thesis_effects of material weakness on stock exchange market
TRANSCRIPT
School of Business Administration
EFFECTS OF MATERIAL
WEAKNESS ON STOCK EXCHANGE
MARKET
The impact of Sarbanes Oxley Act in companies’ share price
Ronnie Damonte
Month Year
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TABLE OF CONTENTS:
1. INTRODUCTION ..................................................................................................................................... 3
1.1 BACKGROUND INFORMATION. .................................................................................................................................. 3
1.2 OBJECTIVES OF THE RESEARCH. ................................................................................................................................ 3
1.2 RESEARCH QUESTIONS. ............................................................................................................................................ 4
1.3 METHODS. ............................................................................................................................................................... 4
2. SARBANES OXLEY ACT........................................................................................................................ 5
2.1 WHAT IS THE “SARBANES OXLEY ACT”? .................................................................................................................. 5
2.2 SOX GENESIS. .......................................................................................................................................................... 5
2.2.1 Toward the SOX. ............................................................................................................................................ 5
2.2.2 The development of SOX bill. ......................................................................................................................... 6
2.3 STRUCTURE AND CONTENTS OF SARBANES OXLEY ACT. ........................................................................................... 8
2.3.1 - 100s Public Company Accounting Oversight Board. .................................................................................. 8
2.3.2 - 200s Auditor Independence. ......................................................................................................................... 8
2.3.3 – 300s Behavior and Compensation of CEO, CFO and professional advisors. ............................................. 9
2.3.4 – 400s Disclosure Rules. .............................................................................................................................. 11
2.3.5 – 500s Conflicts of Analyst Interest. ............................................................................................................. 12
2.3.6 – 600s Funding; 800, 900, 1100s Disciplining Transgressors. .................................................................... 13
2.4 SOX SECTION 404. ................................................................................................................................................ 13
2.4.1 Overview of Section 404. .............................................................................................................................. 13
2.4.2 Internal Auditor Role in Section 404. ........................................................................................................... 14
2.4.3 Definition of deficiencies in internal control system..................................................................................... 15
2.5 MARKET REACTIONS AFTER SOX. .......................................................................................................................... 16
3. IMPLEMENTATION OF THE RESEARCH ...................................................................................... 18
3.1 SELECTION OF THE STUDY SAMPLE. ......................................................................................................................... 18
3.2 RESEARCH METHODOLOGY. .................................................................................................................................... 21
3.2.1 Average variation analysis. .......................................................................................................................... 21
3.2.2 Gaussian distribution analysis. .................................................................................................................... 22
4. EMPIRICAL TEST AND RESULTS .................................................................................................... 27
4.1 INTRODUCTION. ...................................................................................................................................................... 27
4.2 RESULTS OF THE AVERAGE VARIATION ANALYSIS. ................................................................................................... 28
4.2.1 Calculation of the company stock trend. ...................................................................................................... 28
4.2.3 Calculation of the average variation. ........................................................................................................... 29
4.3 RESULTS OF THE GAUSSIAN DISTRIBUTION ANALYSIS FOR THE ENTIRE SAMPLE. ....................................................... 32
4.4 RESULTS OF THE GAUSSIAN DISTRIBUTION ANALYSIS APPLIED TO THE TYPE OF INDUSTRY. ...................................... 35
4.4.1 Automotive and transport. ............................................................................................................................ 35
4.4.2 Construction. ................................................................................................................................................ 36
4.4.3 Consumer product manufacturers. ............................................................................................................... 37
4.4.4 Consumer services. ....................................................................................................................................... 38
4.4.5 Electronics. ................................................................................................................................................... 39
4.4.6 Energy and utilities....................................................................................................................................... 40
4.4.7 Financial services. ........................................................................................................................................ 41
4.4.8 Industrial manufacturing. ............................................................................................................................. 42
4.4.9 Media. ........................................................................................................................................................... 43
4.4.10 Pharmaceutical. ......................................................................................................................................... 44
4.5 RESULTS OF THE GAUSSIAN DISTRIBUTION ANALYSIS APPLIED TO THE COMPANY SIZE. ............................................ 45
4.5.1 Small size companies. ................................................................................................................................... 46
4.5.2 Medium size companies. ............................................................................................................................... 46
4.5.3 Large size companies. .................................................................................................................................. 48
5. CONCLUSIONS ...................................................................................................................................... 50
REFERENCES ............................................................................................................................................ 52
APPENDICES .............................................................................................................................................. 56
APPENDIX 1: SHARE PRICE ANALYSIS PER EACH SELECTED COMPANY OVER A PERIOD OF SIX MONTHS............................ 56
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1. INTRODUCTION
1.1 Background Information.
In recent years Sarbanes Oxley Act (the Act or SOX hereafter), a corporate law of United
States has brought significant changes in the governance, accounting, auditing, and
reporting environment of firms traded in American securities markets.
Under the new regime of SOX, public companies must have a system of internal controls,
management must make disclosures and attestations about the internal controls, and the
external auditors must also test and evaluate the system. Important internal control
deficiencies, called technically material weakness, could lead the auditor to conclude that
internal control over financial reporting is not effective.
In my role of Senior Consultant in Deloitte Touche Tohmatsu, my employer has asked me
to implement a research in order to understand the effect on market share price of
material weakness. In fact, negative market reactions could lead some companies to apply
a delisting program, decreasing the business opportunities regarding SOX consulting and
auditing prospective for Deloitte Touche Tohmatsu.
