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Stock Price Reactions to Accounting Fraud The University of Tennessee

Undergraduate Thesis

Cynthia Bynum 30 April 2012

Global Leadership Scholars Advisor: Dr. Deborah Harrell

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Abstract

This paper documents a four-way analysis of the stock price reactions to lawsuits brought against

a company for corporate misconduct. The four-way analysis interprets the stock price reactions

to lawsuit filings both pre- and post- Sarbanes Oxley Act of 2002 (SOX), and class action

lawsuits and non class action lawsuits. The reactions are based on the announcement date with a

ten-day window both before and after the date. This is based on the assumption that information

can be leaked to the media or stockholders before the announcement day and in order to grasp

the actual affect for days after the announcement day. With this research, I expect to find a

negative stock reaction in all companies when an announcement of corporate misconduct is

made. This negative reaction will show that shareholders are not as confident of the profitability

or success of that company. It may also serve as society’s punitive damage for the mistrust that it

has placed among its consumers, shareholders, and stakeholders. I also expect to find that

companies facing lawsuits for corporate misconduct post-SOX will experience a more negative

reaction than those pre-SOX. My assumption is based on SOX being a far-reaching reform of

regulatory policies of companies’ business practices. I see this as holding companies to a higher

standard with more regulations and policies to follow. I also expect companies with class action

lawsuits to face a larger negative stock reaction than companies without class action lawsuits. To

be declared a class action lawsuit, many prerequisites and trial hearings are required before it can

legally be entitled as a class action lawsuit. This presumes that the company has wronged a

multitude of stakeholders. Non-class action lawsuits do not have the court hearing as a

prerequisite and may include just one party or individual that has been wronged by the company.

I will run regression analyses on the closing stock prices to test my assumptions.

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I. Motivation

When deciding in the infinite realm of topics what to conduct my research on for my

thesis, I knew I wanted something intriguing and related to the financial prosperity of businesses.

Corporate misconduct and financial fraud have always been intriguing topics to me. Though, I

find it more interesting the lengths that companies reach to cover any traces of misconduct. This

led me to the curiosity of what happens to companies when they are charged of accounting fraud.

Accounting fraud can be defined in a multiple of ways. Common cases of accounting

fraud include “cooking the books” by hiding large expenses, overstating revenues, overstating

assets, understating liabilities, etc. My research assumes that accounting fraud is any deception

or misleading information released in accounting and financial statements that leads the

company to appear in a healthier financial position than what they actually are. My research does

not focus on any particular type of accounting fraud such as price-fixing or overstating revenues.

Instead, it covers a wide array of accounting fraud.

The framework of my study will be compiled by analyzing thirty-two different

companies accused of accounting fraud. This number is broken down into four different

categories giving the four-way analysis. These categories were selected by a sparked interest of

how price reactions changed both after SOX was passed and if the classification was a class

action lawsuit. These two specifications are important as I can see significant roles that they play

in the business world. When SOX was passed, many new regulations, policies, and rules were

issued to help monitor and facilitate good business practices. It was the biggest reform in

financial reporting since the 1930s (Cahan). So, it would be a great specification to use to

measure how stock prices were affected both before and after the reform. The other stipulation

on my research is class action lawsuits. Class action lawsuits are when a class of people or

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parties comes together to file a lawsuit against a company who wronged them in the similar

manner. It is common for shareholders to gather and file class action lawsuits against the

company for which they hold shares (Eble). This stipulation also has great significance. Class

action lawsuits have many prerequisites and go through a trial before it is recognized as a class

action lawsuit. This would suggest that with more people being affected and it already being

processed through a court trial that there would be a greater negative reaction to the stock prices.

It would be interesting to study the difference in the stock reactions for companies with class

action lawsuits filed against them and companies without. These two specifications are being

used for comparison of whether they really have an affect on reaction of stock prices when a

company is accused of corporate misconduct.

