THE IMPACT OF THE SARBANESOXLEY ACT ON FIRMS GOING PRIVATE

Nancy J. Mohan and Carl R. Chen

ABSTRACT
We study the impact of SarbanesOxley (SOX) Act on the characteristics of rms going private based upon a sample of 147 companies during the period of June 13, 2000 to October 3, 2003. We partition the sample into pre-SOX and post-SOX periods, and cluster analysis is employed to identify rms with similar characteristics. One group of rms is identied before the SOX Act, while two groups of rms are identied after the Act. Parametric and non-parametric tests conrm a small group of rms going private with characteristics consistent with the contention that SOX Act drives these rms private due to heavy monitoring cost.

1. INTRODUCTION
On July 30, 2002, the SarbanesOxley Act (SOX) was signed into law. This legislation represents the largest change to securities regulation since the adoption of the 1933 and 1934 securities laws. Usually, the impact of new regulation on companies is difcult to measure, in that the regulation is discussed in the Senate and House chambers for months and years before becoming law. The SOX legislation, though, was introduced, discussed, and
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signed into law within a matter of months.1 The speed reected the need to boost public condence in the equity markets after the Enron, Worldcom, and other accounting scandals. In general, the provisions of the bill require that all applicable companies must establish a nancial accounting framework that can generate nancial reports that are readily veriable with traceable source data. Considerable penalties accompany non-compliance. Specifically, y a corporate ofcer who does not comply or submits an inaccurate certication is subject to a ne of up to $1 million and ten years in prison, even if done mistakenly.2 Clearly, implementation of the Acts nancial requirements increases the cost to remaining a public rm. In some cases, the cost to remain public may outweigh the benets. Indeed, anecdotal evidence suggests that these higher costs have caused an increase in companies going private. As early as May 2003, various trade presses began to report a resurgence in buyouts as illustrated in the following quote:
The higher legal and auditing expenses for public rms resulting from last years SarbanesOxley Act may result in more small-cap rms becoming private. Research gathered by USBX Advisory Services reveals that between the time the act took effect in August and the end of April, 85 small rms went private, versus 56 for the same period a year earlier. In addition, the median enterprise worth for those companies fell from $105 million to $57 million.3

More evidence continues to be reported on the burden of SOX, and in particular Section 404,4 to smaller companies. According to The Wall Street Journal, The American Electronics Association estimates that while Section 404 costs the average multibillion-dollar company about 0.05% of revenue, the gure can approach 3% for small companies.5 In addition to the explicit dollar cost of compliance, The Wall Street Journal article also suggests that there may be an implicit cost due to potential increased class-action lawsuits based on the reporting requirements of Section 404. A study conducted by the law rm Foley & Lardner found that the average price of being public has nearly doubled from $1.3 million to $2.5 million since the passage of SOX. A large part of the cost is directors and ofcers insurance, which has increased to $639,000 from $329,000.6 Individually, many small companies have quoted large increased expenditures for regulatory compliance. For example, Sandata estimated the compliance cost during the rst year after the Acts passage was $400,000, compared to profits of $142,000.7 Also, the chief nancial ofcer of Woodhead Industries Inc. estimated the cost of compliance between $500,000 and $2 million compared to $8 million in net income for the scal year 2004.8 Finally, small community banks also nd the additional cost difcult to bear, y community banks

