Abstract

This article investigates whether the passage and the implementation of the Sarbanes-Oxley Act of 2002 (SOX) drove firms out of the public capital market. To control for other factors affecting exit decisions, we examine the post-SOX change in the propensity of American public targets to be bought by private acquirers rather than public ones with the corresponding change for foreign public targets, which were outside the purview of SOX. Our findings are consistent with the hypothesis that SOX induced small firms to exit the public capital market during the year following its enactment. In contrast, SOX appears to have had little effect on the going-private propensities of larger firms. (JEL G30, G34, G38, K22)

The Sarbanes-Oxley Act of 2002 was enacted after a series of corporate failures that had shaken investor confidence in public securities markets. The Act (along with its regulatory implementation, to which we refer collectively as “SOX”) introduced significant changes in the governance, accounting, auditing, and reporting environment of firms traded in American securities markets. Its most notorious mandate is a requirement under Section 404 to include in the annual report an attestation by an outside auditor to the effectiveness of the firm's internal controls over financial reporting. Additional mandates, among many others, include a requirement that the chief executive officer and the chief financial officer certify the accuracy of the firm's periodic reports and the effectiveness of its internal controls, a requirement that the firm maintain an audit committee composed exclusively of independent directors, and a ban on the outside auditor from providing certain non-audit services to the firm.

Since the enactment of SOX, researchers have begun isolating and studying its effects. Some studies have found, for example, that SOX was associated with a decline in the rate of incentive compensation, research and development expenses, and capital expenditures (Cohen et al. 2007). There is also evidence that SOX was associated with a reduction in accrual-based earnings management (Cohen et al. 2008). Nevertheless, the overall effect of SOX on publicly traded firms remains in dispute. Proponents of SOX argue that it facilitates access to the public capital market by alleviating investor concerns (Cunningham 2003; Coates 2007). Opponents argue that it unduly raises the cost of being public (Ribstein 2002; Gordon 2003; Romano 2005).

Of particular interest in this debate is whether SOX disadvantages small firms by applying to them the same standards it applies to large firms. Responding to this concern, the Securities and Exchange Commission (SEC) has granted firms with market capitalization below $75 million several deadline extensions—first in June 2003 and most recently in June 2008—to comply with the most onerous SOX requirement, an annual duty to evaluate the effectiveness of internal controls over financial reporting. Thus far, however, the SEC has stopped short of crafting special carve-outs for these firms despite a recommendation to do so by an SEC committee (Advisory Committee on Small Public Companies 2006).

In this article, we test whether the net cost of complying with SOX has driven firms in general, and small firms in particular, to exit the public capital market. Many other attempts to address this question have had difficulty controlling for unobserved conflating factors that could have affected exit decisions around the enactment of SOX. We address this difficulty using a difference-in-differences empirical strategy. This approach compares changes over time in two populations: one subject to a policy intervention (treatment group) and the other not (control group). To evaluate the impact of the intervention on outcome, one needs to compare the outcome change for the treatment group with the outcome change for the control group. Assuming the two groups are similar in all relevant respects other than their exposure to the intervention, this approach screens out changes not related to the intervention.

The primary outcome variable in our analysis is a public target's probability of being bought by a private acquirer rather than a public one, the treatment group is American targets, and the control group is foreign targets. To evaluate the effect of SOX, we compare the change in the propensity of American public targets to be bought by private acquirers rather than by public acquirers to the corresponding change for foreign public targets. The difference between the two changes—the difference-in-differences—is the change we attribute to SOX.

We predict that any effect of SOX on going-private transactions will be most pronounced for small firms for two related reasons. First, small firms are more likely than large firms to be sold in response to SOX because they derive relatively smaller net benefits from being public and thus stand closer to being sold when there is an increase in the cost of being public, especially if the increase is relatively larger for them. The acquirers in these acquisitions, in turn, tend to be financial acquirers, which are typically private. Second, at least some of the costs of complying with SOX, such as ensuring the effectiveness of internal controls over financial reporting, are firm-specific and thus not avoidable by a sale to another public firm. Accordingly, if SOX imposes a relatively larger net cost on small firms, these firms will lose more of their appeal to public acquirers than will larger firms.

Our results are consistent with this prediction. When we examine acquisitions as a whole, we find no relative increase in the rate of acquisition by private acquirers (going private) among American firms. When we differentiate between acquisitions based on firm size, however, we find a relative increase in the rate of going private by small American firms. Moreover, when we differentiate between acquisitions based on their proximity to the enactment of SOX, we find a relative increase in the rate of going private by American firms in the first year after the enactment. Finally, when we differentiate between acquisitions based on both firm size and the proximity of the acquisition to the enactment of SOX, we find that the increase in the rate of going private by small American firms is concentrated in the first year after the enactment.1

The dampening of the SOX effect in the second year after SOX was enacted is consistent with more than one interpretation. Our preferred interpretation is that maladapted firms realized their susceptibility to the new regime and went private promptly, before the full panoply of its requirements applies to them, leaving behind public firms that were better suited to the new regulatory environment.

A second interpretation is that SOX imposed on firms a large upfront cost and a low recurring cost. This interpretation is consistent with the fact that some of the new mandates took effect immediately and that it took time for the SEC to clarify the new mandates and for a market for SOX consulting services to develop. It is at odds, however, with the fact that the most costly component of SOX—an annual audit report on the effectiveness of internal controls—took effect only in late 2004 and exceeded early cost estimates. Indeed, this component of SOX has yet to be applied to small firms—the very firms whose propensity to go private increased after the enactment of SOX.

A third interpretation is that over time other countries have also tightened the regulation of public firms, bringing going-private rates closer to the American level.2 This interpretation, however, is unlikely to fully explain the disappearance of the SOX effect after a year, as we are unaware of foreign reforms similar in scope to SOX at that time.3

Our analysis proceeds as follows. Section 1 discusses the literature on the effects of SOX. Section 2 outlines our theoretical framework and empirical strategy and describes our data. Section 3 reports our results. Section 4 performs a number of robustness checks. Section 5 concludes.

Related Literature

Existing empirical studies of the impact of SOX follow three approaches.4 One set of studies assess the accounting and audit costs imposed by SOX. These studies do not measure the net effect of SOX on the viability of being public. Carney (2006) reviews some of the studies. Their common theme is that public firms' accounting and audit costs have increased substantially since SOX and exceeded early estimates.

Another set of studies estimate abnormal stock returns associated with events leading to the enactment of SOX. Although the results of these studies are mixed about the overall effect of SOX, they suggest that SOX imposed a disproportionate cost on small firms. Zhang (2007) finds negative returns. Jain and Rezaee (2006) and Li et al. (2008) find positive returns but a negative relation between returns and practices that SOX sought to limit. Engel et al. (2007) find that returns are positively related to market capitalization and stock turnover but do not report whether returns are positive or negative. Chhaochharia and Grinstein (2007) find that small firms with ineffective internal controls or boards that are not independent (which are more affected by SOX) underperform small firms with effective internal controls or independent boards (which are less affected). In contrast, they find no difference in performance for large firms whose internal controls are ineffective and find that large firms whose boards are not independent outperform similar firms whose boards are independent. Wintoki (2007) finds that returns are positively related to firm size and age and negatively related to market-to-book ratio and to expenditure on research and development. Litvak (2007a) finds in a study of foreign firms cross-listed in the United States that small firms and large firms experience similar negative returns. Litvak (2007b) finds that small firms react more negatively when measuring the effect using Tobin's Q.

A third set of studies examines changes around the enactment of SOX in cross-listing in the United States by foreign firms. Zingales (2008) finds a decline in cross-listing from 2000 to 2005 and attributes this decline to a combination of improvements in foreign public capital markets and an increase in the compliance costs for public firms in the United States. Doidge et al. (2008) find that the decline in cross-listings is explained by changes in firm characteristics, rather than by changes in the benefits of cross-listing. Piotroski and Srinivasan (2008) find that, although the cross-listing preferences of large foreign firms choosing between the United States and the United Kingdom did not change after the enactment of SOX, the likelihood of cross-listing in the United States among small foreign firms facing the same choice decreased.