In the awakening of the twenty first century, America witnessed a widespread of

financial scandals with some of the major influences being Enron and WorldCom. Enron was an

American energy company that was based out of Houston, Texas. During the time period of

Enron’s scandals, it was the seventh largest company in the U.S. (EBSCOhost). In November

1997, Enron began its transactions that enabled it to hide its debts from the public eye. Enron

accomplished this by buying out stakes in a company called JEDI. Enron then sold the stakes to

a firm, which it created called Chewco. Three and a half years later in February 2001, three

critical events happened that caused a decline in stock prices: Arthur Andersen made claims of

dropping Enron as a client, Kenneth Lay stepped down from CEO with Jeffrey Skilling taking

his place, and FORTUNE magazine made claims that Enron was piling on debt while keeping it

hidden from Wall Street (Time U.S. and Time Specials). In August, the newly appointed CEO

Jeffrey Skillings resigned, totaling six senior executives leaving the company within the past

year (Time Specials). From this point until Enron filed what was then the largest bankruptcy in

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U.S. history on December 2, the scandals of Enron began to unravel quickly. Arthur Andersen

was quick to rid all of their basic documents with Enron, and the Securities Exchange

Commission filed for an inquiry of Enron’s financial statements (Time Specials). The scandals

incurred by Enron led not only to its bankruptcy but also led the Arthur Andersen accounting

firm, one of the five largest in the world, to an early end. Enron shareholders lost nearly $11

billion. Price per share hit an all time high of $90 in mid 2000, then by October 2001 had

plummeted to less than $1 per share. By the time the stock closed the day Enron filed for

bankruptcy, it was only trading for $0.26 (Time Specials). Enron was the US’s largest

bankruptcy until the WorldCom scandals the following year. WorldCom was once US’s second

largest long distance phone company. WorldCom was considered to have a solid business

strategy as they were acquiring a lot of telecommunication companies during the wake of the

technology boom (Moberg). WorldCom went from a Wall Street favorite to a surprising record

bankruptcy. The CEO of WorldCom, Bernie Ebbers, joined the company in 1985 when it was

formerly know as Long-Distance Discount Services (LDDS) (Washington Post). WorldCom,

known for its strategic business plan of making acquisitions, completed three mergers in

1998.One the mergers was with MCI Communications Corporation for $40 billion, making it

the largest merger in history at that time (Washington Post). The company continued to merge,

but it started to draw attention to the Securities and Exchange Commission who requested

information for WorldCom’s accounting procedures in March 2002. Shortly following, credit

ratings were being cut, and CEO Bernie Ebbers resigned in late April. Investigations into

WorldCom’s financials suggest improper reporting dating back to 1999, and the company filed

for bankruptcy protection on July 21, 2002 (Washington Post). WorldCom became the largest

bankruptcy in US history (Beltran).

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These record setting scandals and bankruptcies are what gave push for the passing of

SOX. The changes that the US faced were swift, and the Public Company Oversight Board

(PCAOB) laid down stiff rules for the financial reporting and auditing for companies (Cahan).

Even those these regulations were issued, it does not prevent another major accounting scandal.

However, with these changes in regulations, we can compare companies before and after to see

if it does affect companies (Cahan).

II. Related Research

The Sarbanes-Oxley Act of 2002

The Sarbanes Oxley Act of 2002 (SOX) was Congress’ effort to respond to corporate

scandals and used to restore confidence in the stock markets. Again, it was the largest

accounting reform in the US since the 1930s. It was nothing to be taken lightly. After a wave of

scandals was uncovered in the start of the 21st Century, Congress had to enact provisions to

protect shareholders and the general public from fraudulent practices. These regulations covered

a range of topics and people: Public Company Accounting Oversight Board, Auditor

Independence, Corporate Responsibility, Enhanced Financial Disclosures, etc. To help explain

the strict regulations placed on companies, here are a couple of examples of rules set in place by

SOX:

Sec. 301‘‘(2) RESPONSIBILITIES RELATING TO REGISTERED PUBLIC

ACCOUNTING FIRMS.—The audit committee of each issuer, in its capacity as a

committee of the board of directors, shall be directly responsible for the appointment,

compensation, and oversight of the work of any registered public accounting firm

employed by that issuer (including resolution of disagreements between management and

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the auditor regarding financial reporting) for the purpose of preparing or issuing an

audit report or related work, and each such registered public accounting firm shall

report directly to the audit committee.”