1.2 Objectives of the Research.
In an attempt to increase investor confidence in financial reporting, the Sarbanes Oxley
Act mandates management evaluation and independent audits of internal control
effectiveness. Motivated by the ongoing debate on the economic impact and
consequences of SOX, this paper investigates the effects of the Act in the Stock Exchange
Market, by examining market reactions to the disclosures of a material weakness during
the evaluation of company internal control system.
We use SOX 404 audit opinions to assess how announcements of a material control
weakness affect the stock price of the listed firms.
In order to achieve these objectives other goals have been set for the thesis:
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to outline the structure and the contents of Sarbanes-Oxley Act;
to provide Deloitte information that can be used to broaden the knowledge about one
of the major business area of the company.
The introduction chapter of this paper presents next the research questions, the methods
of the research and then an overview of Deloitte. The second chapter is concentrated on
the Sarbanes-Oxley Act evolution, composition and theoretical framework. The third
chapter presents the empirical research process and finally, the fourth chapter contains the
results of the research and provides the analysis of the selected data.
1.2 Research Questions.
The main research question of this bachelor's thesis is:
How does a material weakness affect company share price?
This main question is followed by two sub questions:
What are the differences between material weaknesses effects originating from
companies having diverse sizes?
In which way the market reaction is influenced by the type of industry?
1.3 Methods.
This is an inductive research where quantitative methods have been used. The
quantitative analysis consists of stock price data acquired from the New York Stock
Exchange and the results of audit regarding company's internal control over financial
reporting required by the Sarbanes Oxley Act.
Statistical results of the data analysis have been received by using the Gauss curve, as
preferred distribution function, and the Excel spreadsheet, as tool of testing.
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2. SARBANES OXLEY ACT
2.1 What is the “Sarbanes Oxley Act”?
In response to the collapse of a number of high-profile firms since late 2001, Congress
passed the Sarbanes-Oxley Act (the Act or SOX hereafter) in July 2002 to enhance
corporate governance and thereby restore public confidence. The Act has introduced
significant changes in both management‟s reporting responsibilities and the scope and
nature of the responsibilities of the auditor.
The major provisions of the Act established the Public Company Accounting Oversight
Board (PCAOB), prohibit auditors from performing certain non-audit services for their
audit clients, impose greater criminal penalties for corporate fraud, and call for more
detailed and timely disclosure of financial information. Further, Section 404 of the Act
requires that management assess internal controls and that auditors report on the internal
controls of their clients. By requiring deeper oversight, imposing greater penalties for
misconduct, and dealing with potential conflicts of interest, the Act aims to prevent
deceptive accounting and management misbehavior.
2.2 SOX genesis.
2.2.1 Toward the SOX.
In early 2000, the American stock markets crashed, after a long boom period during the
1990s. Stock prices continued to be low for several years, until recovery began in 2003.
During the period of depressed prices, scandals emerged. Some of the companies that had
seen high-flying stock prices, but were now in bankruptcy, or at least in serious financial
trouble, were discovered to have been boosted artificially by major accounting frauds or
manipulations that persisted for remarkable time periods (e.g., Enron, WorldCom). Others
were found to be financially weaker than previously perceived because, among other
things, their executives had engaged in major self-dealing transactions or extractions of
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personal benefits (e.g., Tyco, Adelphia). As the facts were uncovered, journalists
publicized them in a vivid and persistent way.
The situation was really problematic, since the trust of investors in the Corporate
American Market started to fall. To avoid an outflow of capital the Congress, the
Securities and Exchange Commission (hereafter, SEC), and the Bush Administration
worked side by side to produce major changes in corporate governance standards
applicable to U.S. corporations.
The transformation process evolved through three major phases:
1. The federal Sarbanes-Oxley Act of 2002, which enacted sweeping governance
changes and called for the SEC to adopt implementing rules and procedures on
corporate governance and responsibility.
2. The new listing requirements for publicly traded companies governed by the New
York Stock Exchange (NYSE), which impose new Corporate Governance Rules.
3. The utilization of increasingly detailed and stringent corporate governance rating
systems devised by private governance rating agencies (e.g.: “Corporate
Governance Quotient” system used by Institutional Shareholder Services, or the
“Board Effectiveness Ratings” system).
This chapter analyses the structure and the requirements of SOX only. However, it is
important to understand the legislative and economic environment, which constitute both
the reasons and the framework of SOX development.
2.2.2 The development of SOX bill.
After the scandals that started to occurs in Corporate America, the first signal of a
regulatory overhaul was reported on January 16, 2002 (Day et al., January 16, 2002,
Washington Post): SEC Chairman Pitt would announce a reform plan to create an
independent regulatory organization. Legislative activities progressed slowly from
February to May 2002. The Bush Administration unveiled their response to the Enron
scandal in February and March, while Congress moved ahead with several proposals
towards accounting reforms. Republican Rep. Oxley‟s reform bill, which was introduced
in the House on February 13, was considered a business-friendly reform proposal
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(Schroeder, February 12, 2002, Wall Street Journal). Meanwhile, Democratic Senators
reportedly drafted bills that went beyond Oxley‟s bill (Schroeder, March 7, 2002 and
April 23, 2002, Wall Street Journal).
Although Sen. Sarbanes‟ tough reform bill passed in the Senate Banking Committee on
June 18, it was not expected to have much chance of becoming law at that time
(Hilzenrath et al., July 28, 2002, Washington Post). However, the exposure of the
WorldCom scandal in late June boosted rulemaking activities (Hamburger et al., June 27,
2002, Wall Street Journal).
The Senate started debate on July 8, and Sarbanes‟ bill was passed 97 to 0 in the Senate
on July 15 (Hilzenrath et al., July 16, 2002, Washington Post).