A final set of studies, the closest in their approach to this article, examine the effect of SOX on deregistration. Public firms can deregister their stock with the SEC and thereby opt out of federal securities law by selling all their stock to a private acquirer (going private) or cashing out small shareholders to lower the number of shareholders below 300 (going dark). Unlike going dark, going private can achieve a number of business goals other than avoiding federal securities law (Jensen 1989; Kaplan 1989a, 1989b; Baker and Wruck 1990; Lichtenberg and Siegel 1990; Smith 1990). Consistently, existing studies suggest that going-dark transactions are more clearly affected by SOX than going-private transactions. Block (2004) reports that the most commonly cited reason for going private or going dark, especially by small firms and after the enactment of SOX, is the cost of being public. Engel et al. (2007) find a small post-SOX increase in deregistration, which becomes insignificant when going-dark transactions are excluded. Leuz et al. (2008) find a post-SOX increase in going dark but no significant increase in going private. They also find that distress predicts going dark before the enactment of SOX, whereas agency costs predict going dark after its enactment.

The deregistration studies do not separate the effect of SOX from that of contemporaneous factors that can increase the rate of going private or going dark. One such factor is financial market liquidity, which can affect the willingness of public and private investors to pursue acquisitions. This factor applies mainly to going-private transactions because they require more cash than going-dark transactions. Another factor, applicable to both types of transactions, is the weakness of the public capital market. Firms are more likely to leave the public capital market when stock prices are depressed (Maupin et al. 1984; Lerner 1994; Pagano et al. 1998; Benninga et al. 2005). Both of these factors were present around the enactment of SOX.5

Theoretical Framework, Empirical Strategy, and Data

Theoretical Framework

In light of the difficulties noted above, our framework is based on a difference-in-differences approach in which we compare the post-SOX change in the probability that American public firms undergoing an acquisition be acquired by a private acquirer to the correspondent change for foreign public firms, while controlling for the level of stock prices in the country of primary listing when the transaction is announced. This study design separates the effect of SOX from the effect of contemporaneous market conditions in two ways. First, it contrasts the United States with other countries, which were not directly affected by SOX. Second, it contrasts going-private transactions with acquisitions by public acquirers. The disadvantage of this study design is that it does not measure the rate of going-dark transactions which, as noted above, are an alternative way to escape SOX.

As we formally develop in Kamar et al. (2008), SOX could increase the probability that public firms be acquired by private acquirers rather than public ones in two ways.

First, the cost of complying with SOX could trigger the sale of firms that would not be sold otherwise. These sales would tend to involve so-called financial acquirers, which invest in targets, often with target management participation, to sell them later at a profit. Financial acquirers are distinguished from so-called strategic acquirers, which aim to integrate the operations of targets with their own, and are therefore less sensitive to price. Importantly, for reasons unrelated to SOX, most financial acquirers are privately owned. We refer to this explanation as the “new sales hypothesis.” As we demonstrate in Kamar et al. (2008), this hypothesis requires a sufficiently dense population of private acquirers (relative to the population of public acquirers) ready to buy firms that pursue a sale to avoid the cost of complying with SOX. This condition is plausible for financial acquirers because, unlike strategic acquirers, they need not fit the target with operations of their own.6

Second, the cost of complying with SOX could also cause a shift in the composition of acquirers of firms that would be sold for any reason. According to this theory, post-SOX acquisitions would tend to involve private acquirers more than pre-SOX acquisitions because private acquirers retain none of the target's SOX obligations after the acquisition, whereas public acquirers do. The enactment of SOX should therefore reduce the price that public acquirers would pay in the acquisition relative to private acquirers. We refer to this explanation as the “all sales hypothesis.”

The post-SOX increase in the probability of being sold to a private acquirer could be more pronounced for small firms because their costs of being public, especially after adding the costs of complying with SOX, are relatively higher, and their benefits from being public are relatively lower than those of large firms (Pagano and Röell 1998; Pagano et al. 1998). Accordingly, as we explain further below, both the “new sales hypothesis” and the “all sales hypothesis” predict that the effect of SOX on the type of acquirers buying public firms will be most noticeable in small firm acquisitions.

The cost of filing periodic reports is a case in point. Even before SOX, small firms lacked the scale economies that large firms enjoy in preparing these reports. The requirement of Section 404 of SOX that periodic reports also evaluate the internal controls of the reporting firm deepened this disadvantage (Holmstrom and Kaplan 2003). According to one newspaper editorial, “while Section 404 costs the average multibillion-dollar firm about 0.05% of revenue, the figure can approach 3% for small companies” (Wall Street Journal 2005). The new burden was especially heavy for small firms because, unlike large firms, many of them lacked accounting staff to monitor the effectiveness of their internal controls. Consistently, Doyle et al. (2007) find that small firms are more likely to have ineffective internal controls than large firms.

At the same time, small firms gain from being public relatively less than large firms. The financial press routinely stresses this point. The Economist (2003), for example, reports increasing marginalization of small firms in the public capital market. Similarly, Deutsch (2005) notes that small firms often derive low benefits from being public due to limited market attention and liquidity, and quotes the president of Corfacts, a small telemarketing firm that left the public capital market in 2004, explaining: “We have been unable to gain a significant following in the market, yet we have been spending large sums of money for accounting and legal services needed to maintain our reporting status.” By comparison, Deutsch (2005) notes, leaving the public capital market is “not an option for huge companies” because “their identities and structures are inextricably linked with their status as publicly listed entities.” Consistently, Jain et al. (2008) find that large firms experienced a larger increase in stock market liquidity after the enactment of SOX than small firms.

The differences between small firms and large firms in the costs and benefits of being public can make small firms more likely to go private in response to SOX both under the “new sales hypothesis” and under the “all sales hypothesis.”

First, because small firms derive relatively smaller net benefits from being public, they stand closer to being sold in response to any increase in the costs of being public, especially when the increase itself is relatively larger for them. As noted above, this sale will likely involve a financial acquirer, which is typically private, rather than an acquirer aiming to integrate the target's business with its own, which can be either private or public. In other words, SOX is likely to cause small firms to gravitate toward private acquirers under the “new sales hypothesis.”

Second, to the extent that small firms' relatively higher costs of complying with SOX are firm-specific and therefore not avoidable by a sale to other public firms, SOX should reduce the price public acquirers would pay for small firms relatively more than it reduces the price these acquirers would pay for large firms. The duty to establish internal controls under Section 404 of SOX is again a case in point. As Aquila and Golden (2002), Walton and Greenberg (2003), Glover and Krause (2004), and Klingsberg and Noble (2004) explain, because the acquirer will assume responsibility for these controls after the acquisition at uncertain costs, it will demand that they pass muster in advance. The relatively higher cost that small firms incur to establish internal controls thus cannot be avoided through a sale to a public acquirer even though the acquirer has established its own internal controls. Put differently, SOX is likely to cause small firms to gravitate toward private acquirers also under the “all sales hypothesis.”

Empirical Strategy

Our basic empirical specification for estimating the difference between the post-SOX change in going private in the United States and the corresponding change abroad is a probit model in which the dependent variable is an indicator for whether the acquirer is private and the independent variables are an indicator for acquisitions announced after the enactment of SOX (After), an indicator for targets primarily traded in the United States (US), and an interaction between After and US. This interaction is the key variable. Accordingly, we estimate the parameters of the probit specification 

(1)
graphic
where i is a specific acquisition, k is the stock exchange, t is the time of announcement, yikt is an indicator for being acquired by a private acquirer rather than by a public acquirer, USi is an indicator for targets primarily listed in the United States, Aftert is an indicator for acquisitions announced after July 31, 2002, xkt is the log of the normalized stock index of the target's country of primary listing at announcement, zi is an indicator for target's single-digit Standard Industry Classification (SIC) code industry, δk are country fixed effects, ηt are quarter fixed effects, and ϵikt is an error term.

We include several controls for unobserved market characteristics affecting going private decisions. Following Bertrand and Mullainathan (1999), Gruber (2000), Athey and Stern (2002), and Donohue et al. (2002), we assume that these characteristics can be decomposed into a fixed component specific to each market and a component that changes over time but is common to all markets. Accordingly, we modify the specification to include country fixed effects, single-digit SIC industry fixed effects, and calendar quarter fixed effects. We capture some market-specific changes by adding the log of the normalized stock index of the target's country of primary listing at announcement.7 Following Bertrand et al. (2004), we cluster standard errors at the country in which the stock exchange is located to account for potential serial correlation.