Sec. 401 “(b) COMMISSION RULES ON PRO FORMA FIGURES.—Not later than 180

days after the date of enactment of the Sarbanes-Oxley Act of 2002, the Commission shall

issue final rules providing that pro forma financial information included in any periodic

or other report filed with the Commission pursuant to the securities laws, or in any public

disclosure or press or other release, shall be presented in a manner that—

(1) does not contain an untrue statement of a material fact or omit to state a material fact

necessary in order to make the pro forma financial information, in light of the

circumstances under which it is presented, not misleading; and

(2) reconciles it with the financial condition and results of operations of the issuer under

generally accepted accounting principles.” (U.S. Securities and Exchange Commission)

In late 2001, American headlines covered the unraveling of the Enron and Andersen

scandals. Closely followed by these were ImClone, Global Crossing, and other similar stories of

companies falsifying their financial records. At first, Congress did little in reaction to these

events. Though, several committees commenced hearings, and several new bills were introduced

to address the recent trend of corporate misconduct. However, at the time, the Senate was under

Democratic control and the Republican Party controlled the House of Representatives. The

differences between these two legislations were so extreme that is appeared that the effort for

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corporate reform had stalled (Spurzem). During the times that the committees were meeting, two

men, Michael Oxley and Paul Sarbanes, were in the making of a bill to be passed to set

regulations on companies to provide honest representation of financials. In late April 2002, the

House of Representatives passed Representative Michael Oxley’s bill in an attempt to create a

reform and put a stop to the wave of scandals. Shortly after this in June, WorldCom announced

that it had been overstating its earnings for the past fifteen months. This put legislation into full

gear to get a bill passed to stop companies from these scandals. On June 25, Senator Sarbanes

introduced his bill to the full Senate, and it was passed on July 15. The conference committees

that were meeting reconciled the differences between these two bills. They approved the full bill

and named it the Sarbanes-Oxley Act of 2002 on July 24, 2002. The bill became enacted on July

30 when President George W. Bush signed it into law (Digital Pathways).

Although SOX was enacted on July 30, 2002, the complicated bill took over a year to

fully be enforced, ranging from the date it was enacted until December 15, 2003. The bill was

broken into several topics, which were broken into numerous different effective dates.

Examples of these broken down effective dates include:

“Topic 101 (d) Public Company Oversight Board:

Effective Date: SEC determination no later than April 26, 2003”

“Topic 406 Senior Management Code of Ethics:

Effective Date: Final rule issued by the SEC on January 23, 2003. Rule is effective for

fiscal years ending on or after July 15, 2003.” (PricewaterhouseCoopers)

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Legislation passed SOX in an attempt to protect shareholders and the general public from

companies behaving with corporate misconduct. It was also a warning to companies of the

consequences if caught in their actions. SOX enacted guidelines for how companies should report

their financial statements, limiting the number of loopholes that companies could use to

fraudulently misrepresent their financial performance. SOX also includes the responsibility that

companies have to their employees, shareholders, customers, and the public, in general. A code

of ethics is something else that can be found in SOX. Following the law can be the minimal of

ethics, so it is important for companies to understand that following the law is just the bare

minimum. With these guidelines set in place, companies are held to a much higher standard in

honestly and accurately reporting the financials of their companies. My research will show us if

stock prices were affected by these new regulations set in place. More reform may be a solution if

companies are unaffected by SOX and are still fraudulently depicting the financial statements of

the company.

Class Action Lawsuits

For the other part of my research that I am conducting, I am analyzing whether lawsuits

against companies experienced a larger impact on stock prices if they were class action lawsuits.

A class action lawsuit is defined as a type of lawsuit in which a large group of people

collectively brings a claim against the same defendant. This type of lawsuit is prominent in the

United States in which it was originated (Eble). For my study, I will be comparing the reaction

of stock prices in companies with class action lawsuits versus companies with lawsuits or

allegations that are not class action. Class action lawsuits have many prerequisites and go

through a court process before being declared a class action lawsuit. It is a topic of study

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because it will be interesting to see if being a class action lawsuit has a bigger negative reaction

to stock prices.

Class action lawsuits tend to be taken more serious as there has already been a court

overseeing the lawsuit, classifying it as class action. There are four prerequisites to class action

lawsuits: 1. The class is so numerous that joinder of all members is impracticable (numerosity);

2. There are questions of law or fact common to the class (commonality); 3. The claims or

defenses of the representative parties are typical of the claims or defenses of the class

(typicality); and 4. The representative parties will fairly and adequately protect the interests of

the class (adequacy of representativeness) (Rule 23). In a short time after a person sues as a

class representative, the court will determine by order whether to certify the action as a class

action. The order will determine the type of class and appointing the class counsel. After the

class is issued, defined and appointed counsel, the order may be altered or amended before final

judgment. All members of a class may be identified and offered a notice after the final

judgment of the class is made. The notice should include the nature of the action, the definition

of the class certified, the class claims, the right to an attorney, the right to seek exclusion from

the class and the protocol for this exclusion, and the binding effect of a class judgment on

members.