The House and Senate formed a conference committee and started final negotiations to
merge the bills on Friday, July 19 (Hilzenrath, July 20, 2002, Washington Post). The final
rule was agreed upon on July 24 (VandeHei et al., July 25, 2002, Washington Post),
passed in Congress on July 25, and signed into law on July 30 (Hitt, July 31, 2002, Wall
Street Journal).
The implementation of SOX started soon after its passage. August 14, 2002 was the first
deadline for CEOs and CFOs of the 947 largest firms, called accelerated filers, to certify
the truthfulness of their financial reports (Day et al., August 15, 2002, Washington Post).
As directed by SOX, the SEC started rulemaking activities as of late August 2002.
The rulemaking activities directed by SOX continued in 2003. The SEC proposed listing
standards on January 8 (Schroeder, January 9, 2003, Wall Street Journal) and adopted a
series of rules in mid-January. The SEC adopted rules concerning management reports on
internal controls on May 27, adjusting the compliance date from September 2003 in the
original proposal to July 2004 for accelerated filers and April 2005 for non-accelerated
filers (Solomon, May 28, 2003, Wall Street Journal). On October 7, 2003, the PCAOB
proposed a standard on the audit of internal controls, as required by Section 404 of SOX
(Bryan-Low, October 8, 2003, Wall Street Journal). The standard was adopted in March
2004 and approved by the SEC in June, which completed the major rulemaking activities
directed by SOX.
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2.3 Structure and contents of Sarbanes Oxley Act.
The SOX is composed by the following sections:
100s Creation and Operation of the Public Company Accounting Oversight Board
200s Auditor independence
300s Behaviour and compensation of CEO, CFO and professional advisors
400s Disclosure rules
500s Conflicts of analyst interest
600s Funding and power of the SEC
800,900,1100s Penalties for transgression
This paragraph discusses and analyses each section of the Act, in order to provide a
complete understanding of this complex law.
2.3.1 - 100s Public Company Accounting Oversight Board.
Section 101 of the Act creates the Public Company Accounting Oversight Board, a not-
for-profit organization that verifies the correct application and implementation of SOX
rules. The Board consists of five members who serve for five year staggered terms.
Only firms that have registered with the Board are able to audit publicly-quoted
companies. This gives the Board new and significant monopoly powers. It is also
responsible for creating, promulgating and monitoring standards of auditing and of ethical
behavior. The Board is overseen by the SEC and is funded from audit fees (Guy P.
Lander, 2004, What is Sarbanes-Oxley?).
2.3.2 - 200s Auditor Independence.
Section 201 of the Act has caused major changes to the industrial organization of
professional services firms in the United States, and consequently in the whole world.
Therefore international non-American corporations listed on the NYSE have to follow the
SOX rules, which are in fact applied to all the listed companies. Section 201 prohibits
audit firms from also providing non-audit services to audit clients. These include
bookkeeping, financial information systems design, actuarial services, investment advice
or dealing, legal and expert services. Hence, in general, cross-selling of consultancy
services is outlawed.
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The Act also discusses the relationship between the auditing firm and the client. In
particular Section 203 underlines that reviewing partners must be circulated after five
years. Finally, a firm cannot be audited by an institution which in the previous year
employed either the CEO or senior accounting officers upon an audit of the firm (Protiviti
Inc., 2003, Guide to the Sarbanes-Oxley Act: Internal Control Reporting Requirements).
These rules are specifically intended to avoid possible conflicts of interest. Their aim is to
reassure investors that disclosed figures are unbiased. Some industry participants have
however expressed concern that the rules may close important information transmission
channels. For example, changing audit partners may cause a loss of valuable expertise
which could serve to improve oversight, rather than to weaken it. Similarly, if the audit
firm has the best information about a corporation‟s requirements for financial information
then it may be inefficient to prevent it from selling its expertise in the form of IT
consultancy
2.3.3 – 300s Behavior and Compensation of CEO, CFO and professional advisors.
The sections of the Sarbanes-Oxley Act numbered 300 represent possibly the most
substantial shifts in US Federal corporate governance law away from disclosure and
towards detailed conduct of business regulation. The sections which will be discussed
have a significant impact upon the organization of the company (301), the job
descriptions of its senior officers (302), their compensation (304) and the relationship of
the firm to its legal advisors (307).
Section 301 requires US securities exchanges to prevent an issuer from listing, if it does
not have an independent audit committee, which is directly responsible for selecting,
hiring and managing the relationship with any public accounting firms employed by the
firm. In addition, the audit committee must establish procedures for dealing with
complaints, and must have wide authority to engage its own professional advisors. Thus,
this part of the Act stipulates the way in which the firm must be organized.
Some concern has been expressed amongst legal scholars about the fact that it may be
impossible for some non-US firms both to meet the requirement for an independent audit
committee and to satisfy local requirements. For example, in German firms the audit
committee‟s role is generally performed by the supervisory board, the Vorstand, which
does not meet the requirements of section 301. In order to solve this issue, foreign firms
are not required to comply with this part of the legislation since July 31, 2005.
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Section 302 of the Act has received possibly more press attention than any other part of
the Act. It requires the CEO and CFO to certify financial and other information contained
in each annual and quarterly report. They have responsibility for establishing and
maintaining internal controls and they are required to ensure that they receive reports of
all material information. Furthermore, they are under an obligation to disclose to the audit
committee any deficiencies they uncover in the design or operation of internal controls,
along with details of intended corrective action (Robert A Prentice, 2004, Guide to the
Sarbanes-Oxley Act: What Business Needs to Know Now That it is Implemented).