We extend the basic model to allow the coefficient of US × After to differ between small and large targets and between acquisitions announced in the first year after the enactment of SOX and acquisitions announced thereafter.8

Data

Our primary data source is Thomson Reuters's Securities Data Company Platinum database (SDC). The initial sample includes all transactions involving public targets announced between January 1, 2000, and December 31, 2004, other than spinoffs, recapitalizations, self-tenders, exchange offers, repurchases, and privatizations. We classify an acquirer as private when both it and its ultimate parents are private. We classify a target as public when it is traded on an established public stock exchange and classify it as an American public firm when it is primarily traded on any such market in the United States other than Pink Sheets. We treat firms traded on Pink Sheets as private firms because many of these firms are not registered with the SEC and are therefore not subject to SOX. The American public firms in our sample are traded on American Stock Exchange, Boston Stock Exchange, Nasdaq, New York Stock Exchange, OTC Bulletin Board, and Philadelphia Stock Exchange.

SDC does not identify which of the firms primarily traded abroad are also traded in the United States. Because these firms are subject to some of the provisions of SOX, our inability to identify them biases our results toward zero. This weakening should nevertheless be minimal because cross-listed firms, which tend to be large, are unlikely to give up their access to the public capital market abroad just to avoid SOX. Rather, as Whoriskey (2005) reports, they are likely to go dark in the United States while maintaining their listing abroad.

Our initial sample contains 19,947 announced acquisitions between January 2000 and December 2004. We exclude, in the following order, 1562 withdrawn acquisitions, 413 acquisitions of American firms by foreign public firms or their subsidiaries (which, despite being direct or indirect acquisitions by public acquirers, would relieve the targets of their SOX duties), 711 acquisitions of foreign firms by American public firms or their subsidiaries (which, despite being acquisitions of public firms, would bring the targets into the ambit of SOX), 29 acquisitions by the targets themselves, 3200 acquisitions of firms partially owned by public firms (which would not relieve the parent firms of their SOX duties even if made by private acquirers), 661 acquisitions of targets whose primary stock exchange is unknown, 854 acquisitions whose status is “Intended,” “Rumor,” “S buyer,” (seeking buyer) or “Unknown,” 786 acquisitions lacking information about the percentage of target stock sought to be owned by the acquirer after the transaction, 3933 acquisitions lacking information about the target's stock market value, 4933 acquisitions by acquirers seeking to own only part of the target's stock (because the targets of such partial acquisitions remain public—and subject to SOX—even when the acquirer is private), and 208 acquisitions of firms primarily listed on stock exchanges with fewer than 20 acquired firms in the sample period (to reliably differentiate between small and large firms within each stock exchange).9

We record each target's primary stock exchange, single-digit SIC code, stock market value 4 weeks before the announcement of the acquisition, and announcement date—all as provided in SDC. The foreign firms in our sample are primarily traded in one of 17 countries.10 We scale the stock market value of the firm by the United States Consumer Price Index (CPI) in the month in which the transaction was announced.

We complement the SDC data with the Morgan Stanley Capital International, Inc. (MSCI) stock index data. MSCI provides monthly stock indexes for developed and emerging countries. For each transaction, we compute the normalized stock index of the target's country of primary listing at announcement, defined as the ratio of the value of the stock index in the target's country of primary listing when the acquisition was announced to the value of that index in January 1999.

Results

Table 1 reports summary statistics. After the enactment of SOX, the percentage of small targets, defined as firms whose market value is in the bottom quartile of their primary stock exchange over the sample period (the mean threshold is about $18 million and the standard deviation is about $10 million), increases by 36% in the United States (from 22% to 30%), while increasing by 13% abroad generally (from 24% to 27%) and by 8% (from 25% to 27%) in Canada and Western Europe, whose markets are arguably more integrated with the American market than other markets. The percentage of acquisitions by private acquirers also increases in the United States more than abroad. Focusing on acquisitions of small targets, this percentage increases by 35% (from 40% to 54%) in the United States, while increasing by 2% (from 45% to 46%) abroad generally and by 13% (from 53% to 60%) in Canada and Western Europe. Taken as a whole, these summary statistics are consistent with the hypothesis that SOX increased the probability that small firm acquisitions involve private acquirers. The results reported below provide additional evidence consistent with this hypothesis.

Table 1.

Full Acquisitions of Public Targets Announced Between January 1, 2000 and December 31, 2004

 United States Western Europe and Canada All abroad 
Panel A: Acquisitions announced between January 1, 2000, and July 30, 2002 
    Number of observations 974 441 724 
    Market value ($1,000,000)    
    Mean 827 557 525 
    Standard deviation 4753 2069 2221 
    % Small targets 22 25 24 
    % Private acquirers 23 45 37 
    % Private acquirers among small targets 40 53 45 
Panel B: Acquisitions announced between August 1, 2002, and December 31, 2004 
    Number of observations 679 319 712 
    Market value ($1,000,000)    
    Mean 475 616 388 
    Standard deviation 1895 3251 2232 
    % Small targets 30 27 27 
    % Private acquirers 32 42 42 
    % Private acquirers among small targets 54 60 46 
 United States Western Europe and Canada All abroad 
Panel A: Acquisitions announced between January 1, 2000, and July 30, 2002 
    Number of observations 974 441 724 
    Market value ($1,000,000)    
    Mean 827 557 525 
    Standard deviation 4753 2069 2221 
    % Small targets 22 25 24 
    % Private acquirers 23 45 37 
    % Private acquirers among small targets 40 53 45 
Panel B: Acquisitions announced between August 1, 2002, and December 31, 2004 
    Number of observations 679 319 712 
    Market value ($1,000,000)    
    Mean 475 616 388 
    Standard deviation 1895 3251 2232 
    % Small targets 30 27 27 
    % Private acquirers 32 42 42 
    % Private acquirers among small targets 54 60 46 

We start with testing whether the number of acquisitions of public targets traded in the United States increases after the enactment of SOX relative to the corresponding change abroad. Specifically, we compare the number of acquisitions announced per quarter in the United States and abroad in a sample of acquisitions announced up to a year after the enactment of SOX using an ordinary least squares regression model, while distinguishing between small targets and large ones.

Table 2 reports the results. The difference-in-differences estimate is positive and significant for small firms, consistent with the notion that anticipated SOX compliance costs drove small target acquisitions in the first year after the enactment. In terms of economic significance, the coefficients reported in Column (2) indicate a 38% post-SOX increase in the average number of small target acquisitions per quarter in the United States from 21 to 29. In contrast, the difference-in-differences estimate is negative and significant for large targets. The results are robust to replacing After by quarter fixed effects and replacing After × Small by the interaction of quarter fixed effects with Small. In unreported regressions for a sample period ending on December 31, 2004, the difference-in-differences estimate for small firms becomes smaller and insignificant, whereas the difference-in-differences estimate for large firms becomes smaller but remains significant.

Table 2.

Number of Full Acquisitions Announced Through June 30, 2003, SOX Effect Is Differentiated by Target Size

Panel A: Coefficient estimates
 
 (1)
 
(2)
 
 Coefficient Standard error Coefficient Standard error 
US 65.29*** (3.23) 65.47*** (3.47) 
Small −2.92** (1.11) 2.43 (3.02) 
US × Small −50.99*** (1.11) −51.10*** (1.15) 
US × After −32.36*** (0.52) −32.51*** (0.57) 
US × After × Small 40.74*** (0.60) 40.91*** (0.59) 
After −0.99* (0.52) —  
After × Small 1.66** (0.60) —  
Quarter fixed effects —  Included  
Quarter fixed effects × Small —  Included  
Country fixed effects Included  Included  
Number of observations
 
315
 
 315
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions of small targets     
    US × After + US × After × Small 8.38*** (0.00) 8.40*** (0.00) 
Acquisitions of large targets     
    US × After −32.36*** (0.00) −32.51*** (0.00) 
Panel A: Coefficient estimates
 
 (1)
 
(2)
 
 Coefficient Standard error Coefficient Standard error 
US 65.29*** (3.23) 65.47*** (3.47) 
Small −2.92** (1.11) 2.43 (3.02) 
US × Small −50.99*** (1.11) −51.10*** (1.15) 
US × After −32.36*** (0.52) −32.51*** (0.57) 
US × After × Small 40.74*** (0.60) 40.91*** (0.59) 
After −0.99* (0.52) —  
After × Small 1.66** (0.60) —  
Quarter fixed effects —  Included  
Quarter fixed effects × Small —  Included  
Country fixed effects Included  Included  
Number of observations
 
315
 
 315
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions of small targets     
    US × After + US × After × Small 8.38*** (0.00) 8.40*** (0.00) 
Acquisitions of large targets     
    US × After −32.36*** (0.00) −32.51*** (0.00) 

This table reports the results of estimating an ordinary least squares regression in which the dependent variable is the number of acquisitions announced per quarter, per country, and per size category (small/large). Panel A reports coefficient estimates and, in parentheses, standard errors clustered at the country in which the targets have their primary listing. Panel B reports difference-in-differences estimates and, in parentheses, the significance (p-value) of these estimates based on Wald tests. US is an indicator for acquisitions of targets primarily listed in the United States. Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's primary stock exchange in the sample period. After is an indicator for acquisitions announced after July 31, 2002. Quarter fixed effects are based on the quarter and year in which the acquisition is announced. Country fixed effects are based on the country in which the target is primarily listed. Significance (p-value): *10%, **5%, ***1%.

