Section 404 of Sarbanes-Oxley Act: Did the Stock Market Anticipate It?

Abstract

With the 2002 passage of the Sarbanes-Oxley Act (SOX), substantial new internal control disclosures are required of publicly traded companies. This paper examines the relationship between internal control and SOX and analyzes evidence supporting the efficient market hypothesis found in the timing of stock market reaction to internal control disclosures. Our conclusion is that stock price behavior for companies with material weaknesses in internal control reflects the additional risk associated with the weakness and this reflection occurs before the SOX mandated public disclosure of the weakness. Stock price characteristics examined for periods prior to and following public disclosure are changes in stock value and changes in beta coefficient.