Some of the top class action lawsuits include AOL Time Warner who settled for $2.5

billion, Tyco Telecommunications who settled for $3.2 billion, Exxon who was ruled to pay $5

billion (late reduced to $500 million), WorldCom who settled for $6.2 billion, and Enron who

settled for $7.2 billion (American Greed). All of these companies had class action lawsuits filed

against the after a court found that they had met all of the prerequisites and thought it was a

viable reason. The majority of lawsuits are settled outside of the court system either through

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negotiation, mediation, or arbitration (Obringer). It will not be common to find lawsuits make it

through the entire court process. An alternative settlement seems enticing to many companies,

as it would save much time and a lot of court expenses.

Class action lawsuits must follow procedural law. There are many steps and actions that

must be taken before a class action lawsuit is bind by law. With the steps taken, much time must

be allocated to define the class and make final judgment of the class and their lawsuit. This must

be taken into consideration when judging the effects of the stock prices. My research will show

if class action lawsuit cases have a larger affect on stock prices.

III. Hypothesis

After further research into the stipulations and guidelines of SOX, I expect to find that

the sixteen companies with allegations of accounting fraud post-SOX will experience larger

negative stock effects than those of the sixteen pre-SOX. More so, I expect to find the companies

with class action lawsuits filed against them to experience a greater negative stock price reaction

as compared to those companies without class action lawsuits. Class action lawsuits go through a

lengthier litigation process and have a more sever punishment for companies. This gives

adherence as to why I expect this sample to experience a more negative stock price reaction.

IV. Methodology

For  my  topic,  I  am  researching  the  stock  price  reaction,  if  any,  that  occurred  to  

thirty-­‐  two  companies  once  an  allegation  was  lodged  against  the  company  for  accounting  

fraud.  My  research  consisted  of  collecting  a  significant  amount  of  primary  data.  The  thirty-­‐

two  companies  consist  of  sixteen  companies  whose  litigations  occurred  before  the  

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Sarbanes-­‐Oxley  Act  (SOX)  of  2002  and  sixteen  companies  with  litigations  occurring  after  

SOX  was  in  full  effect.  Like  many  large  reforms,  SOX  was  broken  down  into  several  topics,  

covering  different  aspects  of  the  financial  reporting  process.  These  different  topics  had  a  

wide  array  of  dates  in  which  the  bill  was  to  be  enacted,  even  though  it  was  signed  into  law  

on  July  30,  2002.  These  dates  of  enactment  ranged  from  July  30,  2002  until  December  15,  

2003.  Chart  1  gives  a  more  visual  aid  for  the  enactment  dates.  For  this  reason,  the  

companies  chosen  for  the  pre-­‐  and  post-­‐  SOX  study  were  all  chosen  with  announcement  

dates  of  lawsuit  either  prior  to  July  2002  or  after  the  year  ending  2003.    This  would  yield  all  

pre-­‐SOX  companies  to  have  announcement  dates  prior  to  July  1,  2002  and  all  post-­‐SOX  

companies  to  have  announcement  dates  after  January  1,  2004.  This  stipulation  is  to  prevent  

complication  and  confusion  for  the  pre-­‐  and  post-­‐SOX  companies.  Then,  to  further  my  

analysis,  of  the  sixteen  companies  both  pre-­‐  and  post-­‐  SOX,  they  were  divided  into  eight  

class  action  lawsuits  and  eight  non-­‐class  action  lawsuits.  This  will  give  me  a  four-­‐way  

analysis  in  comparing  effects  of  stock  prices.  There  are  class  action  lawsuits  versus  non-­‐

class  action  lawsuits  and  pre-­‐SOX  versus  post  -­‐SOX.  

 

 

 

 

 

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Chart  1.  Outlined  is  the  number  of  topics  that  became  effective  on  various  dates  ranging  from  July  31,  2002  

until  December  15,  2003.  This  does  not  include  all  topics  in  the  Sarbanes-­‐Oxley  Act  of  2002.  Some  topics  of  

the  Act  were  not  given  an  effective  date.  The  dates  listed  are  not  actual  effective  dates,  but  rather  month  end  

dates,  so  it  encompasses  the  number  of  topics  that  became  effective  during  that  given  month.  