In prescribing the reports that the CEO and CFO will and in defining precisely some of
their job responsibilities, section 302 again moves significantly from the former emphasis
in US law upon disclosure requirements. It has been criticized on the grounds that the
CEO and CFO are already responsible for internal controls and for the accuracy of
financial information. However, it may be difficult for a CEO to commit to examine
internal controls in the absence of a clear auditing requirement or of legal machinery for
dealing with transgressions. Equally, this legislation makes it easier for the CFO to
commit never to use ignorance as an excuse: while ex post this excuse may be acceptable
to both the company officers and to the investors, it is never ex ante efficient (Anne M.
Marchetti, 2005, Beyond Sarbanes-Oxley Compliance: Effective Enterprise Risk
Management).
Section 304 is a rare example in the US of State interference with compensation policies.
It requires the corporation‟s CEO and CFO to reimburse any equity-based compensation
or profits from stock sales following a required restatement of a financial document as a
result of material noncompliance of the issuer due to misconduct with any financial
reporting requirement under securities laws.
In practice the section 304 seems likely simply to raise the costs of employing senior
corporate officers, both directly because of the danger of confiscation of compensation,
and indirectly, because the replacing stock options with cash payments will undermine
managerial incentives (Cohen, Daniel A., Aiyesha Dey, and Thomas Z. Lys, 2005, Trends
in earnings management and informativeness of earnings announcements in the pre- and
post-Sarbanes Oxley periods, Working paper, New York University).
Section 307 undermines the confidentiality of the firm-lawyer relationship. It requires the
firm‟s lawyers to report evidence of material breaches of securities laws or of fiduciary
duty to the firm‟s chief legal officer and to its CEO. If they do not respond with sufficient
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speed, the breach must be reported to the audit committee or to the full board of directors.
There has been quite a bit of criticism of this law, some of it from lawyers. It has been
suggested that corporate officers may be unwilling to ask for advice if they think that in
doing so they may reveal a problem which will then become public knowledge with
potentially harmful effects for the officers involved. This may of course be a problem. At
the same time, this is a classic example of a rule which in the absence of legal strictures
neither the law firm nor the firm would be able to commit ex ante. So introducing this law
may help to increase the value of the corporations which are subject to it. Some authors
think that it is almost impossible to tell a priori whether this is the case. As it was
introduced with an extremely wide-ranging raft of other laws, it is probably impossible to
disentangle its effects from the rest of the legislation (Guy P. Lander, 2004, What is
Sarbanes-Oxley?).
2.3.4 – 400s Disclosure Rules.
Some straightforward changes have been made to disclosure requirements with respect to
off-balance sheet transactions, and to insider transactions. The Act also requires firms to
disclose whether their audit committee contains a financial expert. This part of the Act
also imposes some conduct of business obligations. For example, section 402 prohibits
listed companies from making loans to executive officers or directors.
Section 406 requires companies to disclose a written code of ethics, or to explain why
they do not have one. This reflects an increasing tendency towards notions of corporate
social responsibility. In the wake of scandals like the Enron affair, it has received little
real critical attention, but it is nevertheless an interesting step. Many commentators have
argued that attempting to endow corporations with moral responsibilities risks subverting
their real purpose of wealth creation. In practice, the ethical requirements of the Sarbanes-
Oxley Act relate mostly to compliance with the law and to the management of conflicts of
interest so this part of the Act appears unlikely to be an immediate cause of disputes
(Scott Green, 2004, Sarbanes-Oxley and the Board of Directors: Techniques and Best
Practices for Corporate Governance).
Sections 404 will constitute much of the remainder of this chapter, so I will outline briefly
it now before returning later to its implications. Its main point of interest is represented by
the fact that it requires an annual internal control report containing a statement of the
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responsibility of management for establishing and maintaining adequate control of
financial reporting.
Section 409 has received perhaps less attention than 404, but its impact may in the longer
term be fundamental. It requires quoted companies to disclose to the public in plain
English and on a “rapid and current basis” any information concerning material changes
in the financial condition of the company‟s operations. It appears that the initial
requirement for a 48 hour reporting horizon has been supplanted by a four business day
requirement.
Like section 404, section 409 is simply a disclosure requirement: compliance methods
and their structural implications are left to the regulated firm. Nevertheless, and
notwithstanding the extension of the reporting deadline, section 409 is likely to have
major repercussions for regulated companies, particularly if detailed reporting standards
are introduced. Like section 409, it requires quantative and verifiable information on
company procedures, and it forces firms to make a rapid decision about the likely impact
of changes to standard conditions. Although financial markets appear on average to be
pretty good at aggregating information, one obvious concern is that frequent company
announcements of potentially deleterious events will destabilize the stock price. This area
of study will be analyzed in the following chapters.
More immediately, section 409 requires the implementation of real-time monitoring
systems. In brief, though, corporations have to capture important operational information
and establish procedures for responding to it. As with section 404, this introduces
organizational complications. The obligation to maintain near real-time information on
decision-making within the firm and systemic shocks outside requires both a clear
understanding of the firm‟s organizational structure and of the consequences of
exogenous shocks such as supplier failure or severe weather. At the very least careful
mapping of organizational form will be required; conceivably, that this requirement can
most efficiently be met if the corporation is somewhat restructured (Michael F. Holt,
2006, The Sarbanes-Oxley Act: Overview and Implementation Procedures Manual).
2.3.5 – 500s Conflicts of Analyst Interest.