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biggest expense related to SarbanesOxley is the bureaucracy cost: the time and resources the board uses to sort out the acts regulatory details and establish policies and procedures to meet them y with the exception of those that are or plan to be active acquirers, banking companies with under $2 billion of assets and fewer than 2,000 shareholders would be better off going private.9 If these and other reports10 of the new costs of remaining a public company have merit, we suspect that small companies should have the most nancial difculty implementing SOX requirements. Large rms, such as Microsoft, could easily absorb this new cost, but not the smaller ones. Thus, the cost of being a public company may outweigh the benet, and we may see small rms emerging as one type of rm going private.11 Historically, researchers proposed that rms going private would exhibit certain characteristics associated with the free cash ow hypothesis. Generally, one would expect going private candidates to be poorly performing rms that have stable business histories and substantial free cash ow. Additionally, these companies would not need access to public capital markets due to low growth prospects, high potential for generating cash ows, and low debt usage.12 Empirical evidence supporting this prototype, however, is mixed. Research that supports a significant relation between free cash ow and the likelihood of a rm going private includes Lehn and Poulsen (1989) and Opler and Titman (1993). Furthermore, Opler and Titman nd that LBOs are more likely to have a low Tobins q and relatively high levels of cash ow, while Lehn and Poulsen report a significant relation between undistributed cash ow and the rms decisions to go private. The work by Denis (1992) also provides support for free cash ow theory to explain why rms go private by documenting that those rms for which the market reacted negatively to capital investment decisions were more likely to go private. Maupin, Bidwell, and Ortegren (1984) and Servaes (1994) nd evidence that is not consistent with the free cash ow hypothesis. Long and Ravenscraft (1993) also nd little exceptional differences between LBO candidates and their respective industry control companies, except for the amount of bank debt. They do nd, though, that operating performance improves for the rst three years after going private. Other researchers also document the increase in performance after a rm goes private (Kaplan, 1989a; Lichtenberg & Siegel, 1991). To reconcile the conicting ndings, Halpern, Kieschnick, and Rotenberg (1999) suggest that there are two types of poorly performing rms that go private through an LBO, that is, managerial ownership of LBOs may split between high and low ownership. Failing to separate these two types of LBOs may result in confounding evidence. Under this heterogeneity hypothesis, poor performing rms with low managerial ownership use LBOs

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to prevent third-party takeovers while low-performing companies with high managerial ownership will use an LBO to further concentrate ownership yet allow the owners to cash out some of their invested wealth. Researchers have suggested other motivations for going private, such as the tax-saving hypothesis due to the increased interest expense from the debt used to nance the buyout (Kaplan, 1989b) and the private information hypothesis where share repurchases occur when management believes the stock to be undervalued (Netter & Mitchell, 1989). Long and Ravenscraft (1993) further suggest that rms may go private because a private corporation incurs less monitoring costs. The additional reporting requirements of SOX increase these monitoring costs. Therefore, the monitoring cost hypothesis provides further motivations for a rm to go private. Existing literature, however, focuses on the agency costs associated with free cash ow, which maintains that poorperforming rms with free cash ows are more likely to become LBOs. Our paper examines the characteristics of rm groups that go private before and after the SOX Act. If the corporate outcry of heavy compliance costs on small rms has merit, then in post-SOX we would expect to see additional heterogeneity in the types of rms going private a new group of rms going private that are smaller, but are not necessary poor performers. For this cluster of rms, the cost of being public outweighs the advantages, supporting the monitoring costs hypothesis. To test this hypothesis, we conduct cluster analyses on a sample of rms that go private. Our results show that before SOX became effective, only one cluster of rms is identied. However, our analysis reveals two clusters of rms after SOX is in effect. Parametric and non-parametric tests suggest the emergence of a small, but new cluster of rms going private after the SOX, supporting the monitoring costs hypothesis. The rest of the paper is organized as follows: In Section 2, we describe the data and variable definitions. Section 3 discusses the research method and the statistical ndings. We conclude the paper with the implications from our research concerning the impact of SOX on the nature of rms that decide to go private in Section 4.