 

My  sample  data  consists  of  thirty-­‐two  companies  in  total  that  faced  allegations  for  

corporate  misconduct.  For  the  class  action  lawsuits,  I  used  the  class  action  lawsuit  filings  

off  Stanford’s  securities  website,  http://securities.stanford.edu.  Under  the  filings  section,  I  

randomly  selected  sixteen  companies,  eight  whose  litigation  dates  were  before  July  2002  

and  eight  whose  litigation  dates  were  after  January  1,  2004.    Companies  that  were  

randomly  selected  but  did  not  meet  the  requirements  were  thrown  out  and  another  

company  was  chosen  at  random.  The  companies  chosen  had  to  meet  the  requirements  of  

being  a  publically  traded  company,  having  historical  stock  prices  available,  and  having  

stock  price  returns  data  publically  available  for  the  event  window  occurring  in  the  set  pre-­‐  

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or  post-­‐SOX  time  frame.  To  account  for  bias,  another  specification  added  on  to  my  

empirical  research  was  that  I  have  no  prior  knowledge  of  the  company.  Of  the  two  hundred  

eighty-­‐six  companies  posted  on  Stanford’s  securities  website,  only  seventeen  companies  

met  the  requirements,  eight  post-­‐SOX  and  nine  pre-­‐SOX.  This  explains  my  small  sample  

size,  as  I  was  very  limited  to  the  companies  that  met  the  qualifications  for  my  research.  My  

randomized  selection  was  based  off  blindly  pointing  at  a  company  and  testing  to  see  if  it  

met  the  specifications.  If  it  did  not,  then  it  was  crossed  out  and  another  company  was  

selected.  Chart  2  identifies  the  sixteen  class  action  lawsuits  companies,  both  pre-­‐  and  post-­‐

SOX  that  were  selected  for  my  study.  

Chart  2.  Identified  are  the  sixteen  companies  selected  as  the  class  action  lawsuits  sample  of  my  research.  

 

For  the  non-­‐class  action  lawsuits,  I  used  the  LexisNexis  Academic  database.  The  

same  requirements  were  applied  to  non-­‐class  action  lawsuits  categories  as  well:  to  account  

for  bias,  I  must  have  no  previous  knowledge  of  the  company,  it  must  be  a  publically  traded  

company,  have  historical  stock  prices  available,  and  have  an  announcement  date  in  the  set  

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pre-­‐  or  post-­‐SOX  time  frame.  The  companies  that  met  these  requirements  were  then  

crossed  check  with  the  Stanford  database  to  ensure  that  they  did  not  fall  into  the  class  

action  lawsuit  sample.  My  selection  process  for  this  part  of  my  sample  was  still  random,  but  

it  was  conducted  in  a  different  manner.  Using  LexisNexis,  I  used  key  terms  to  search  all  

major  publications  for  companies  accused  of  accounting  fraud.  Key  terms  used  to  search  

for  companies  include:  accounting  fraud,  financial  fraud,  corporate  misconduct,  accounting  

scandals,  price-­‐fixing,  fraud,  and  financial  scandals.  Again,  I  randomly  selected  companies  

and  tested  the  criteria.  If  the  company  did  not  meet  the  qualifications,  then  it  was  thrown  

out,  and  the  selection  process  continued.  Through  this  process,  I  identified  one  hundred  

forty-­‐three  companies.  Only  twenty  companies  met  the  qualifications  for  this  sample,  and  

sixteen  were  randomly  selected.  Chart  3  lists  the  companies  chosen  for  the  non-­‐class  action  

lawsuit  sample.  

Chart  3.  Identified  are  the  sixteen  companies  selected  as  the  non-­‐class  action  lawsuits  sample  of  my  research  

 

 

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The  announcement  date  for  my  samples  is  the  date  in  which  the  allegations  were  

made  public.  To  encompass  a  range  of  possibilities  to  capture  stock  price  reactions,  I  will  

use  an  event  window  period.  This  includes  ten  days  prior  to  the  announcement  date  to  

account  for  early  leakage  to  the  media  or  shareholders  and  ten  days  after  the  

announcement  date  to  capture  the  actual  public  reaction  to  the  allegations.  This  creates  a  

twenty-­‐one  day  event  window,  including  t=o  as  the  announcement  date.  Prior  to  the  event  

window,  I  pulled  a  year  worth  of  stock  prices  to  be  able  to  calculate  the  normal,  expected  

return.  Using  a  regression  analysis,  the  assumed  stock  price  for  the  announcement  day  can  

be  calculated.  It  can  then  be  compared  to  the  actual  stock  price  for  the  announcement  day.  