During the stock market boom of the 90‟s there were some instances where it appeared
that stock market analysts had overstated the value of some corporations in order to
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secure valuable corporate finance advisory business for their employers. This type of
cross-selling is potentially more damaging to the efficient operation of the capital markets
than that by auditors to their consultancy divisions. Sarbanes-Oxley‟s section 501
contains provisions which force securities exchanges to adopt rules in order to deal with
the problem.
For example, analysts are no longer allowed to submit their reports to the subject
companies for clearance; retaliation for bad reports is prohibited; and better information
partitions are mandated.
Some commentators have expressed muted opposition to the changes on the grounds that
they will undermine information gathering incentives in financial markets. Their longer
term effect has yet to be determined, but SOX experts consider overall results as positive
(Robert Charles Clark, 2005, Corporate governance changes in the wake if the Sarbanes
Oxley Act, Discussion Paper, University of Harvard).
2.3.6 – 600s Funding; 800, 900, 1100s Disciplining Transgressors.
The remainder of the Act provides for the enhanced funding which the SEC requires
(section 601) and gives the legislation teeth. For example, section 802 stipulates a 20 year
penalty for destruction, alteration of falsification of records in Federal investigations and
bankruptcy; section 807 raises the criminal penalty for securities law to 25 years
imprisonment, and section 906 institutes a $1,000,000 fine or 10 years‟ imprisonment for
CEOs and CFOs who knowingly give false certification of compliance with the Act (Alan
D. Morrison, 2004, Sarbanes Oxley, Corporate Governance and Operational Risk,
Sarbanes-Oxford Seminar, University of Oxford).
2.4 SOX Section 404.
2.4.1 Overview of Section 404.
Section 404 is one of the most important parts of SOX. It requires management to include
an internal control report in its annual report that:
States the responsibility of management for establishing and maintaining an adequate
internal control structure and procedures for financial reporting;
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Contains an assessment, as of the end of the most recent fiscal year, of the
effectiveness of the internal control structure and procedures of the company for
financial reporting.
The auditor is required to attest to the accuracy of these statements, that is referred to as
the audit of internal control over financial reporting.
Thus, the requirements of section 404 place new and possibly costly demands upon
regulated companies. In particular, they imply the existence of a formal and verifiable
system of checking internal controls.
In many firms controls are essentially built into formal and informal communication
channels and it can be difficult to codify them. This process of formalization is
complicated by the need to provide audit trails.
So, it is not only necessary to write down the corporation‟s control mechanisms: it is also
compulsory to prove that they have been employed. It is possible that in some firms
compliance is achieved only by changing significantly the corporation‟s reporting lines
(KPMG LLP, 2004. Sarbanes-Oxley Section 404: An overview of the PCAOB’s
requirements).
2.4.2 Internal Auditor Role in Section 404.
The auditor's role defined by Section 404 of the Act is to express an opinion on
management's assessment of the effectiveness of the company's internal control over
financial reporting.
To form a basis for state such an opinion, the auditor must plan and perform the audit to
obtain reasonable assurance about whether the company maintained effective internal
control over financial reporting as of the date specified in management's assessment.
For the auditor to satisfactorily complete an audit of internal control over financial
reporting, management must fulfill the following important duties:
Accepting responsibility for the effectiveness of the company‟s internal control
system;
Evaluating the effectiveness of the company‟s internal control system using suitable
control criteria;
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Supporting the evaluation with sufficient evidence, including adequate
documentation;
Presenting a written assessment of the effectiveness of the company‟s internal control
system as of the end of the most recent fiscal year.
Management fulfills these responsibilities by undertaking a comprehensive approach that
includes thorough planning and evaluation of its system of internal controls (Financial
Reporting Council, 2004, The Turnbull guidance as an evaluation framework for
the purposes of Section 404(a) of the Sarbanes-Oxley Act).
2.4.3 Definition of deficiencies in internal control system.
The audit of the company's internal control over financial reporting can present three
types of deficiencies, which affect in different ways the auditor‟s evaluation:
Control Deficiency.
A control deficiency exists when the design or operation of a control does not allow
management or employees, in the normal course of performing their assigned
functions, to prevent or detect misstatements on a timely basis (Financial Accounting
Standards Board Statement No. 5, Accounting for Contingencies ("FAS No. 5").
Significant Deficiency.
A significant deficiency is a control deficiency, or combination of control
deficiencies, that adversely affects the company's ability to initiate, authorize, record,
process, or report external financial data reliably in accordance with generally
accepted accounting principles such that there is more than a remote likelihood that a
misstatement of the company's annual or interim financial statements that is more than
inconsequential will not be prevented or detected (Financial Accounting Standards
Board Statement No. 5, Accounting for Contingencies ("FAS No. 5").
Material Weakness.
A material weakness is a significant deficiency, or combination of significant
deficiencies, that results in more than a remote likelihood that a material misstatement
of the annual or interim financial statements will not be prevented or detected.
(Paragraph 3 of FAS No. 5).
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As explained in the previous paragraph, the company‟s auditor is required to attest
management‟s assessment and also report its own conclusion regarding the effectiveness
of the company‟s internal control over financial reporting. Maintaining effective internal
control over financial reporting means that no material weaknesses exist. For this reason
the objective of the audit of internal control over financial reporting is to obtain
reasonable assurance that no material weaknesses exist as of the date specified in
management's assessment.
The existence of one or more material weaknesses will require management and the
auditor to conclude that internal control over financial reporting is not effective.
Such a conclusion, however, will not result in any sanctions or penalties from the SEC,
provided the auditor issues an unqualified opinion on the financial statements, but the
shareholders reactions can lead to have deep negative effects in the stock price of the
company.
