KNOWLEDGE LINK
Accounting study: Impact of SOX reforms foreshadowed
by 1992 FDIC Improvement Act outcomes

A comprehensive study of the Federal Depository Insurance Corporation (FDIC) Improvement Act of 1992 (FDICIA) in the banking industry provides strong indication that similar internal control reforms under Sarbanes-Oxley are likely to be effective, according to research conducted by Fisher accounting professors.

“The potential effectiveness of Sarbanes-Oxley (SOX) internal controls reforms in improving the quality of earnings reports are of great interest and importance to regulators, practitioners and academics,” said Jennifer Altamuro, an assistant professor in accounting and co-author of the study. “However, a short time horizon since implementation and confounding macroeconomic events during the SOX implementation period make the impact of SOX reforms on earnings quality difficult to discern.”

In the paper “Do Internal Control Reforms Improve Earnings Quality,”Anne Beatty, the Deloitte & Touche Chair in Accounting, and Altamuro, addresses the question of whether changes in internal control monitoring for U.S. banks led to improvements in earnings quality. The paper examines characteristics of earnings among banking industry firms, using both accounting and market-based measures.

Beatty’s and Altamuro’s results suggest that FDICIA-mandated internal control reforms led to improvements in each of these earnings characteristics for banks affected by the regulation, relative to banks that were not required to adopt FDICIA-reforms during the same time period. The authors reported that “affected firms showed significant increases in earning persistence, ability to predict cash flows and a stronger relationship between earnings and returns in the post-FDICIA period.”

By focusing on all firms that are affected by the regulation, not just those with internal control weaknesses, the authors were able to provide evidence that internal control reforms on average lead to improvements in earnings quality in the banking industry.

The FDICIA-mandated internal control reforms were a cornerstone of the internal control provisions of Sarbanes-Oxley. Beatty said their paper’s findings should be good news to corporate financial executives and regulators concerned about the long-term effectiveness of the Sarbanes Oxley mandates.

The entire paper is available on SSRN at: papers.ssrn.com/sol3/papers.cfm?abstract_id=930690.