2. SAMPLE SELECTION AND VARIABLE CHOICE

2.1. Data and Variables We searched the SEC website at edgar.com for a list of 13e-3 lings.13 When we began this study, there were 307 lings during the period from 6/13/00 to 10/03/03 that were available from this site. In order to verify that the 13e-3

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ling was motivated by a going private transaction, we searched for a company announcement at the time of the ling using factiva.com. We excluded duplicate lings, cash-out mergers due to a prior merger transaction or offers from other rms. Also, if the company was an ADR or a publicly traded partnership, it was deleted from the sample. Quite different from earlier periods, an interesting and popular method of going private during this period is the reverse stock split, reducing the number of shareholders to less than 300 such that the company is no longer required to register with the SEC. Since many of our sample companies are quite small and do not have data available on the COMPUSTAT or CRSP, we collected data from nancial statements (10k or annual report plus the annual proxy) led for the two scal years before the 13e-3 ling. Stock price data were retrieved from a variety of sources, including CRSP, Bigcharts, and S&P Daily Stock Price Records. After collecting the data, the sample size employed in this study was reduced to 147 companies. Even so, all rms do not have complete data for each variable used; the sample size per variable thus changes. Prior buyout literature suggested our choice of variables. As discussed earlier, the predominate theory for explaining leveraged buyouts has been the free cash ow theory; that is, leverage buyouts can transform a publicly traded, poorly performing, under-leveraged rm into an efcient producer of free cash ow. In order to support the new debt load, the rm would have limited growth opportunities (i.e., not need access to public market issue) and have a stable base business. Referencing prior research (discussed earlier in Section 1), we chose the following variable definitions to conduct the cluster analysis based upon free cash ow theory: FCF Two-year average (preceding ling) of free cash ow measured as [EBIT (taxes deferred taxes) dividends stock repurchases]/sales. LEV Two-year average (preceding ling) of nancial leverage measured by dividing total debt by total assets. TAX Potential savings due to reduced taxes is measured by the two-year average (preceding ling) of taxes divided by sales. Q A Tobins q proxy measured by the two-year average (preceding ling) of the market to book value ratio of equity. ROA Average return on assets (net income divided by total assets) over the two-year period preceding ling date. OWN Managerial equity ownership for the last scal year preceding ling. REVENUE Revenue growth rate measured by the percentage changes in revenues over the two-year period preceding ling.

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R Excess stock returns (in excess of the NASDAQ returns) over the twoyear period computed by taking the natural logarithm of the price ratio. The following variables are proxies for rm size, the focus of this study, which was to determine whether SOX has created a new prole of rms going private: EMPLOYEE The number of employees for the last scal year preceding ling. TA Total assets in $millions for the last scal year preceding ling. EQUITY Total book value of equity in $million for the last scal year preceding ling. Firm performance is measured by ROA, Tobins q, and stock return over the two-year period before the ling date; Tobins q also measures growth potential. The two-year change in revenue (REVENUE) measures shortterm growth; the level of potential savings due to reduced taxes is measured as the two-year average taxes divided by sales (TAX); and LEV measures a rms leverage. Our primary interest is the size of the company, for which we include the following measures: number of employees (EMPLOYEE), total assets (TA), and total equity (EQUITY) from the last scal year preceding ling.

2.2. Descriptive Statistics Table 1 reports descriptive statistics for the variables employed in this study. The negative values for average FCF, R, EQUITY, REVENUE, and ROA probably are results unique to the sample period studied; i.e., a period of economic recession after the burst of internet bubbles.14 Other than these variables, an average rm nances its assets with 65% debt, has a Tobins q of 1.16, and management equity ownership of 48.65%. The average rm size measures are 1,461 employees, and $304 million in total assets. While the sampled rms are relatively small, the largest has an employee size of 59,000. As explained earlier, sample size varies depending on the variable considered. For example, total assets information is available for 147 rms, but only 89 rms had sufcient data to calculate Tobins q.15 Since our primary interest is whether SOX has changed rms decision to go private, we examine rm characteristics both before and after SOX. Table 2 provides a description of the entire sample broken down into two

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Table 1.
Variable FCF LEV TAX Q R OWN EMPLOYEE TA EQUITY REVENUE ROA N 107 137 109 89 134 146 143 147 146 146 137 Mean 0.1268 0.6490 0.0216 1.1637 0.0808 0.4865 1,461.78 304.6139 82.9661 0.0322 0.1301

