiency in the overall management. Empirical evidence shows that the average firm experience 3% increase in the cash flow and 7.3% increase in the total revenue. The findings of the Ahmed have revealed that SOX may not really have long-term negative effect on the U.S. economy. Leuz (2007) supports this argument by pointing out that it is natural for firms to engage in avoidance strategies because of the costs associated with SOX, however, firms go private at post-SOX event is not due to the SOX enactment. To support his argument, Leuz compares the percentages of the publicly traded firms that go private in the U.S. with the UK and other rest of the world. His finding reveals that there is no significant difference between the number of firms that go private in the U.S. And the UK and the rest of the world. Deeper analysis conducted on firms going private after the SOX reveals,

"there is no significant increase in going private in the months immediately following SOX. These findings may be surprising in light of all the anecdotal evidence that going-private activity has significantly increased over the last few years." (Leuz, 2007 P. 160).

Since SOX has been costly to smaller firm in the U.S., it is expected that the percentage increase in the number of firms going private will be significantly greater in the U.S. than the UK and other rest of the world. While there is increase in the number of the firm going private immediately after SOX, there is no statistical correlation between SOX and the increase in firm going private.

Mohan, and Chen, (2007) believes that many smaller firms go private after SOX because their stocks are undervalued before SOX. Typically, there is no statistical evidence that firms go private because of the effect of SOX costs burden. Many firms that go private are the underperformed firms and they believe that with the stringent requirements of SOX, it will be difficult for them to raise capital.

With evidence from the literatures that going private is not related to SOX Acts, the U.S. economy is not likely to experience long-term effect from going private because many firms that go private are the underperformed firms and the firms believe that they are not likely to improve their internal controls. Many firms go private because of the financial difficulties and deteriorating growth opportunity. The study develops second hypothesis.

H2: SOX associated costs burden only make smaller and larger firms to go private.

H0: SOX associated costs burden only does not make smaller and larger firms to go private.

2.4: Summary

The review of the literatures reveals that the effect of SOX Act on the publicly traded firms. Many publicly traded firms recorded the super buoyant returns after the SOX because firms have improved their internal controls and their financial data. Unlike pre-SOX where the financial misappropriation was very common, at post-SOX, firms are more committed to improve their financial reporting to avoid scandal. The review of the literatures also revealed that many smaller firms are more affected by SOX. To avoid the costs of compliance, many smaller firms have opted to go private. While smaller firms migrate from the public to become private firms, the larger firms are unaffected by the SOX mandates. Going private may reduce growth because of the inability to raise capital from the public. Larger percentages of the firms that go private are firms with unattractive stocks even before the SOX.

While the literatures have revealed the impact of SOX on the publicly traded firms and the effects of going private, it is still critical to validate the data collected from the secondary sources. The research methodology reveals the method of data collection, research design, and sample population.

CHAPTER 3: RESEARCH METHODOLOGY

The purpose of research methodology is to reveal the method of data collection. The data collection is essential to evaluate the impact of the SOX on smaller firms and the decision to stay private. The decision of the publicly traded smaller firms to migrate to privately owned companies is quantified. Stratified random sample is used to sample the smaller companies who have been in the public and decide to go private. Moreover, the stratified random sampling is used to sample large corporations that decides to go private.

remains public after the SOX enactment.

chooses to be acquired vs. spend to be compliant with the Act.

The statistical analysis is used to reveal the effect of Acts on the three classes of firms. The correlation analysis is used to evaluate the level of variation in three dominant strategies. For example going private after being public. Staying public and decide comply with the Acts' requirements. Choosing to be acquired is also analyzed. Statistical techniques such as t-test, Pearson's Correlation Coefficient analysis, the predictive statistics and ANOVA, techniques are used.

3.2: Research Design

The study uses deductive quantitative approach to test the hypothesis. The sample population is the smaller publicly traded firms that go private after the SOX . Typically, there is evidence that large proportion of smaller firms migrate to private after the SOX. Moreover, the net increase of the privately held smaller firms is evaluated to reveal the impact of SOX on the privately held smaller firms. The sample population includes the large corporations that migrate from being public to private firms. The financial valuation of the impact of smaller and larger firms is quantified. The statistical techniques is used to reveal the effects of SOX Acts on smaller and larger firms that migrate to private own firms.

Stratified random sample is used to select the smaller and larger firms. Stratified random sampling technique divides the population into homogeneous subgroup and a simple random is taking from each subgroup. For example, the sample population is divided into strata (non-overlapping groups) of N1, N2, and N3 ... Ni where N1 + N2 + N3 + ... + Ni = N. There are many reasons for choosing stratified random sampling for choosing the sample population. Stratified random sampling enables the researcher to cover overall population, and the key subgroup and the use of stratified random sampling generates more statistical precision. (Trochim, & Donnelly 2007). In choosing larger firm for sampling, the study specifically samples the larger corporations from the 1000 Fortune lists. The paper categorizes smaller firms as those having value of $15 millions in their current fiscal years. The smaller and larger firms sampled are those having headquarters in the United States.

