SOX Code of Ethics Rule Lowered Restatements

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The Sarbanes-Oxley provision requiring senior financial officers to adopt a code of ethics tended to reduce the number of earnings restatements by their companies, according to a new study.

The study, by O.C. and Linda Ferrell of Belmont University in Nashville, co-authored by Saurabh Ahluwalia of the University of New Mexico and Terri Rittenberg of the University of Wyoming, examined the effectiveness of Section 406 of the Sarbanes-Oxley Act of 2002. It was published last month in the Journal of Business Ethics.

Passed in the wake of the Enron and WorldCom accounting scandals, Section 406 was supposed to decrease the prevalence of financial misconduct by requiring public companies to state whether they had adopted a specific code of ethics for principal, financial and accounting officers. The researchers wanted to determine how effective this requirement turned out to be in practice after passage of the law.

They studied companies’ financial statements beginning in 2005. At the time, only 67 of the 176 Fortune 500 public companies sampled in the study had a specific code of ethics for CFOs. A decade later, that number had only inched up to 77 of the 176 companies in their sample, despite the requirement under SOX. However, the companies that implemented the specific code of ethics were catching misreporting earlier and seeing significant declines in the number of financial restatements they made, according to the researchers.

“Our results clearly confirm that the adoption of a financial code of ethics improves the integrity of financial reporting,” said Linda Ferrell in a statement. “This study should encourage all public companies to develop and implement a financial code of ethics, and public policy decision makers should continue to monitor and support SOX 406’s implementation.”

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