Next we examine whether SOX increased the probability that small target acquisitions involve private acquirers. We begin our analysis by estimating the model in Equation (1), which does not distinguish between acquisitions according to target size or the proximity of the acquisition to the enactment of SOX.

Table 3 reports the results. The Wald tests reported in the table do not reject the null hypothesis that SOX did not affect acquisitions.

Table 3.

The Probability of Being Acquired by a Private Acquirer

Panel A: Coefficient estimates
 
 Coefficient Standard error 
US −0.72*** (0.12) 
US × After 0.07 (0.06) 
Log of stock index −0.31 (0.27) 
Quarter fixed effects Included  
Industry fixed effects Included  
Country fixed effects Included  
Number of observations
 
3089
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
US × After 0.07 (0.25) 
Panel A: Coefficient estimates
 
 Coefficient Standard error 
US −0.72*** (0.12) 
US × After 0.07 (0.06) 
Log of stock index −0.31 (0.27) 
Quarter fixed effects Included  
Industry fixed effects Included  
Country fixed effects Included  
Number of observations
 
3089
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
US × After 0.07 (0.25) 

This table reports the results of estimating a probit model in which the dependent variable is being acquired by a private acquirer rather than by a public acquirer. Panel A reports coefficient estimates and, in parentheses, standard errors clustered at the country in which the target has its primary listing. Panel B reports difference-in-differences estimates and, in parentheses, the significance (p-value) of these estimates based on Wald tests. US is an indicator for acquisitions of targets primarily listed in the United States. Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's primary stock exchange in the sample period. Log of stock index is the log of the normalized stock index of the target's country of primary listing at announcement. After is an indicator for acquisitions announced after July 31, 2002. Quarter fixed effects are based on the quarter and year in which the acquisition is announced. Industry fixed effects are based on the single-digit SIC code of the target. Country fixed effects are based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

To test the hypothesis that SOX affected small firms more than others, we estimate a model similar to Equation (1) while distinguishing between large targets and small targets. We do so by adding an indicator (Small) for targets with market value in the bottom quartile of their primary stock exchange and the interaction terms US × Small and US × After × Small.

Table 4 reports the results. As before, Column (1) assumes that all acquisitions are affected by the same changes in unobserved economic conditions over time. Column (2) relaxes this assumption by adding to the regression model a set of quarter fixed effects interacted with Small. Column (3) relaxes the assumption that the stock exchanges in our sample undergo the same unobservable changes over time. Following Athey and Stern (2002), this is done by adding to the regression model a set of quarter fixed effects interacted with the log of the normalized stock index of the target's country of primary listing at announcement. In all of the columns, the difference-in-differences estimate is positive and significant for acquisitions of small targets, consistent with SOX driving small firms to exit the public capital market. In contrast, the difference-in-differences estimate is insignificant for acquisitions of large targets. In terms of economic significance, the coefficients reported in Column (2) predict a significant increase from 0.40 to 0.54 in the probability that an acquisition of a small target involve a private acquirer after the enactment of SOX.

Table 4.

The Probability of Being Acquired by a Private Acquirer, SOX Effect Is Differentiated by Target Size

Panel A: Coefficient estimates
 
 (1)
 
(2)
 
(3)
 
 Coefficient Standard error Coefficient Standard error Coefficient Standard error 
US × After −0.04 (0.05) −0.09 (0.07) −0.09 (0.07) 
US × After × Small 0.21*** (0.01) 0.46*** (0.17) 0.50** (0.23) 
US −0.09 (0.09) −0.03 (0.10) −0.80*** (0.13) 
Small 0.19* (0.10) −0.19 (0.27) 2.25 (10.98) 
US × Small 0.42*** (0.11) 0.30** (0.11) 0.36** (0.14) 
Log of stock index −0.29 (0.26) −0.31 (0.25) −0.41 (0.30) 
Quarter fixed effects Included  Included  Included  
Quarter fixed effects × Small —  Included  Included  
Quarter fixed effects × Log of stock index —  —  Included  
Industry fixed effects Included  Included  Included  
Country fixed effects Included  Included  Included  
Number of observations
 
3089
 
 3089
 
 3089
 
 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions of small targets       
    US × After + US × After × Small 0.17*** (0.00) 0.37*** (0.00) 0.41** (0.04) 
Acquisitions of large targets       
    US × After −0.04 (0.44) −0.09 (0.17) −0.09 (0.19) 
Panel A: Coefficient estimates
 
 (1)
 
(2)
 
(3)
 
 Coefficient Standard error Coefficient Standard error Coefficient Standard error 
US × After −0.04 (0.05) −0.09 (0.07) −0.09 (0.07) 
US × After × Small 0.21*** (0.01) 0.46*** (0.17) 0.50** (0.23) 
US −0.09 (0.09) −0.03 (0.10) −0.80*** (0.13) 
Small 0.19* (0.10) −0.19 (0.27) 2.25 (10.98) 
US × Small 0.42*** (0.11) 0.30** (0.11) 0.36** (0.14) 
Log of stock index −0.29 (0.26) −0.31 (0.25) −0.41 (0.30) 
Quarter fixed effects Included  Included  Included  
Quarter fixed effects × Small —  Included  Included  
Quarter fixed effects × Log of stock index —  —  Included  
Industry fixed effects Included  Included  Included  
Country fixed effects Included  Included  Included  
Number of observations
 
3089
 
 3089
 
 3089
 
 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions of small targets       
    US × After + US × After × Small 0.17*** (0.00) 0.37*** (0.00) 0.41** (0.04) 
Acquisitions of large targets       
    US × After −0.04 (0.44) −0.09 (0.17) −0.09 (0.19) 

This table reports the results of estimating a probit model in which the dependent variable is being acquired by a private acquirer rather than by a public acquirer. Panel A reports coefficient estimates and, in parentheses, standard errors clustered at the country in which the target has its primary listing. Panel B reports difference-in-differences estimates and, in parentheses, the significance (p-value) of these estimates based on Wald tests. US is an indicator for acquisitions of targets primarily listed in the United States. Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's primary stock exchange in the sample period. Log of stock index is the log of the normalized stock index of the target's country of primary listing at announcement. After is an indicator for acquisitions announced after July 31, 2002. Quarter fixed effects are based on the quarter and year in which the acquisition is announced. Industry fixed effects are based on the single-digit SIC code of the target. Country fixed effects are based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

As noted earlier, we account for potential serial correlation by clustering standard errors at the target's country of primary listing. In addition, we performed two checks to ensure that serial correlation is not a concern. First, we conducted the Arellano–Bond (1991) test and the Wooldridge (2002) test for serial correlation after converting the data into a true panel by taking the means of the relevant variables for each country of primary listing and quarter. Neither test showed serial correlation: The Arellano–Bond test yielded a p-value of 0.98, and the Wooldridge test yielded a p-value of 0.48. Second, following Bertrand et al. (2004), we examined whether the results of Table 4 remain when we divide the sample into fewer periods.11 Specifically, in unreported regressions, we repeated the analysis in Column (2) of Table 4 while dividing the sample into three periods (pre-SOX, first year after SOX, second year after SOX) and four periods (second year before SOX, first year before SOX, first year after SOX, second year after SOX). The results remained.12

To investigate whether SOX triggered an immediate exodus from the public capital market, we distinguish between acquisitions announced within the first year after the enactment of SOX and acquisitions announced thereafter. We do so by replacing the interaction of US with After in Equation (1) by an interaction of US with an indicator for acquisitions announced between August 1, 2002, and June 30, 2003 (Period 1), and an interaction of US with an indicator for acquisitions announced between July 1, 2003, and December 31, 2004 (Period 2).