2.5 Market reactions after SOX.
Ever since the passage of the Act, the business community has expressed substantial
concerns for its costs of compliance.
An August 2003 survey of executives by CFO Magazine indicated that 70% of the
respondents did not believe the benefits of compliance justify its costs (CFO Magazine,
2003). Moreover, Financial Executives International (FEI) surveyed 224 public firms in
July 2004 about the direct costs of complying with Section 404 of SOX. The survey finds
that the average first-year cost estimate is almost $3 million for roughly 26,000 hours of
internal work and 5,000 hours of external work, plus additional audit fees of $823,200, or
an increase of 53% (Financial Executive International (FEI), 2004. Section 404 costs
survey).
In addition, the Act exposes executives to greater litigation risks and possible penalties.
As a result, CEOs are likely to take less risky actions, consequently changing their
business strategies and potentially reducing the value of their firms (Wallison, September
2005, Wall Street Journal).
For many experts of SOX, the lack of flexibility outlined by the Act could be far more
detrimental to the vast majority of firms than a few scandals. Further, the passage of SOX
17
gives rise to a broader concern that SOX could signal a shift to more rigid federal
regulation and legislation of corporate America. Such a shift would likely reduce the
flexibility of the current governance systems and business environment, causing extensive
changes in the economy (Holmstrom, B. and S. Kaplan, 2003. The state of U.S. Corporate
governance: What’s right and what’s wrong? Journal of Applied Corporate Finance).
A PricewaterhouseCoopers survey of CEOs at the World Economic Forum in 2005 finds
that 59% of the respondents currently view the risk of overregulation as one of the biggest
threats to the growth of their firms (Norris., January 2005, New York Times).
The economic significance of the Sarbanes-Oxley Act has been widely acknowledged and
is considered comparable only to that of the Securities Acts of 1933 and 1934 (Li, H., M.
Pincus, and S. Rego, 2004. Market reaction to events surrounding the Sarbanes-Oxley
Act of 2002. Working paper, University of Iowa).
Thus, it is important to understand how this Act affects businesses and how the market
interprets the information conveyed by the passage of the Act.
This paper extends the event study literature by examining changes in stock prices in
response to announcements that affect the internal control system of the listed firms.
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3. IMPLEMENTATION OF THE RESEARCH
3.1 Selection of the study sample.
The initial population of firms providing internal control deficiencies disclosures is
obtained from compilations of SEC filings reported in “Compliance Week”, a weekly
electronic newsletter published by Boston‟s Financial Media Holdings Group (source:
www.complianceweek.com).
The sample period spans filings made from January 2006 to September 2006. In addition,
I supplement this database with additional hand collected data from SEC filings (source:
www.pcaob.com).
This results in an initial population of 753 firms disclosing at least one internal control
deficiency in the SOX 404 reporting regimes.
For the sample selection process I utilize two criteria:
1. Total revenues during Fiscal Year 2005.
The figure “Total revenues” represents an excellent measure of company dimension.
The aim of the selection is to provide a complete view of market, starting from
relatively small companies, as Hemispherx Biopharma Inc. (1.1 million dollars of
revenues), to truly global players, as General Motors Corporation (192.604 million
dollars of revenues).
2. Type of industry,
One of the sub questions of this thesis is to understand in which way the market
reaction caused by an announcement of a material control weakness is influenced by
the type of industry. In order to answer this question I have decided to examine
companies that operate in the following industries:
Automotive & Transportation;
Construction;
Consumer Products Manufacturers;
19
Consumer Services;
Electronics;
Energy & Utilities;
Financial Services;
Industrial Manufacturing.
Media.
Of the 753 firms, I selected 77 firms that have the necessary characteristics to be included
in the stock value change analysis.
Table 1 reports the sample of companies used in empirical tests and comprises detailed
information concerning the following matters:
Revenues during fiscal year 2005 ;
Stock exchange market (NYSE, Nasdaq and AMEX);
Type of industry;
Effectiveness of disclosure controls and procedures;
Effectiveness of internal control over financial reporting;
Date of announcement;
Type of weaknesses (control environment, inadequate training and staffing, financial
procedures, lease accounting, taxes, cash-flow, revenue recognition, hedges,
information technology, vendor contracts and documentation).
20
Table 1: Companies selected for the research: Detailed Information.
Material Weaknesses In Internal Control Over Financial Reporting - Company List
FY '05 Rev.