This  comparison  will  allow  the  analysis  of  the  actual  shock,  if  any,  of  the  stock  prices  on  the  

date  the  allegation  was  announced.    

For  the  regression  analysis,  the  closing  prices  have  been  pulled  from  the  Bloomberg  

Database.  Yahoo  Finance  proved  to  be  an  unreliable  and  inaccurate  source  of  data  for  my  

research.  It  was  my  original  source  of  stock  price  information,  but  after  providing  

inaccurate,  insufficient,  or  unreliable  data  for  specific  stocks,  it  has  become  a  mere  

checkpoint  for  certain  stock  prices.  Bloomberg  has  provided  all  of  the  closing  stock  prices  

and  can  account  for  dividends  paid.      

  The  date  of  the  first  public  announcement  of  accounting  fraud  will  be  set  as  t=0.  The  

ten  days  prior  to  the  announcement  date  will  be  t=-­‐10,  t=-­‐9…  with  t=-­‐1  being  the  day  

before  the  announcement  date.  The  ten  days  after  the  announcement  date  will  be  t=1,  t=2…  

with  t=10  being  the  tenth  day  after  the  announcement  was  made  public.  Using  the  Brown  

  17  

and  Warner  (1985)  standard  event  study  methodology,  I  was  able  to  capture  the  stock  

price  reactions  during  the  event  window  of  the  first  public  announcement.  I  was  able  to  

examine  the  single  day  abnormal  returns,  ARt  and  the  multi-­‐day  cumulative  abnormal  

return,  CAR(a,b),  where  a  and  b  indicate  days  that  are  relative  to  t=0.  

  For  sufficient  regression  results,  there  must  be  a  minimum  of  150  days  prior  to  the  

event  window.  For  my  study,  250  days  were  used,  giving  roughly  a  year’s  worth  of  daily  

returns  prior  to  the  event  window.  Using  the  250,  t=-­‐11  to  t=-­‐260,  days  prior  to  the  event  

window,  I  calculated  the  Beta,  β,  and  the  Intercept,  α,  using  a  least  square  regression  of  

€

rit  

and  

€

rmt  to  use  in  the  equation  to  define  the  abnormal  return.  The  Brown  and  Warner  

(1985)  market  model  used  for  abnormal  returns  for  firm  i  is  defined  as  

                                                                                                             

€

Rit = rit −α i −βirmt                                                                                                                (1)  

where  

€

rit  represents  the  firm  i’s  common  stock  on  day  t,  and  

€

rmt  is  the  return  on  the  

Standard  and  Poor’s  (S&P  500)  return  on  the  index  of  day  t.  To  calculate  the  average  

abnormal  return  for  each  day  t  in  the  event  window,  it  was  computed  as  

                                                                                 

€

ARt =1Nt

Riti=1

Nt

∑#

$ % %

&

' ( (                                                                                                                  (2)  

where  

€

Nt  represents  the  number  of  firms  in  the  average  on  day  t.  The  cumulative  average  

return  was  calculated  as    

                                                                                    ∑=

=b

attARbaCAR ),(                                                                                                                          (3)  

where  a  and  b  are  days  relative  to  the  announcement  date.  

  18  

V.  Data  and  Results  

Table  1.  The  daily  abnormal  returns  during  the  event  window  are  based  on  the  Beta  and  Intercept  over  the  period  -­‐260  days  to  -­‐11  days  relative  to  the  event  period  of  the  announcement  date.  This  table  lists  the  daily  abnormal  returns  during  the  event  window  for  the  eight  companies  in  the  post-­‐SOX  and  class  action  lawsuit  category  and  the  average.  

 

 

Table  2.  The  daily  abnormal  returns  during  the  event  window  are  based  on  the  Beta  and  Intercept  over  the  period  -­‐260  days  to  -­‐11  days  relative  to  the  event  period  of  the  announcement  date.  This  table  lists  the  daily  abnormal  returns  during  the  event  window  for  the  eight  companies  in  the  pre-­‐SOX  and  class  action  lawsuit  category  and  the  average.  