Table 5 reports the results. The difference-in-differences estimate for acquisitions announced in the first year after the enactment of SOX is positive and significant, consistent with the hypothesis that anticipated SOX compliance costs caused firms to exit the public capital market in that period. In contrast, there is no effect for acquisitions announced more than a year after the enactment of SOX.

Table 5.

The Probability of Being Acquired by a Private Acquirer, SOX Effect Is Differentiated by Proximity to the Enactment of SOX

Panel A: Coefficient estimates
 
 Coefficient Standard error 
US × Period 1 0.31*** (0.08) 
US × Period 2 −0.11 (0.08) 
US −0.70*** (0.11) 
Log of stock index −0.28 (0.27) 
Quarter fixed effects Included  
Industry fixed effects Included  
Country fixed effects Included  
Number of observations 3089  
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Acquisitions announced in Period 1   
    US × Period 1 0.31*** (0.00) 
Acquisitions announced in Period 2   
    US × Period 2 −0.11 (0.20) 
Panel A: Coefficient estimates
 
 Coefficient Standard error 
US × Period 1 0.31*** (0.08) 
US × Period 2 −0.11 (0.08) 
US −0.70*** (0.11) 
Log of stock index −0.28 (0.27) 
Quarter fixed effects Included  
Industry fixed effects Included  
Country fixed effects Included  
Number of observations 3089  
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Acquisitions announced in Period 1   
    US × Period 1 0.31*** (0.00) 
Acquisitions announced in Period 2   
    US × Period 2 −0.11 (0.20) 

This table reports the results of estimating a probit model in which the dependent variable is being acquired by a private acquirer rather than by a public acquirer. Panel A reports coefficient estimates and, in parentheses, standard errors clustered at the country in which the target has its primary listing. Panel B reports difference-in-differences estimates and, in parentheses, the significance (p-value) of these estimates based on Wald tests. US is an indicator for acquisitions of targets primarily listed in the United States. Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's primary stock exchange in the sample period. Log of stock index is the log of the normalized stock index of the target's country of primary listing at announcement. Period 1 is an indicator for acquisitions announced between August 1, 2002, and June 30, 2003. Period 2 is an indicator for acquisitions announced after June 30, 2003. Quarter fixed effects are based on the quarter and year in which the acquisition is announced. Industry fixed effects are based on the single-digit SIC code of the target. Country fixed effects are based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

Having found a post-SOX increase in going private by small targets (Table 4) and an increase in going private in the first year after the enactment of SOX (Table 5), we proceed to test whether the effect on small targets is concentrated in the first year after the enactment of SOX. We do so by estimating the model reported in Table 5 for a sample of small target acquisitions.

Table 6 reports the results. Column (1) includes all the small targets in our sample. The probability of acquisition by a private acquirer is significantly higher for acquisitions of American targets announced in the first year after the enactment of SOX. This effect is not only statistically significant but also economically meaningful, raising the mean probability of going private by small targets predicted by the coefficients from 0.39 to 0.64.13 In contrast, there is no effect for acquisitions announced more than a year after the enactment of SOX. In an unreported regression, we repeated this analysis for large firms, finding no similar effect (the coefficient estimate of the difference-in-differences in the first year after the enactment of SOX was 0.01 and the p-value was 0.92). This evidence is consistent with the hypothesis that SOX induced small firms, but not large firms, to go private within a year after its enactment.

Table 6.

Small Targets' Probability of Being Acquired by a Private Acquirer, SOX Effect Is Differentiated by Proximity to the Enactment of SOX

Panel A: Coefficient estimates
 
 All countries
 
U.S. and Western countries
 
U.S. and non-Western countries
 
 (1)
 
(2)
 
(3)
 
 Coefficiet Standard error Coefficient Standard error Coefficient Standard error 
US × Period 1 0.72*** (0.21) 0.71*** (0.25) 0.62* (0.37) 
US × Period 2 0.13 (0.25) 0.05 (0.29) −0.02 (0.38) 
US −0.72** (0.29) −0.04 (0.30) −0.77** (0.36) 
Log of stock index −0.16 (0.71) 0.38 (0.79) −0.67 (0.72) 
Quarter fixed effects Included  Included  Included  
Industry fixed effects Included  Included  Included  
Country fixed effects Included  Included  Included  
Number of observations
 
742
 

 
649
 

 
507
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions announced in Period 1       
    US × Period 1 0.72*** (0.00) 0.71*** (0.00) 0.62* (0.09) 
Acquisitions announced in Period 2       
    US × Period 2 0.13 (0.62) 0.05 (0.87) −0.02 (0.95) 
Panel A: Coefficient estimates
 
 All countries
 
U.S. and Western countries
 
U.S. and non-Western countries
 
 (1)
 
(2)
 
(3)
 
 Coefficiet Standard error Coefficient Standard error Coefficient Standard error 
US × Period 1 0.72*** (0.21) 0.71*** (0.25) 0.62* (0.37) 
US × Period 2 0.13 (0.25) 0.05 (0.29) −0.02 (0.38) 
US −0.72** (0.29) −0.04 (0.30) −0.77** (0.36) 
Log of stock index −0.16 (0.71) 0.38 (0.79) −0.67 (0.72) 
Quarter fixed effects Included  Included  Included  
Industry fixed effects Included  Included  Included  
Country fixed effects Included  Included  Included  
Number of observations
 
742
 

 
649
 

 
507
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions announced in Period 1       
    US × Period 1 0.72*** (0.00) 0.71*** (0.00) 0.62* (0.09) 
Acquisitions announced in Period 2       
    US × Period 2 0.13 (0.62) 0.05 (0.87) −0.02 (0.95) 

This table reports the results of estimating a probit model in which the dependent variable is being acquired by a private acquirer rather than by a public acquirer. Targets are included if their CPI-adjusted stock market value 4 weeks before the acquisition is announced is less than the bottom quartile of stock market value in their primary stock exchange. Panel A reports coefficient estimates and, in parentheses, standard errors clustered at the country in which the target has its primary listing. Panel B reports difference-in-differences estimates and, in parentheses, the significance (p-value) of these estimates based on Wald tests. US is an indicator for acquisitions of targets primarily listed in the United States. Log of stock index is the log of the normalized stock index of the target's country of primary listing at announcement. Period 1 is an indicator for acquisitions announced between August 1, 2002, and June 30, 2003. Period 2 is an indicator for acquisitions announced after June 30, 2003. Quarter fixed effects are based on the quarter and year in which the acquisition is announced. Industry fixed effects are based on the single-digit SIC code of the target. Country fixed effects are based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

To test whether the disappearance of the SOX effect is the result of a tightening of regulation outside the United States, Columns (2) and (3) exclude, respectively, targets primarily listed in Western Europe and Canada (which are more likely to have reformed their laws following SOX) and targets primarily listed in other foreign countries (which are less likely to have done so). The results in both columns are qualitatively similar to those in Column (1), though the statistical significance is lower in Column (3), perhaps due to the small number of foreign targets primarily listed outside Western Europe and Canada (93 targets, compared to 235 targets primarily listed in Western Europe or Canada). These findings suggest that the disappearance of the SOX effect is not due to a tightening of regulation outside the United States.

Robustness Checks and Hypotheses Testing

We now turn to a number of robustness checks of our results.

Modifying the Control Group

Table 7 presents sensitivity analyses of the specification reported in Table 4. Column (1) reproduces Column (2) of Table 4. Column (2) reports the results of estimating the same regression model while excluding acquisitions by acquirers with more than one generation of parents. In our original sample, we define acquirers as private when both they and their ultimate parents are private. This definition, however, will cause us to label acquirers with private ultimate parents but public intermediate parents as private acquirers. SDC reports the Committee on Uniform Securities Identification Procedures (CUSIP) code of intermediate parents of acquirers but does not report whether these parents are public. To ensure that we do not label acquirers with public intermediate parents as private acquirers, we exclude acquisitions in which the immediate parent and the ultimate parent of the acquirer have different CUSIP codes.

Table 7.

