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Sarbanes–Oxley Section 406 Code of Ethics for Senior Financial Officers and Firm Behavior

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Abstract

Sarbanes–Oxley Section 406 requires a code of ethics for top financial and accounting officers in public companies. The objective of this research is to discover the impact of a financial code of ethics on firm behavior. We performed a longitudinal tracking of firm adoption of a financial code of ethics starting in 2005. We checked these companies’ codes again in 2011 to confirm their continued implementation. Financial restatements were used as a dependent variable to measure improved financial reporting after the adoption of the financial codes. The results confirm that the adoption of a financial code of ethics improves the integrity of financial reporting.

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Notes

  1. SEC regulations require the use of a Form 8 K 4.02 to announce an earnings restatement; however, not all firms do so. The SEC has expressed concern that many firms fail to file 8-Ks to announce restatements (White 2008). To ascertain the possible cause of firms’ noncompliance, we looked at the SEC website. The SEC has detailed FAQs regarding the form 8-K on the SEC website (https://www.sec.gov/divisions/corpfin/form8kfaq.htm). Many FAQs suggest that a firm can avoid filing an 8 K if the ‘triggering event’ (earnings restatement) for filing an 8-K occurs within four business days prior to the firm’s filing of a periodic report. The firm can chose to disclose the restatement in its periodic report rather than a separate Form 8-Ks. Another reason why a firm may not file an 8-K is that a restatement may be cumulatively material for previous financial statements but is not material for one specific financial statement. In such cases, the rule for filing 8-K leaves some ambiguity, which can allow a firm to choose not to file an 8-K to announce an earnings restatement (Plumlee and Yohn 2008). The SEC has recognized the non-filing of form 8-Ks to accompany the restatements as an issue and is working to resolve the ambiguities surrounding the form 8-K filing.

Abbreviations

CEFO:

Code of ethics for financial officers

SOX:

Sarbanes–Oxley Act

GAAP:

Generally accepted accounting principles

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Acknowledgments

We appreciate the assistance of Harper Baird and Jennifer Sawayda for assisting in the collecting of the data as well as research and editing in the development of the manuscript.

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Authors and Affiliations

  1. Anderson School of Management, University of New Mexico, MSC05 3090, 1 University of New Mexico, Albuquerque, NM, 87131-0001, USA

    Saurabh Ahluwalia

  2. Jack C. Massey College of Business, Belmont University, 1900 Belmont Boulevard, Nashville, TN, 37212-3757, USA

    O. C. Ferrell & Linda Ferrell

  3. College of Business, University of Wyoming, 1000 E. University Ave., Laramie, WY, 82071, USA

    Terri L. Rittenburg

Authors
  1. Saurabh Ahluwalia
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  2. O. C. Ferrell
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  3. Linda Ferrell
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  4. Terri L. Rittenburg
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Corresponding author

Correspondence to O. C. Ferrell.

Appendix: Data Dictionary

Appendix: Data Dictionary

Adverse restatement

A restatement is classified as an adverse restatement if the revised numbers worsen the past reported performance

Book to market

Book value of equity divided by market value of equity. Compustat (seq) over Compustat (MKVALT)

Cash flow ratio

Compustat (IB + DP) over lagged Compustat (PPE)

Cash ratio

Compustat (CHEE) over Compustat (AT)

CEFO

Code of ethics for financial officers. Takes the value of 1 if the company had code of conduct specifically for financial officers

Days to report

Time between the beginning date of a restatement and the reporting date of the restatement

Improves or improving restatement

A restatement is classified as an improves or improving restatement if the revised numbers enhance the past reported performance

Investment

Compustat (CAPX) over lagged Compustat (PPE)

Interest coverage ratio

Compustat (OIBDP) over lagged Compustat (XINT)

LevBook

Book value of debt divided by sum of book value of debt and book value of equity. Compustat (DLC + DLTT) over Compustat (DLC + DLTT + CEQ)

Log assets

Natural log of assets (Compustat AT)

Return on assets

Compustat (NI) over lagged Compustat (AT)

SG&A ratio

Compustat (XSGA) over lagged Compustat (SALE)

Tangibility

Compustat (PPE) over Compustat (AT)

Total days in restatement

Time between beginning of the restatement period and end of the restatement period

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Ahluwalia, S., Ferrell, O.C., Ferrell, L. et al. Sarbanes–Oxley Section 406 Code of Ethics for Senior Financial Officers and Firm Behavior. J Bus Ethics 151, 693–705 (2018). https://doi.org/10.1007/s10551-016-3267-7

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