Descriptive Statistics.
Standard Deviation 0.9403 0.4302 0.1849 1.2429 0.9692 0.2480 6,233.68 1,375.95 1,160.47 0.4059 0.5085 Minimum 5.5642 0.0006 1.6765 0.0001 3.8997 0 2.0 0.3320 9,899.80 1.8493 4.111 Maximum 3.3832 2.5519 0.1376 8.9884 2.4076 0.9940 59,000 15,849 904.28 1.6342 2.7517

Note: The stock prices used may not correspond to the last trading day of the scal year for a few companies with infrequent trading. FCF Two-year average of free cash ow measured as [EBIT (taxes deferred taxes) dividends stock repurchases]/sales. LEV Two-year average of nancial leverage measured by dividing total debt by total assets. TAX Potential savings due to reduced taxes is measured by the two-year average of taxes divided by sales. Q A Tobins q proxy measured by the two-year average of the market to book value ratio of equity. ROA Average return on assets (net income divided by total assets) over the two-year period before ling date. OWN Managerial equity ownership for the last scal year before ling. EMPLOYEE The number of employees for the last scal year before ling. TA Total assets in $millions for the last scal year before ling. EQUITY Total book value of equity in $million for the last scal year before ling. R Excess stock returns (in excess of the NASDAQ returns) over the two-year period computed by taking the natural logarithm of the price ratio. REVENUE Revenue growth rate measured by the percentage changes in revenues.

time periods, pre- and post-SOX. The dividing month is August 2002 when SOX became effective. Thus the pre-SOX period begins in 6/13/2000 and continues through 7/31/2002, while the post-SOX period spans from 8/31/ 2002 to 10/03/2003. Again, sample size varies depending on the variable, although the sample size for the pre-SOX period is smaller. There is a maximum size of 44 companies during the pre-SOX period and 103 for the postSOX period. Considering that the time period is shorter for the post-SOX sample, our data indicate an increased activity in going private after SOX. Referring to the univariate analysis of means comparison, only one variable, change in revenues, is statistically significant between the two

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Table 2.
Variable FCF LEV TAX Q R OWN EMPLOYEE TA EQUITY REVENUE ROA

Characteristics of Sample Firms in Subperiods.

N Post-SOX 21 40 21 27 38 44 43 44 44 44 40 0.158 0.6798 0.0118 1.2644 0.0687 48.92% 1,713.9 368.13 141.26 0.081 0.175 Pre-SOX 0.0026 0.5694 0.063 0.9326 0.1112 48.03% 875.4 155.5 52.16 0.081 0.019 t-Test 1.3 1.42 0.61 1.04 0.32 0.31 1.08 1.25 1.40 (1.94) 0.24 Z-Test 0.55 (2.45) 0.71 0.86 0.08 0.37 (2.13) 0.56 1.53 (2.66) (2.13)

86, 97, 88, 62, 96, 102, 100, 103, 102, 102, 97,

Note: N provides the sample sizes for post- and pre-SOX. See note to Table 1 for description of variables. Significant at the 5% level. Significant at the 1% level.

subperiods using a standard parametric t-test. However, the non-parametric Z-test statistics for the variables leverage (total debt/total assets), number of employees, and return on assets are significant at the 5% level, while revenue growth is significant at the 1% level. The pre-SOX group is less leveraged and has fewer employees, a higher two-year growth in revenue, and a better return on assets. These results do not indicate that smaller, more profitable rms are going private after SOX. This partition, however, is too noisy to extract meaningful information related to SOX. For example, the partitioned results probably reect the changes in the economic environment more than the impact of SOX. The statistics also could be confounded if rms going private for traditional reasons still outnumber rms that go private for cost reasons. In the next section, we employ cluster analysis in order to detect a new prole of rms going private.