Sensitivity Analysis of the Foreign Target Definition

 Column (2) of Table 4
 
Acquirers with multiple parents excluded
 
U.S. and Western countries
 
U.S. and Canada
 
 (1) (2) (3) (4) 
Acquisitions of small targets     
    US × After + US × After × Small 0.37*** (0.00) 0.40*** (0.00) 0.42** (0.01) 0.88*** (0.00) 
Acquisitions of large targets     
    US × After −0.09 (0.17) −0.07 (0.32) −0.11 (0.18) −0.38*** (0.00) 
Number of observations 3089 2920 2577 1759 
 Column (2) of Table 4
 
Acquirers with multiple parents excluded
 
U.S. and Western countries
 
U.S. and Canada
 
 (1) (2) (3) (4) 
Acquisitions of small targets     
    US × After + US × After × Small 0.37*** (0.00) 0.40*** (0.00) 0.42** (0.01) 0.88*** (0.00) 
Acquisitions of large targets     
    US × After −0.09 (0.17) −0.07 (0.32) −0.11 (0.18) −0.38*** (0.00) 
Number of observations 3089 2920 2577 1759 

This table reports difference-in-differences estimates obtained from fitting a probit model in which the dependent variable is being acquired by a private acquirer rather than by a public acquirer. Standard errors are clustered at the country in which the target has its primary listing. The significance (p-value) of these estimates based on Wald tests is provided in parentheses. Column (1) reproduces Column (2) of Table 4. Columns (2–4) report the results of estimating the same specification for different samples. US is an indicator for acquisitions of targets primarily listed in the United States. Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's primary stock exchange in the sample period. After is an indicator for acquisitions announced after July 31, 2002. The regressions include the log of the normalized stock index of the target's country of primary listing at announcement, quarter fixed effects based on the quarter and year in which the acquisition is announced, industry fixed effects based on the single-digit SIC code of the target, and country fixed effects based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

To control for cross-country variation in market conditions not captured by the stock index, Column (3) reports the results of estimating the same regression model for targets traded in United States, Canada, or Western Europe. Similarly, Column (4) presents results for targets traded in the United States or Canada. Over the sample period, the correlation between the stock index in the United States and the mean stock index in the Western European countries in our sample is 0.97, and the corresponding correlation between the stock indexes in the United States and Canada is 0.90. In contrast, the corresponding correlation between the stock index in the United States and the mean stock index in the remaining countries in our original sample is 0.56.

As Table 7 suggests, our results are robust. Indeed, the difference-in-differences estimate for acquisitions of small targets retains not only its sign and significance but also its magnitude, in most specifications. Moreover, in some specifications the magnitude of our estimates increases. This is the case, for example, in Columns (3) and (4), which report stronger results for acquisitions in the most comparable markets to the American market (Canada and Western Europe), even though the samples in these columns are smaller than our original sample.

Modifying the Definition of a Small Firm

Next, we conduct robustness checks of our definition of a small firm. Table 8 reports our results. Column (1) of Table 8 reproduces Column (2) of Table 4, which classifies a target as small if its CPI-adjusted stock market value 4 weeks before the acquisition is announced was in the bottom quartile of its primary stock exchange regardless of when the target was acquired. However, if target stock prices declined during the sample period, using a fixed value cutoff would result in an increase in the number of firms classified as small after the enactment of SOX. To address this concern, we calculate the bottom quartile of the CPI-adjusted stock market value for pre-SOX and post-SOX acquisitions separately and classify a target as small based on the bottom quartile of its primary stock exchange in the period its acquisition was announced. Column (2) reports the results of using this classification. Column (3) reports the results of using the bottom quartile of the entire sample ($16 million) as a value cutoff for all targets. Column (4) reports the results of classifying a target as small if it was in the bottom quartile of the entire sample in the period its acquisition was announced ($20 million before SOX, and $13 million after SOX). The estimates in Columns (1) through (4) are qualitatively similar.

Table 8.

Sensitivity Analysis of the Small Target Definition

 Market value in bottom quartile by country
 
Market value in bottom quartile by country, defined pre/post-SOX separately
 
Market value in bottom quartile (<$16 million)
 
Market value in bottom quartile, defined pre/post-SOX separately (<$20/$13 million)
 
Definition of Small (1) (2) (3) (4) 
Acquisitions of small targets     
    US × After + US × After × Small 0.37*** (0.00) 0.50*** (0.00) 0.30** (0.02) 0.45*** (0.00) 
Acquisitions of large targets     
    US × After −0.09 (0.17) −0.07 (0.30) −0.08 (0.19) −0.06 (0.34) 
Number of observations 3089 3089 3089 3089 
 Market value in bottom quartile by country
 
Market value in bottom quartile by country, defined pre/post-SOX separately
 
Market value in bottom quartile (<$16 million)
 
Market value in bottom quartile, defined pre/post-SOX separately (<$20/$13 million)
 
Definition of Small (1) (2) (3) (4) 
Acquisitions of small targets     
    US × After + US × After × Small 0.37*** (0.00) 0.50*** (0.00) 0.30** (0.02) 0.45*** (0.00) 
Acquisitions of large targets     
    US × After −0.09 (0.17) −0.07 (0.30) −0.08 (0.19) −0.06 (0.34) 
Number of observations 3089 3089 3089 3089 

This table reports difference-in-differences estimates obtained from fitting a probit model in which the dependent variable is being acquired by a private acquirer rather than by a public acquirer. Standard errors are clustered at the country in which the target has its primary listing. The significance (p-value) of these estimates based on Wald tests is provided in parentheses. Column (1) reproduces Column (2) of Table 4. In Column (2), Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of the stock market value distribution in the target's primary stock exchange in the period in which the acquisition is announced (pre-SOX or post-SOX). In Column (3), Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is less than $16 million, corresponding to the bottom quartile of stock market value distribution of the sample. In Column (4), Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is less than $20 million for acquisition announced before the enactment of SOX, and $13 million for acquisitions announced after the enactment of SOX, corresponding to the bottom quartile of stock market value distribution of the sample in each period. US is an indicator for acquisitions of targets primarily listed in the United States. After is an indicator for acquisitions announced after July 31, 2002. The regressions include the log of the normalized stock index of the target's country of primary listing at announcement, quarter fixed effects based on the quarter and year in which the acquisition is announced, industry fixed effects based on the single-digit SIC code of the target, and country fixed effects based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

Controlling for the Availability of Private Equity

As a final robustness check, we investigate whether our results are driven by an increase in the availability of private equity capital in the United States relative to other countries after the enactment of SOX. We do so by examining whether post-SOX private acquirers in the United States gravitate toward public targets and away from private targets. Even if post-SOX private equity capital became more available in the United States, the additional funds could be invested in public targets and private targets in the same proportions as pre-SOX. An increase in the ratio of public target acquisitions would imply an increase in the appeal of going-private transactions as an investment outlet in the United States.

Accordingly, we estimate for a sample of domestic acquisitions by private acquirers a variation of the regression model reported in Table 4 in which the dependent variable is an indicator for acquisitions of public targets, rather than private ones. We determine a public target's nation by its stock exchange and a private target's by its headquarters. Based on our earlier finding that the SOX effect was strongest in the first year following the enactment of SOX, we include only acquisitions announced in that period.

Table 9 reports the results. Column (1) presents the results we obtain when defining a target as small if its CPI-adjusted stock market value 4 weeks before the acquisition is announced was less than the bottom quartile of the market distribution in its primary stock exchange. Column (2) presents the results we obtain when we use the pre-SOX bottom quartile of the target's primary stock exchange as a value cutoff for acquisitions announced before the enactment of SOX and the post-SOX bottom quartile for acquisitions announced thereafter. In both columns, the difference-in-differences estimates for acquisitions of small targets are positive. In contrast, the difference-in-differences estimate is insignificant for acquisitions of large targets. This suggests that the availability of private equity is not the only driving force behind our earlier finding that small public targets gravitate toward private acquirers after the enactment of SOX. In terms of economic significance, the coefficients reported in Column (2) predict a significant increase from 0.24 to 0.33 in the probability of purchasing a small public target rather than a small private target after the enactment of SOX.

Table 9.