 

  19  

 

Table  3.  The  daily  abnormal  returns  during  the  event  window  are  based  on  the  Beta  and  Intercept  over  the  period  -­‐260  days  to  -­‐11  days  relative  to  the  event  period  of  the  announcement  date.  This  table  lists  the  daily  abnormal  returns  during  the  event  window  for  the  eight  companies  in  the  post-­‐SOX  and  non-­‐class  action  lawsuit  category  and  the  average.  

 

 

Table  4.  The  daily  abnormal  returns  during  the  event  window  are  based  on  the  Beta  and  Intercept  over  the  period  -­‐260  days  to  -­‐11  days  relative  to  the  event  period  of  the  announcement  date.  This  table  lists  the  daily  abnormal  returns  during  the  event  window  for  the  eight  companies  in  the  pre-­‐SOX  and  non-­‐class  action  lawsuit  category  and  the  average.  

 

  20  

Table  5.  Cumulative  average  abnormal  returns  are  calculated  using  the  Brown  and  Warner  (1985)  methodology.  The  CARs  are  measured  relative  to  the  announcement  date  of  t=0.  The  whole  sample  includes  all  thirty-­‐two  companies  from  the  four  different  categories.  Post-­‐Sarbanes-­‐Oxley  2002  includes  sixteen  companies,  eight  class  action  lawsuits  and  eight  non-­‐class  action  lawsuits.  Then  the  class  action  lawsuits  and  non-­‐class  action  lawsuits  make  up  the  fourth  and  fifth  category.  Then,  all  four  categories  are  separated  for  comparison.    

 

  21  

  After  calculating  the  abnormal  returns  and  the  cumulative  average  abnormal  

returns,  my  results  suggest  that  there  is  no  difference  between  pre-­‐SOX  (-­‐0.04017)  and  

post-­‐SOX  (-­‐0.04778).  However,  there  does  appear  to  be  a  difference  between  Post-­‐SOX  

class  action  lawsuits  (.007713)  and  pre-­‐SOX  class  action  lawsuits  (-­‐0.00461)  and  also  

between  class  action  lawsuits  (0.001552)  and  non-­‐class  action  lawsuits  (-­‐0.0895).  

Although,  it  should  be  noted  that  given  my  small  sample  size  of  only  thirty-­‐  two  firms,  I  am  

unable  to  test  if  these  differences  are  statistically  significant.  Given  the  time  frame  that  I  

used  (1997-­‐2011),  there  were  not  enough  companies  that  met  the  data  qualifications.  

Through  much  research,  it  has  become  apparent  that  in  order  to  encompass  enough  

companies  for  my  research,  my  time  frame  would  need  to  be  altered  and  extended.  Other  

studies  such  as  that  done  by  Murphy,  Shreives,  and  Tibbs  encompass  394  companies  using  

the  time  frame  from  1982-­‐1996.    My  specification  to  reduce  bias  by  eliminating  companies  

with  previous  knowledge  also  limited  my  research  sample  size.    

  After  compiling  my  research  and  analyzing  the  data,  my  hypothesis  has  been  

rejected.  I  hypothesized  that  the  firms  with  announcement  dates  post-­‐SOX  would  have  a  

larger  negative  stock  effect  than  those  with  announcement  dates  before  SOX.  I  also  

concluded  that  companies  with  class  action  lawsuits  would  experience  greater  negative  

effects  than  companies  with  class  action  lawsuits.  However,  as  my  results  show,  there  

appears  to  be  no  substantial  difference  between  pre-­‐SOX  and  post-­‐SOX  companies.  And  

contrary  to  my  hypothesis,  the  companies  with  non-­‐class  action  lawsuits  appear  to  

experience  a  larger  negative  stock  effect.  Again,  I  am  unable  to  test  if  this  is  significant  due  

to  the  small  sample  size.  Future  research  can  be  conducted  to  help  explain  my  findings  and  

test  for  the  significance  of  the  differences  in  the  cumulative  average  returns.  

  22  

VI.  Future  Research  

  Further  research  would  be  needed  to  maybe  help  explain  why  class  action  lawsuits  

saw  a  much  less  effect  than  the  non-­‐class  action  lawsuits  category.  One  reason  may  be  due  

to  bankruptcy  filings  prior  to  the  announcement  date,  which  would  cause  a  large  negative  

effect  at  the  bankruptcy  announcement.  This  could  take  away  from  the  negative  effect  of  

the  accounting  fraud.  Other  factors  that  could  contribute  to  my  findings  could  be  the  size  of  

the  company,  the  number  of  stockholders,  the  number  of  shares  outstanding,  the  industry  

of  the  company,  the  revenues  of  the  company,  the  type  of  the  accounting  fraud,  etc.  