3.3: Method of data collection

Both primary and secondary researches are used for data collection. The secondary data consist of journal articles, academic books, report, journal reviews, research articles, and published statistical data. The sources of secondary data are from electronic database. The data are collected from the database of Science direct, Emerald, Wiley, Social Science Research Network, EBSCO Host and the university library. These databases contain several accounting and social science journals relevant to the study. One of the reasons for using secondary data is that they are easily accessible. The secondary data is also cost effective.

Added to the secondary data, the study also uses primary data. The primary data consists of the raw data of smaller and larger companies. The financial data of these companies are collected to evaluate their financial performances at pre-SOX and post-SOX. Using the primary data for evaluation enhances greater understanding on the impact of the SOX on smaller and larger public traded companies. The data also reveals the financial performances of these companies at pre- and post SOX. Evaluation of these data reveals the effect of SOX. The review of the literatures reveals that the number of smaller firms going private has doubled at post-SOX. The data collected at pre-SOX and post-SOX is to evaluate the impact of SOX on the smaller firms. The evaluation reveals the extent the SOX; especially the Section 404 has affected the smaller firms.

The data consist of the larger publicly traded firms that are listed in the stock exchanges between 1998 and 2005. The data of the smaller firms and the LBO are collected from the LBO and smaller firm specialists notable Salomon Brothers and Bear Stearns. The researcher also identifies some firms by searching the Wall Street Journal Index. The sample consists of 114 firms that go private after the SOX. The samples are selected from wide range of industries to represent large proportion of the industries in the United States.

To understand the impact of SOX on firms and the primary factor that drive firms to private. The financial data of the firms are collected four years (1998-2002) before the SOX enactment. Data are also collected three years after the SOX (2002-2005). The target firms are publicly traded firms in the American Stock Exchange (ASE), New York Stock exchange, (NYSE), or the NASDAQ stock market.

CHAPTER 4: ANALYSIS AND FINDINGS

This chapter presents the analysis and the findings. The paper implements data analysis for both primary and secondary data. The findings reveal the impact of SOX on the smaller and larger firms. The reasons for the increase in going private are also established. The benefits that firms accrue from staying in private are also revealed. The findings are used to test the hypotheses formulated.

4.1: Analysis

The objective of data analysis is to enhance the validity and reliability of data collected. To confirm the credibility, trustworthiness, and dependability of data collected, all secondary data are collected from the academic journals of the reputable research database. In addition, the experts in the economics, finance and accounting studies write all the previous studies reviewed, and all the research articles reviewed are relevant to the study. Typically, all the research articles relevant to the study are handpicked and all the research articles not relevant are discarded. The quantitative data analysis is used for the primary data. Several techniques are used to analyze primary data. First, the researcher cleans the data to enhance data integrity. One of the techniques used in cleaning the data is by using explanatory analysis and cleaning. The technique is to identify and rectify errors in the dataset. The data are inspected thoroughly and all erroneous data are corrected or removed.

Moreover, the statistical technique is used in the data analysis to enhance data integrity. The descriptive statistics is used to summarize the mass of raw data. The essence of using descriptive statistics is to enhance the greater understanding of data. With descriptive statistics, a reader will be able to understand the value of data and its correlation to the research project. In addition, the inferential statistics are used to reveal the outcome of the data collected. With the inferential statistics, the outcome of the statistical test is known. (University of West England 2006).

Further analysis is the testing of hypothesis to show whether the hypothesis could be accepted or rejected. The t-test is also used to compare the value of the two samples, and the study tests whether the samples from the population have the same or different mean value.

Analysis of the data collected generates the research findings, and the results reveal the extent the SOX has affected the publicly traded firms and the going private transactions of smaller and larger firms.

4.2: Findings

4.2.1: Effect of SOX on smaller publicly traded firms

Analysis of the primary data and the secondary data has revealed that the costs burden of SOX compliance affect the smaller publicly traded firms than the larger firms. Following the high profile financial scandals that has eroded the public confidence on the corporate governance, the legislators swiftly passed the SOX Act to restore the public confidence and protect investors. However, Section 404 of the Act affects majority of the smaller firms. The findings have revealed that quarterly going private has increased after SOX. Costs of SOX compliance has made the benefits of remaining in public to decline for smaller firms. From the financial data of the smaller firms, this study identifies the decline of the total assets of smaller firms by 1.34% after SOX. There is also decline in the revenue by 1.9%. Moreover, there is significant decline in the profitability between 2002 and 2005. The estimated coefficient from the samples of the smaller firms reveals that there is significant burden of non-audit costs estimated to be about $6.2 millions, which has been one major reason that lead to the decline of the profitability of the smaller firms at post-SOX. The findings also reveal that the operating cash flow is more severe for smaller publicly traded firms after the SOX. Typically, there is significant decline of the operating cash flow, and this has translated to the lower growth opportunity. Many smaller firms in the samples incur equal magnitude of the indirect and direct costs, and this has led to the negative stock price for smaller firms. The findings of this study is similar to what Zhang (2007) has revealed in his paper. Zhang (2007) argues that there are cumulative abnormal negative returns for smaller firms at post-SOX.