Company Exch. Ticker Industry (in millions)
ABM INDUSTRIES INC NYSE ABM Electronics $2.587,8 Not Effective Not Effective 03/28/06 12/31/05 X X X
AES CORP NYSE AES Energy & Utilities $11.086,0 Not Effective Not Effective 04/03/06 12/31/04 X X X X X X
AIRTRAN HOLDINGS INC NYSE AAI Automotive & Transport $1.450,5 Not Effective Not Effective 03/09/06 12/31/05 X
ALLION HEALTHCARE INC Nasdaq ALLI Pharmaceuticals $123,1 Not Effective Not Effective 04/18/06 12/31/05 X
AMERICA SERVICE GROUP INC NASDAQ ASGR Pharmaceuticals $562,7 Not Effective Not Effective 04/03/06 12/31/05 X
BANK OF AMERICA CORP NYSE BAC Financial Services $83.980,0 Not Effective Not Effective 03/16/06 09/30/05 X
BELL INDUSTRIES INC AMEX BI Electronics $130,9 Not Effective Not Effective 04/16/06 12/31/05 X
BIOSCRIP, INC. NASDAQ BIOS Financial Services $1.073,2 Not Effective Not Effective 03/31/06 12/31/05 X X X X X X
BOWNE & CO INC NYSE BNE Financial Services $694,1 Not Effective Not Effective 05/09/06 12/31/05 X X
BRADLEY PHARMACEUTICALS INC NYSE BDY Pharmaceuticals $133,4 Not Effective Not Effective 05/18/06 12/31/05 X X
CACHE INC NASDAQ CACH Consumer Services $266,3 Not Effective Not Effective 03/21/06 12/31/05 X
CAPITAL SENIOR LIVING CORP NYSE CSU Pharmaceuticals $105,2 Not Effective Not Effective 03/31/06 12/31/05 X
CASTLE A M & CO AMEX CAS Industrial Manufacturing $959,0 Not Effective Not Effective 03/31/06 12/31/05
CDI CORP NYSE CDI Financial Services $1.133,6 Not Effective Not Effective 03/16/06 12/31/05 X
CERIDIAN CORP NYSE CEN Financial Services $1.459,0 Not Effective Not Effective 03/16/06 12/31/05 X
CHESAPEAKE CORP NYSE CSK Industrial Manufacturing $1.042,0 Not Effective Not Effective 03/10/06 01/01/06 X
CHICAGO BRIDGE & IRON CO N V NYSE CBI Construction $2.257,5 Not Effective Not Effective 05/31/06 12/31/05 X X
CNA FINANCIAL CORP NYSE CNA Financial Services $9.862,0 Not Effective Not Effective 03/08/06 12/31/05 X X X
CORNING INC NYSE GLW Financial Services $4.579,0 Not Effective Not Effective 05/08/06 12/31/05 X
CROSS A T CO AMEX PRZ Consumer Products Manufacturers $129,1 Not Effective Not Effective 03/28/06 12/31/05 X
CROWN MEDIA HOLDINGS INC NASDAQ CRWN Media $197,4 Not Effective Not Effective 03/28/06 12/31/05 X X
CT COMMUNICATIONS INC NASDAQ CTCI Electronics $171,7 Not Effective Not Effective 03/31/06 12/31/05 X X X
DEVCON INTERNATIONAL CORP Nasdaq DEVC Construction $84,9 Not Effective Not Effective 04/16/06 12/31/05 X
DRESSER-RAND GROUP INC. NYSE DRC Industrial Manufacturing $1.208,2 Not Effective Not Effective 04/04/06 12/31/05 X X X X X
DYNEGY INC NYSE DYN Energy & Utilities $2.313,0 Not Effective Not effective 04/30/06 12/31/05 X
EMS TECHNOLOGIES INC NASDAQ ELMG Electronics $310,0 Not Effective Not Effective 04/02/06 12/31/05 X X X
EVCI CAREER COLLEGES HOLDING CORP Nasdaq EVCI Consumer Services $50,7 Not Effective Not Effective 05/14/06 12/31/05 X X X X X
GENERAL GROWTH PROPERTIES INC NYSE GGP Financial Services $3.073,4 Not Effective Not Effective 03/31/06 12/31/05 X X X
GENERAL MOTORS CORP NYSE GM Automotive & Transport $192.604,0 Not Effective Not Effective 03/28/06 12/31/05 X X X X
H&R BLOCK INC NYSE HRB Consumer Services $4.420,0 Not Effective Not Effective 03/31/06 04/30/05 X
HEMISPHERX BIOPHARMA INC AMEX HEM Pharmaceuticals $1,1 Not Effective Not Effective 06/06/06 12/31/05 X
HIGHWOODS PROPERTIES INC NYSE HIW Financial Services $410,7 Not Effective Not Effective 06/05/06 12/31/05 X
HOLLINGER INTERNATIONAL INC NYSE HLR Media $457,9 Not Effective Not Effective 03/31/06 12/31/05 X X X X X
INPUT OUTPUT INC NYSE IO Electronics $368,7 Not Effective Not Effective 04/03/06 12/31/05
KANSAS CITY SOUTHERN NYSE KSU Automotive & Transport $1.352,0 Not Effective Not Effective 04/06/06 12/31/05 X
KROGER CO NYSE KR Consumer Services $56.434,0 Not Effective Not Effective 04/13/06 01/29/05 X
LANDAMERICA FINANCIAL GROUP INC NYSE LFG Financial Services $3.959,6 Not Effective Not Effective 03/09/06 12/31/05 X
LAUREATE EDUCATION, INC. NASDAQ LAUR Consumer services $875,4 Not Effective Not Effective 03/23/06 12/31/05 X X
LEAP WIRELESS INTERNATIONAL INC NASDAQ LEAP Electronics $914,7 Not Effective Not Effective 03/27/06 12/31/05 X X
LENNOX INTERNATIONAL INC NYSE LII Industrial Manufacturing $3.366,2 Not Effective Not Effective 03/16/06 12/31/05
LHC GROUP, INC NASDAQ LHCG Pharmaceuticals $162,5 Not Effective Not Effective 03/31/06 12/31/05 X