3. CLUSTER ANALYSIS
We test our hypothesis, that SOX has created an additional prole of rms going private, by employing cluster analysis. Cluster analysis seeks to assign observations to a group or cluster such that the observations in the group are similar to each other and dissimilar to those observations in other clusters. Similarity is measured as Euclidean distances between pairs of

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observations across all variables. Cluster analysis is suitable for our research question because we do not have prior knowledge regarding the rm groups. Discriminate and/or logistic analysis may be suitable if we have a priori information about the class a rm belongs to. Cluster analysis begins with groups that are initially undifferentiated and ask whether a given group can be partitioned into subgroups that differ in some meaningful way.16 A two-stage density linkage cluster analysis is employed for this part of our study. Clusters are differentiated based upon a set of variables. We chose FCF, LEV, TAX, Q, R, OWN, and ROA as variables relevant to the free cash ow theory, and EMPLOYEE as a proxy for size. The choice of free cash ow variables is based upon the existing theory of rms going private. According to Jensens (1986) free cash ows theory, the characteristics for one type or cluster of rms going private would be high free cash ow, but low profitability as characterized by low Tobins Q or ROA, and low leverage. We expect to see rms going private exhibit these characteristics before SOX. After SOX, we are interested in nding if a new type or cluster of rms has emerged: companies for which being public has become too expensive. For this group, rm characteristics probably will not be consistent with the predictions of traditional free cash ow theory. Since SOX is expected to be particularly harsh to small-cap rms, we would expect the group of rms that goes private to avoid the excessive monitoring cost to be smaller, as measured by number of employees.17 Furthermore, since poor performance is not a pre-requisite for this group of rms to go private, we do not expect to see poorer performance measures such as stock returns, ROA, and/or Tobins q in comparison to a group of rms that have characteristics more consistent with the free cash ow theory. Since our primary interest is whether SOX has created a new category of rms going private, our null hypothesis is stated as follows: H0. SOX has created a new category of rms going private that would have otherwise remained public. Alternatively, H1. SOX has no impact on the decision to go private. To test our hypothesis, we perform cluster analysis for both subperiods of the sample and the mean values of rm characteristics for each cluster are provided for comparison purposes. For the pre-SOX subperiod, our cluster analysis identies only one cluster of rms. This cluster includes 15 rms. The remaining rms were not assigned to a cluster by the statistical

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Table 3. Pre-SOX Cluster Analysis.

Variable Cluster N 15 0.0283 0.45 0.97 0.897 0.0191 53.88% 1303 81.39 35.92 0.058 0.042 Unassigned Group N 629 0.062 0.635 0.024 0.977 0.308 45.03% 646.14 193.83 60.56 0.153 0.0559 t-Test Z-Test

FCF LEV TAX Q R OWN EMPLOYEE TA EQUITY REVENUE ROA

0.68 1.32 1.06 0.3 1.64 1.11 1.37 1.61 0.8 1.39 0.73

0.51 0.61 1.05 0.07 1.49 1.26 0.57 0.45 0.42 0.62 (1.93)

Note: Variables used to classify clusters are FCF, LEV, TAX, Q, R, OWN, EMPLOYEE, and ROA. Cluster revealed by two-state density linkage cluster analysis. See note to Table 1 for description of variables. Significant at the 10% level.

procedure. There are different factors causing these rms not to be classied in the cluster, but one reason might be the missing values for some of the variables. For example, only 21 rms have Tobins q value in the pre-SOX subsample. Table 3 reports rm characteristics for this cluster of rms. For comparison purposes, we also report the same statistics for the unassigned group of rms. By construction, rms in the cluster share similar characteristics, while rms in the unassigned group do not. The fact that there are rms that do not share similar characteristics speaks to the conicting evidence found in the existing literature. Based upon Table 3, cluster rms have small free cash ows (2.83% of sales), which is not consistent with the prediction of free cash ow theory. However, the sample period studied is a period dominated by economic recession during which many rms experienced negative profits. Cluster rms also have an average Tobins q of 0.897, 53.83% managerial equity ownership, and 1,303 employees. Compared to the unassigned group of rms, the only variable that is significantly different between these two groups of rms is ROA. Therefore, rms going private are not statistically different from each other during the period of pre-SOX. For the post-SOX subperiod, we nd that the cluster procedure identies two clusters with 40 rms assigned to cluster 1, and nine rms assigned to