Private Acquirers' Probability of Acquiring a Public Target for Acquisitions Announced Through June 30, 2003

Panel A: Coefficient estimates
 
 Market value in bottom quartile by country
 
Market value in bottom quartile by country, defined pre/post-SOX separately
 
 (1)
 
(2)
 
Definition of Small Coefficient Standard error Coefficient Standard error 
US × After 0.11 (0.13) 0.16 (0.12) 
US × After × Small 0.21 (0.21) 0.12 (0.18) 
US −0.92*** (0.08) −0.47*** (0.07) 
Small −0.55*** (0.13) −0.95*** (0.24) 
US × Small 0.26** (0.11) 0.25*** (0.10) 
Number of observations
 
3012
 

 
3012
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions of small targets     
    US × After + US × After × Small 0.32** (0.04) 0.28** (0.05) 
Acquisitions of large targets     
    US × After 0.11 (0.38) 0.16 (0.19) 
Panel A: Coefficient estimates
 
 Market value in bottom quartile by country
 
Market value in bottom quartile by country, defined pre/post-SOX separately
 
 (1)
 
(2)
 
Definition of Small Coefficient Standard error Coefficient Standard error 
US × After 0.11 (0.13) 0.16 (0.12) 
US × After × Small 0.21 (0.21) 0.12 (0.18) 
US −0.92*** (0.08) −0.47*** (0.07) 
Small −0.55*** (0.13) −0.95*** (0.24) 
US × Small 0.26** (0.11) 0.25*** (0.10) 
Number of observations
 
3012
 

 
3012
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Acquisitions of small targets     
    US × After + US × After × Small 0.32** (0.04) 0.28** (0.05) 
Acquisitions of large targets     
    US × After 0.11 (0.38) 0.16 (0.19) 

This table reports the results of estimating a probit model in which the dependent variable is acquiring a public target rather than a private target. All the acquirers are private. Panel A reports coefficient estimates and, in parentheses, standard errors clustered at the country in which the target has its primary listing. Public targets' nation is determined by stock exchange, and private targets' nation is determined by headquarters. Cross-border acquisitions are excluded. Panel B reports difference-in-differences estimates and, in parentheses, the significance (p-value) of these estimates based on Wald tests. US is an indicator for acquisitions of public targets primarily listed in the United States or private targets headquartered in the United States. After is an indicator for acquisitions announced after July 31, 2002. In Column (1), Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's primary stock exchange in the sample period. In Column (2), Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of the stock market value distribution in the target's primary stock exchange in the period in which the acquisition is announced (pre-SOX or post-SOX). Unreported regressors include the log of the normalized stock index of the target's country of primary listing at announcement, quarter, industry and country fixed effects, and an interaction of quarter fixed effects with Small. Quarter fixed effects are based on the quarter and year in which the acquisition is announced. Industry fixed effects are based on the single-digit SIC code of the target. Country fixed effects are based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

In an unreported regression, we use a sample of small target acquisitions by private acquirers to examine the longevity of the increase in the probability that private acquirers will buy public targets. We find that this effect, like the increase in the probability that public targets will be sold to private acquirers, disappears in the second year after the enactment of SOX, suggesting that the two effects are related.

New Sales Hypothesis versus All Sales Hypothesis

Finally, we use two indirect tests to examine which of our hypotheses—the “new sales hypothesis” or the “all sales hypothesis”—is generating our results.

First, we test the “new sales hypothesis” separately. This hypothesis predicts that SOX would increase the number of public firms for sale and, given a sufficiently dense population of private acquirers, these firms would in turn attract financial acquirers looking for a bargain, rather than a strategic match. We test this prediction by estimating the regression model reported in Table 4 separately for financial acquirers and strategic acquirers. We classify an acquirer as a financial acquirer if its industry is investment-related whereas the target's industry is not. This classification ensures that acquisitions by financial firms for strategic reasons are not mistakenly classified as acquisitions for financial reasons.

Table 10 presents the results. Column (1) reproduces Column (2) of Table 4. In Column (2), which excludes financial acquirers, the small target effect disappears. In contrast, in Column (3), which excludes strategic acquirers, the small target effect becomes stronger.14 These findings suggest that the “new sales hypothesis” is the driving force behind our results.

Table 10.

Probability of Being Acquired by a Private Acquirer

 Column (2) of Table 4
 
Strategic acquirers
 
Financial acquirers
 
 (1) (2) (3) 
Acquisitions of small targets    
    US × After + US × After × Small 0.37*** 0.13 2.20*** 
 (0.00) (0.49) (0.00) 
Acquisitions of large targets    
    US × After −0.09 −0.04 −0.09 
 (0.17) (0.66) (0.50) 
Number of observations 3089 2295 736 
 Column (2) of Table 4
 
Strategic acquirers
 
Financial acquirers
 
 (1) (2) (3) 
Acquisitions of small targets    
    US × After + US × After × Small 0.37*** 0.13 2.20*** 
 (0.00) (0.49) (0.00) 
Acquisitions of large targets    
    US × After −0.09 −0.04 −0.09 
 (0.17) (0.66) (0.50) 
Number of observations 3089 2295 736 

This table reports difference-in-differences estimates obtained from fitting a probit model in which the dependent variable is being acquired by a private acquirer rather than by a public acquirer. Standard errors are clustered at the country in which the target has its primary listing. The significance (p-value) of these estimates based on Wald tests is provided in parentheses. Column (1) reproduces Column (2) of Table 4. Column (2) reports the results of estimating the same specification excluding financial buyers. Column (3) reports the results of estimating the same specification excluding strategic buyers. US is an indicator for acquisitions of targets primarily listed in the United States. Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's primary stock exchange in the sample period. After is an indicator for acquisitions announced after July 31, 2002. The regressions include the log of the normalized stock index of the target's country of primary listing at announcement, quarter fixed effects based on the quarter and year in which the acquisition is announced, industry fixed effects based on the single-digit SIC code of the target, and country fixed effects based on the country in which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

Second, we test the “all sales hypothesis” separately. This hypothesis predicts that post-SOX public acquirers will shy away from acquiring any target that would add to their SOX costs. This includes not only public targets, which in the period we study were not yet required to comply, but also private targets, which were never required to comply.15 In contrast, the “new sales hypothesis” predicts that SOX will affect the acquisition market only by pushing public targets to go private and will have no effect on private target acquisitions. In other words, whereas the “new sales hypothesis” predicts an increase in the number of public targets selling, with the new sales attracting private acquirers, the “all sales hypothesis” predicts a decrease in the number of public acquirers buying any target.

We test this prediction by estimating the regression model reported in Table 4 for a sample of acquisitions of private targets. Because our focus is the acquirer's decision, we determine whether the acquisition creates SOX obligations based on the acquirer's nation, rather than the target's. We determine public acquirers' nation by their primary stock exchange and private acquirers' nation by their headquarters.

Table 11 reports the results. Columns (1) and (2) differ only in the definition of a small target. There is no evidence that a private target's probability of acquisition by a public acquirer rather than a private one decreases after the enactment of SOX. These findings, like the ones in Table 10, suggest that the “new sales hypothesis” is the driving force behind our results.

Table 11.

Private Targets' Probability of Being Acquired by a Public Acquirer for Acquisitions Announced through June 30, 2003

Panel A: Coefficient estimates
 
 Market value in bottom quartile by country
 
Market value in bottom quartile by country, defined pre/post-SOX separately
 
 (1)
 
(2)
 
Definition of Small Coefficient Standard error Coefficient Standard error 
US × After 0.14 (0.19) 0.17 (0.13) 
US × After × Small −0.13 (0.15) −0.18 (0.11) 
US 0.05 (0.47) 0.06 (0.46) 
Small −0.12 (0.14) 0.11 (0.12) 
US × Small −0.13 (0.15) −0.13 (0.09) 
Number of observations
 
9680
 

 
9680
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Small targets     
    US × After + US × After × Small 0.01 (0.93) −0.01 (0.97) 
Large targets     
    US × After 0.14 (0.46) 0.17 (0.20) 
Panel A: Coefficient estimates
 
 Market value in bottom quartile by country
 
Market value in bottom quartile by country, defined pre/post-SOX separately
 
 (1)
 
(2)
 
Definition of Small Coefficient Standard error Coefficient Standard error 
US × After 0.14 (0.19) 0.17 (0.13) 
US × After × Small −0.13 (0.15) −0.18 (0.11) 
US 0.05 (0.47) 0.06 (0.46) 
Small −0.12 (0.14) 0.11 (0.12) 
US × Small −0.13 (0.15) −0.13 (0.09) 
Number of observations
 
9680
 

 
9680
 

 
Panel B: Difference-in-differences estimates
 
 Coefficient
 
p-Value
 
Coefficient
 
p-Value
 
Small targets     
    US × After + US × After × Small 0.01 (0.93) −0.01 (0.97) 
Large targets     
    US × After 0.14 (0.46) 0.17 (0.20) 

This table reports the results of estimating a probit model on a sample of private targets in which the dependent variable is being acquired by a public acquirer rather than by a private acquirer. Panel A reports coefficient estimates and, in parentheses, standard errors clustered at the country level. Public acquirers' nation is determined by stock exchange, and private acquirers' nation is determined by headquarters. Panel B reports difference-in-differences estimates and, in parentheses, the significance (p-value) of these estimates based on Wald tests. US is an indicator for acquisitions by public acquirers primarily listed in the United States or private acquirers headquartered in the United States. After is an indicator for acquisitions announced after July 31, 2002. In Column (1), Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of stock market value distribution in the target's country of primary listing in the sample period. In Column (2), Small is an indicator for acquisitions of targets whose CPI-adjusted stock market value 4 weeks before the acquisition is announced is in the bottom quartile of the stock market value distribution in the target's country of primary listing in the period in which the acquisition is announced (pre-SOX or post-SOX). Unreported regressors include the log of the normalized stock index of the target's country of primary listing at announcement, quarter, industry, and country fixed effects, and an interaction of quarter fixed effects with Small. Quarter fixed effects are based on the quarter and year in which the acquisition is announced. Industry fixed effects are based on the single-digit SIC code of the target. Stock exchange fixed effects are based on the stock exchange on which the target is primarily listed. Significance (p-value): * 10%, ** 5%, *** 1%.