  I  would  like  to  conduct  future  research  into  companies  to  see  if  insider  secrets  or  

bankruptcy  played  a  significant  role  the  effects  of  the  stock  prices.  Some  of  the  companies  

included  in  my  samples  faced  large  negative  effects  after  filing  for  bankruptcy,  which  

usually  occurred  a  few  months  before  the  announcement  of  accounting  fraud  was  made.  

This  factor  could  have  made  a  huge  impact  on  why  there  was  not  such  a  dramatic  effect  

when  the  fraud  was  announced.  Another  factor  could  have  been  that  the  major  

stockholders  in  the  company  could  have  been  informed  prior  to  the  allegations  and  started  

to  sell  their  stock.  This  could  have  a  more  gradual  effect  on  the  price  of  the  stock  as  

opposed  to  the  immediate  effect  expected  when  the  announcement  is  made.  Further  

research  needs  to  be  conducted  to  determine  if  these  factors  played  a  meaningful  role  in  

the  stock  price  reactions.    

  Since  my  sample  size  was  rather  small,  future  research  would  need  to  be  conducted  

with  a  larger  sample  size  to  see  if  the  differences  are  statistically  significant.  With  a  larger  

sample  size,  given  a  larger  scale  of  time,  different  results  may  be  concluded,  but  the  

  23  

difference  can  be  test  for  statistical  significance.  I  would  suggest  analyzing  a  minimum  of  

thirty  companies  in  each  classification  group  in  order  for  it  to  render  significant  results.    

  Future  research  can  also  be  conducted  to  test  to  see  if  the  industry  plays  a  

significant  role  in  the  stock  price  reactions.  In  my  research,  I  found  that  many  companies  

were  either  in  the  energy,  communications,  or  health  industry.  Therefore,  it  would  be  

interesting  to  see  if  certain  industries  experience  occurrences  of  accounting  fraud  more  

frequently  and  if  particular  industries  experience  a  larger  negative  stock  effect.  It  would  be  

interesting  to  find  out  if  the  public  is  more  involved  through  stocks  with  choice  industries  

as  opposed  to  other  industries.  

VII.  Conclusion  

  There  were  some  limitations  to  my  research  that  may  have  affected  my  results.    Due  

to  my  specific  qualifications  for  companies  for  my  research,  I  was  only  able  to  use  a  sample  

size  of  thirty-­‐two.  This  sample  size  is  not  large  enough  to  test  if  the  differences  in  my  

results  are  significant  or  not.  With  such  a  small  sample  size,  any  one  company’s  data  could  

have  skewed  all  of  the  data  for  that  particular  category.  Therefore,  future  research  

conducted  on  this  topic  should  definitely  change  the  qualifications  to  implement  more  

companies  in  the  research  and  further  be  able  to  encompass  and  capture  the  stock  price  

reactions.  My  research  also  did  not  account  for  factors  such  as  bankruptcy,  company  size,  

number  of  shareholders  and  shares  outstanding,  and  some  other  factors  that  might  have  

affected  the  results  of  my  data.    

  My  hypothesis  was  proven  wrong,  as  my  results  concluded  that  the  implementation  

  24  

of  Sarbanes-­‐Oxley  2002  did  not  affect  the  stock  price  reactions.  It  also  concluded  that  non-­‐

class  action  lawsuits  experienced  a  larger  negative  stock  effect  than  class  action  lawsuits,  

which  is  completely  opposite  of  what  I  would  argue.  An  analysis  of  my  research  suggests  

that  companies  may  not  experience  as  large  of  punitive  damages  from  stockholders  than  

one  might  think.  I  plan  to  extend  my  study  in  the  future  to  research  some  of  the  factors  that  

may  have  affected  my  study.  I  would  also  encourage  companies  to  study  these  results  in  

hopes  of  implementing  a  stronger  policy  to  help  filter  out  and  detect  fraud.  Undetected  

fraud  might  be  the  biggest  secret  in  the  corporate  world,  and  it  would  be  my  hope  that  

significant  research  be  published  in  arguing  that  companies  do  suffer  through  stock  price  

reactions  as  a  direct  result  of  accounting  fraud.    

  25  

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