Reporting Quality, SOX, and the Cost of Debt

This paper studies the heretofore unexamined effect of Sarbanes-Oxley Act of 2002 (SOX) on the spread-accruals relationship. We document that SOX has no impact on the overall spread-accruals relationship but, as hypothesized, it has a moderating effect on the discretionary (but not innate) component of accruals. The latter effect however is only revealed in the subset of firms characterized by high information quality risk in the pre-SOX period. The paper also adds robustness to prior findings by reconfirming the positive relationship between accruals and cost of debt but using a sample of seasoned debt issues with available secondary market prices. Earlier studies used historical costs of debt or focused only on newly issued debt. We also reconfirm that the accrual-debt cost relationship is stronger for innate than for discretionary accruals