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Table 4.
Variable Cluster 1 N 40

Post-SOX Cluster Analysis.

Cluster 2 N9 0.446 0.728 0.027 1.94 0.15 39.53% 26.56 85.22 12.85 0.012 0.22 t-Test (1.73) (2.59) (1.95) (1.70) 1.05 1.33 (1.91) (1.96) (2.74) (2.12) 1.02 Z-Test

FCF LEV TAX Q R OWN EMPLOYEE TA EQUITY REVENUE ROA

0.02 0.471 0.0129 1.057 0.142 50.61% 3,437 278 93.66 0.163 0.068

1.28 (2.49) 1.42 (2.57) 0.79 1.33 (4.61) 0.5 (2.44) 1.05 0.014

Note: Variables used to classify clusters are FCF, LEV, TAX, Q, R, OWN, EMPLOYEE, and ROA. Cluster revealed by two-state density linkage cluster analysis. See note to Table 1 for description of variables. Significant at the 10% level. Significant at the 5% level. Significant at the 1% level.

cluster 2. The remaining rms were not assigned to a cluster by the statistical procedure but we have placed them into an unassigned group for purposes of comparison. Table 4 provides the mean values of rm characteristics and standard t-tests and non-parametric Z-tests for clusters 1 and 2. A few differences between these two clusters are noted. First, we nd that cluster 2 does appear to consist of smaller rms, as measured by the number of employees, total assets, and equity. On average, rms in cluster 2 have 26.56 employees and $12.85 million equity, while cluster 1 rms have 3,437 employees and $93.66 million equity. (Both the t-statistics and the Z-statistics are statistically significant.) Furthermore, we observe that cluster 2 rms have higher Tobins q (1.94 vs. 1.057), and higher leverage (0.728 vs. 0.471), a result more consistent with the monitoring cost hypothesis and less consistent with free cash ow theory. One would expect that Tobins q would be smaller for companies that have high agency costs, and larger for those that do not. Therefore, the observation of a larger q value for cluster 2 is consistent with our hypothesis that these rms were not motivated by agency costs to go private. We also nd that cluster 2 companies pay significantly more in taxes, another sign of profitability. Furthermore, the higher nancial leverage measure for cluster 2 contradicts the free cash ow theory, which predicts an under-utilization of debt for rms with agency

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costs. The higher free cash ows (statistical significant using t-test) provide additional support of profitability and that the rms in this cluster are capable of generating cash ows to cover investment needs. The results reported in Table 4, therefore, provide some evidence that there are, at least, two groups of rms that go private after SOX. More importantly, cluster 2 rms share rm characteristics that are more consistent with the monitoring costs hypothesis, and less with the traditional free cash ow hypothesis, thereby supporting the contention that SOX has created a new category of rms that go private. Although the cluster analysis identies only two clusters of rms after SOX, there are rms not included in either of the two clusters and the number of rms in this unassigned group ranges from 4 to 51 depending on the variables examined. Therefore, it may be informative to compare rm characteristics of the unassigned group with those of the new cluster of rms. Table 5 reports such comparison. Compared to cluster 2, the unassigned group has negative cash ows, negative taxes, and negative equity, higher managerial ownership, and larger size. This unassigned group does not t the free cash ow theory well due to, for example, its negative free cash ows and very high nancial leverage (87%). The negative equity and Table 5.
Variable Cluster 2 N9 0.446 0.0728 0.027 1.94 0.15 39.53% 26.56 85.22 12.85 0.012 0.22

Post-SOX Cluster Comparison.