Conclusion

In this article, we reported evidence consistent with the hypothesis that the Sarbanes-Oxley Act of 2002 disproportionately burdens small firms. In particular, using acquisitions of foreign targets as a control group, we have found that the propensity of small public American targets to be acquired by private acquirers rather than public ones increased substantially in the first year after enactment of SOX. In contrast, we did not find a similar effect for large targets. These results were robust in a number of alternative specifications.

We offered two interpretations of these findings. According to the “new sales hypothesis,” the enactment of SOX induced small firms to be sold. The acquirers of these firms, in turn, tended to be financial acquirers for reasons unrelated to SOX. According to the “all sales hypothesis,” SOX reduced the price that public acquirers would be willing to pay in an acquisition because they inherit any firm-specific compliance costs associated with the target. These compliance costs are relatively higher for smaller targets. We found more evidence in favor of the “new sales hypothesis.”

To be sure, our findings do not answer all the questions that need to be answered for evaluating SOX. First, the exodus of small firms from the public capital market would be a blessing if the departing firms were prone to the type of financial fraud that SOX seeks to limit. Second, even if SOX burdened small firms with no connection to the integrity of their financial statements, it could benefit firms that remained public enough to justify this cost. Finally, the experience that market participants have continued to develop in complying with SOX and the steps that regulators have taken to clarify its requirements may have lowered the costs below their level in the period we study. This article sheds light on an important piece of this puzzle.

We thank an anonymous referee, Barry Adler, Yakov Amihud, Oren Bar-Gill, Lucian Bebchuk, Stephen Choi, Robert Cooter, John Donohue, Guido Ferrarini, Victor Fleischer, Jesse Fried, Susan Gates, Clayton Gillette, Marcel Kahan, Lewis Kornhauser, Russell Korobkin, Eran Lempert, Alexander Ljungqvist, David Loughran, Robert Reville, Larry Ribstein, Michael Rich, Roberta Romano, Gerald Rosenfeld, Daniel Rubinfeld, Alan Schwartz, Seth Seabury, Sagiv Shiv, Stanley Siegel, Pablo Spiller (the editor), James Thompson, Mark Weinstein, Dana Welch, and workshop participants at the American Law and Economics Association 2006 Annual Meeting, the American Economic Association 2007 Annual Meeting, Columbia University, Cornell University, New York University, RAND Corporation, University of California at Berkeley, University of California at Los Angeles, University of Southern California, University of Colorado, and University of Virginia for comments and discussion, and RAND/Kauffman Center for the Study of Small Business, New York University School of Law, and University of Southern California Gould School of Law for financial support. All errors are ours.

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Bartlett (2008) notes that taking a company private does not relieve it of its SOX obligations when the deal is at least partially financed by high-yield public debt. He finds a post-SOX decrease in the use of high-yield debt in U.S. going-private transactions for firms below the top size quintile of his sample (firms with less than $985 million in assets). He also reports, however, that going-private transactions in the bottom two size quintiles of his sample (firms with a mean asset value of $45.6 million and a median asset value of $41.7 million) virtually never use public debt as a financing vehicle, before or after SOX. These firms include the ones we define as small, enabling us to have greater confidence in attributing the increase in going private among small firms to SOX.
2
In July 2003, for example, the United Kingdom required public firms to establish independent audit committees with at least one financial expert to monitor their internal controls (Financial Services Authority 2003).
3
We do not separate the effect of SOX from the effect of other mechanisms of heightened scrutiny to which public firms in the United States became subject around its enactment. SOX was a response to the end of the technology bubble of the late 1990s and the spate of corporate scandals that followed. But it was not the only response. Within the United States, courts, regulators, stock exchanges, and investors all intensified their scrutiny of public firms in additional ways. Each of these non-SOX changes could have raised the cost of being public. Our study compares the combined effect of SOX and these related changes to that of contemporaneous trends abroad.
4
Kamar et al. (2007) provide a detailed review of the literature.
5
Holstein (2004), MacFayden (2002, 2003, 2004), and Carney (2006) report that the ready availability of private equity financing around the enactment of SOX fueled going-private transactions. Block (2004) reports that almost 40% of firms that either went private or went dark after the enactment of SOX cited as the primary reason not the cost of being public under SOX, but rather pressure and time constraints for top management, lack of coverage by security analysts, absence of liquidity in the public capital market, absence of opportunity for a secondary market, or threat of delisting by Nasdaq.
6
The sale of Toys “R” Us to financial acquirer KKR, which began in an attempt to sell one of the firm's divisions (Global Toys), is a useful illustration: “[The firm's investment bank] First Boston contacted 29 potential buyers for Global Toys … None of the 29 potential buyers was a so-called “strategic buyer” and apparently for good reason. At oral argument and in their briefs, the plaintiffs have been unable to identify any existing retailer that would have a plausible strategy for combining itself in a synergistic manner with Global Toys … The 29 financial buyers First Boston contacted are a “who's who” of private equity funds.” In re Toys “R” Us, Inc., Shareholder Litigation, 877 A.2d 975, 987 (Del. Ch. 2005).
7
The results are robust to adding as controls other financial statistics (by month, year, and country) published by the International Monetary Fund, such as the central bank deposit rate, the lending rate, the treasury bill rate, and the money market rate.
8
In principle, this framework could be expanded to a nested set of decisions, with the first decision concerning whether to be sold and the second decision concerning the type of acquirer. Because of data restrictions, we focus on the second decision by investigating firms' propensity to be sold to private acquirers rather than public ones conditional on being sold. In Section 3, however, we return to the first decision by investigating whether the number of acquisitions increased after the enactment of SOX.
9
To the extent that, SOX aside, partial acquisitions and full acquisitions are affected by similar economic conditions, partial acquisitions can serve as a useful comparison group (in addition to foreign acquisitions) for isolating the effect of SOX. In unreported regressions, we included partial acquisitions in the sample and distinguished between them and full acquisitions, finding no effect for partial acquisitions or an opposite effect to the one we found for full acquisitions.
10
The countries are Australia, Canada, Denmark, France, Germany, Hong Kong, India, Italy, Japan, Malaysia, Netherlands, Norway, Singapore, South Africa, Sweden, Thailand, and United Kingdom.
11
We thank an anonymous referee for suggesting this test.
12
The coefficient estimate of the difference-in-differences for small targets were 0.29 and 0.29, and the p-value were 0.04 and 0.02, when dividing the sample into three periods and four periods, respectively. The coefficient estimate of the difference-in-differences for large targets was negative and insignificant in both regressions.
13
The figures 0.39 and 0.64 are, respectively, the mean predicted probability that the American firms in our sample go private when both Period 1 and Period 2 are set to 0, and the mean predicted probability that the American firms in our sample go private when Period 1 is set to 1 and Period 2 is set to 0.
14
In the sample, 34% of 439 American private acquirers, and 35% of 566 foreign private acquirers, are strategic acquirers.
15
In June 2003, the SEC issued rules on the duty to evaluate annually the effectiveness of internal controls over financial reporting. These rules required firms with a minimum float of $75 million and at least one year of financial reporting to comply in their annual reports for fiscal years ending after June 14, 2004, and required other firms to comply for fiscal years ending after April 14, 2005. Both deadlines were subsequently postponed.