Unassigned Group N 451 0.276 0.871 0.015 1.536 0.232 49.04% 688 506.75 367.58 0.04 0.27 t-Test (1.75) 1.35 (2.37) 0.67 0.15 0.98 (1.92) 1.33 1.38 0.013 0.016 Z-Test

FCF LEV TAX Q R OWN EMPLOYEE TA EQUITY REVENUE ROA

1.43 1.06 1.18 1.06 0.12 1.09 (2.61) 0.42 (1.72) 0.19 0.26

Note: This table compares rm characteristics of cluster 2 and the unassigned group of rms. Variables used to classify clusters are FCF, LEV, TAX, Q, R, OWN, EMPLOYEE, and ROA. Cluster revealed by two-state density linkage cluster analysis. See note to Table 1 for description of variables. Significant at the 10% level. Significant at the 5% level. Significant at the 1% level.

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taxes, however, explain why the rms in this group do not belong to cluster 2 either. The existence of this unassigned group of rms suggests that rms going private are more heterogeneous than a single theory could explain. To summarize, our cluster analysis of rms going private reveals that there is only one cluster of rms before the passage of SOX, but two clusters of rms after SOX. A new cluster of rms that go private after SOX, although small in number, does suggest a different motivation for going private, consistent with the monitoring costs hypothesis.

4. CONCLUSIONS
We analyze whether the SOX Act has resulted in a new company prole that is going private because the cost of remaining public outweighs the rewards of being public. Cluster analysis suggests only one cluster of rms before the passage of SOX, but two clusters of rms after SOX. More importantly, the newly emerged cluster of rms exhibits characteristics that are more consistent with the monitoring costs hypothesis, supporting the argument that SOX increases rms monitoring costs substantially and is particularly harsh to smaller rms. This newly emerged cluster of rms chooses to go private not to reduce agency costs, but rather to reduce monitoring costs. These rms are small in size, have higher leverage, and higher Tobins q, in contrast to the prediction of the free cash ow theory. Cluster analysis, however, failed to assign all rms into clusters, suggesting that rms going private are quite heterogeneous, consistent with the conicting results reported in the literature. During our sample period, a number of rms used reverse stock splits to reduce the number of shareholders below the threshold of 300, essentially becoming a private company still held by the public. Obviously, this type of going private differs significantly from the more traditional LBO. We suspect that the controversy over the impact of SOX on small- and medium-sized entities will continue. A recently released Rand study found that small companies had a propensity to be purchased by private rms that are not subject to SOX requirements.18 Additionally, there are press reports of U.S. companies choosing to go public abroad, specifically in London to avoid the nancial burden due to SOX requirements. For example, CNN reported that in 2005, 19 U.S.-based companies went public on the London Stock Exchanges Alternative Investment Market, raising $2.1 billion.19 The impact may not be limited to the U.S. companies; foreign companies are now more reluctant to raise capital in the U.S. due to the SOX regulations.

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Non-U.S. companies can offer American Depository Receipts (ADRs) to the U.S. investors for capital. Now these ADRs are more likely to be replaced by Global Depository Receipts (GDRs), which are offered in, for example, London and Luxembourg.20 The effect of SOX on the nancial markets, therefore, is widespread in scope, and invites further research in this topic area.

NOTES
1. Senator Paul Sarbanes originally introduced his bill as a reaction to the Enron, Global Crossing, and Author Anderson scandals in early 2002. This bill passed in the Senate. However, after WorldCom became front-page news in June 2002, the Senate bill quickly gained favor in the House. Members of both parties, facing a midterm election and enraged constituents, clamored for action, pressing House Financial Services Committee Chairman Michael Oxley (R-OH) to move the legislation. Christopher Whalen (2003, p. 40). For a complete history of the legislative process, see Haidan Li, Morton Pincus, and Sonja Olhoft Rego (2004). 2. From http://www.sarbanes-oxley-101.com/sarbanes-oxley-faq.htm 3. Research by USBX Advisory Services summarized in Mergers and acquisitions report, Mark Cecil, 16(20), May 19, 2003, p. 6. Quote summarizing report appears in online resource Association for Financial Professionals, www.afponline.org 4. Section 404 requires that companies demonstrate that their internal controls can prevent fraud. 5. Appearing in The Wall Street Journal Review and outlook section, April 19, 2005, p. a20. 6. Study summarized in the Stanford law school securities class action clearinghouse, 2003 News and Press Releases, May 5, 2003. 7. SarbanesOxley burdens small companies, Tamara Loomis, the New York Lawyer, December 19, 2002. 8. See Andrew Countryman, Compliance law changes urged, Chicago Tribune, January 3, 2005. Author reports that an SEC advisory committee began work in December 2004 To assess the effect of the law on smaller companies and make recommendations about how the burdens could be eased. The article quotes Alan Beller, director of the SECs Division of Corporate Finance, I dont know what percentage of Americas companies is interested in delisting. Thats one of the reasons the panel was formed. 9. Some small banks delist to avoid SarbanesOxley, Laura K. Thompson, American Banker, March 26, 2003, 168(58), p. 1. 10. See, for example, a recent editorial appearing in The Wall Street Journal. Neal Wolkoff, the Chairman and CEO of the American Stock Exchange, voices his concern that smaller rms traded on the AMEX nd the regulation threatens the survival of their companies as independent, publicly traded entities. He estimates that SOX compliance costs consume 1.5% of revenues for an average AMEX traded rm. SarbanesOxley is a curse for small-cap companies, The Wall Street Journal, August 15, 2005, p. A13.

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11. Although beyond the scope of this paper, it is worthwhile to note that the reporting requirement of SOX is affecting foreign rms as well as domestic ones. Some foreign rms are delisting from U.S. exchanges due to the additional costs. See, for example, Foreign outts rue SarbanesOxley, Business Week online, December 15, 2004. 12. See Jensen (1986). Also see Alan C. Shapiro (1989, pp. 476477). 13. A 13E-3 ling is required pursuant to the Securities Exchange Act of 1934 when a public company goes private. A 13E-3 transaction refers to any transaction involving (a) a purchase of equity security by the issuer or by an afliate of such issuer; (b) a tender offer of any equity security made by the issuer or an afliate of such issuer; and (c) a solicitation to merge, consolidate, reclassify, recapitalize, or reorganize by an issuer or its afliate. Such transaction may cause the equity securities to be held by less than 300 persons, or delisted from any national securities exchange, inter-dealer quotation system, and/or any registered national securities association. 14. The fact that our sample period comes from a recessionary period may be in favor of nding no unique clusters, as rms would tend to be uniformly negatively affected by the poor economy. 15. Since rms with negative equity are excluded from computing Tobins q, q has the smallest sample size among all variables. The mean value of Tobins q (1.16) is also upward biased due to the truncation of rms with negative equity. 16. Dillon and Goldstein (1984, p. 161) 17. We chose only one measure of rm size, EMPLOYEE, for the cluster analysis procedure because of high correlations among these variables (total assets, equity, and number of employees). 18. Going Private decisions and the SarbanesOxley Act of 2002: A cross-country analysis, Ehud Kamar, Pinar Karace-Mondic, and Eric Talley http://www.rand.org/ pubs/working_papers/2006/RAND_WR300-1.pdf 19. See http://www.CNNmoney.com, June 19, 2006, Why tech IPOs are moving to Europe. 20. See http://www.forbes.com, May 25, 2006, The courting of foreign exchanges.

ACKNOWLEDGMENTS
We thank two anonymous reviewers and the editor, Gary Previts for helpful comments.

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