LIGAND PHARMACEUTICALS INC NASDAQ LGND Pharmaceuticals $176,6 Not Effective Not Effective 04/03/06 12/31/05 X X X X X
LINN ENERGY, LLC NASDAQ LINE Energy & Utilities $49,7 Not Effective Not Effective 05/30/06 12/31/05 X X X
MAGELLAN HEALTH SERVICES INC NASDAQ MGLN Pharmaceuticals $1.808,0 Not Effective Not Effective 03/08/06 12/31/05 X
MAX RE CAPITAL LTD NASDAQ MXRE Financial Services $1.175,0 Not Effective Not Effective 06/06/06 12/31/05 X
MEADOW VALLEY CORP NASDAQ MVCO Construction $183,9 Not Effective Not Effective 03/30/06 03/02/06 X X
MODTECH HOLDINGS INC NASDAQ MODT Consumer Products Manufacturers $230,3 Not Effective Not Effective 04/03/06 12/31/05 X X X
MOLSON COORS BREWING CO NYSE TAP Consumer Products Manufacturers $5.506,9 Not Effective Not Effective 03/10/06 12/25/05 X X
MOVIE GALLERY INC NASDAQ MOVI Media $1.987,2 Not Effective Not Effective 03/24/06 01/01/06 X X X
MUELLER INDUSTRIES INC NYSE MLI Industrial Manufacturing $1.729,9 Not Effective Not Effective 03/15/06 12/31/05 X X X
NATURAL HEALTH TRENDS CORP Nasdaq BHIP Consumer Products Manufacturers $194,5 Not Effective Not Effective 05/08/06 12/31/05 X X X X X
NAUTILUS, INC. NYSE NLS Consumer Products Manufacturers $631,3 Not Effective Not Effective 03/16/06 12/31/05 X X
OM GROUP INC NYSE OMG Industrial Manufacturing $2.149,6 Not Effective Not Effective 03/09/06 12/31/05 X
ONEOK INC NYSE OKE Energy & Utilities $12.760,2 Not Effective Not Effective 03/13/06 12/31/05 X X
ORCHID CELLMARK INC Nasdaq ORCH Pharmaceuticals $61,6 Not Effective Not Effective 05/23/06 06/30/05 X X X
OVERSTOCK.COM, INC NASDAQ OSTK Financial Services $803,8 Not Effective Not Effective 03/16/06 12/31/05 X
PACIFIC CMA INC AMEX PAM Automotive & Transport $125,0 Not Effective Not Effective 03/31/06 12/31/05 X X
PAXSON COMMUNICATIONS CORP AMEX ION Media $254,2 Not Effective Not Effective 03/22/06 12/31/05 X
PERFICIENT INC NASDAQ PRFT Financial Services $97,0 Not Effective Not Effective 03/31/06 12/31/05 X X
PETROLEUM DEVELOPMENT CORP NASDAQ PETD Energy & Utilities $343,1 Not Effective Not Effective 05/30/06 12/31/05 X X X X X
POPULAR INC NASDAQ BPOP Financial Services $3.451,1 Not Effective Not Effective 03/15/06 12/31/05 X
RETAIL VENTURES INC NYSE RVI Consumer Services $2.739,6 Not Effective Not Effective 04/10/06 01/29/05 X
ROCK OF AGES CORP Nasdaq ROAC Construction $89,5 Not Effective Not Effective 04/17/06 12/31/05 X
RUSS BERRIE & CO INC NYSE RUS Consumer Products Manufacturers $290,2 Not Effective Not Effective 04/18/06 12/31/05 X
SM&A Nasdaq WINS Financial Services $76,7 Not Effective Not Effective 05/15/06 12/31/05 X X
STERLING CONSTRUCTION CO INC NASDAQ STRL Automotive & Transport $219,4 Not Effective Not Effective 03/29/06 12/31/05 X
STONEMOR PARTNERS LP Nasdaq STON Consumer Services $99,7 Not Effective Not Effective 05/15/06 12/31/05 X X
SUPERIOR INDUSTRIES INTERNATIONAL INC NYSE SUP Automotive & Transport $844,9 Not Effective Not Effective 03/28/06 12/31/05 X X X
TECUMSEH PRODUCTS CO NASDAQ TECUA Industrial Manufacturing $1.847,0 Not Effective Not Effective 03/15/06 12/31/05 X X X
TEREX CORP NYSE TEX Industrial Manufacturing $6.380,4 Not Effective Not Effective 05/16/06 12/31/05 X X X X
TITANIUM METALS CORP NYSE TIE Industrial Manufacturing $749,8 Not Effective Not Effective 03/24/06 12/3/105 X X X
USA MOBILITY, INC Nasdaq USMO Electronics $618,6 Not Effective Not Effective 05/24/06 12/31/05 X X
UTSTARCOM INC NASDAQ UTSI Electronics $2.929,3 Not Effective Not Effective 05/31/06 12/31/05
VALHI INC NYSE VHI Consumer Products Manufacturers $1.529,3 Not Effective Not Effective 03/24/06 09/30/05 X X
WORLD FUEL SERVICES CORP NYSE INT Energy & Utilities $8.733,9 Not Effective Not Effective 03/16/06 12/31/05 X X
ZAPATA CORP NYSE ZAP Consumer Products Manufacturers $109,9 Not Effective Not Effective 04/04/06 12/31/05 X
Average $6.017,5
Source:
(1) NYSE (www.nyse.com)
(2) Compliance Week (www.complianceweek.com)
Other Acct.
(M&A, etc.)
IT, Financial
Systems
Vendor
ContractsDocumentation
Taxes
(Income,
Payroll)
Cash-FlowRevenue
RecognitionHedges
Control
Environment
Personnel:
Inadequate
Training and
Staffing
Financial
Procedures
Lease
Accounting
Disclosure
Controls &
Procedures
Internal Control
Over Financial
Reporting
Date of
Announcement As Of
COMPANY DETAILS (1)
ACCOUNTING ISSUES
ASSESSMENT (2) WEAKNESSES (2)
21
3.2 Research methodology.
To study the stock price value change after the disclosure of material weakness in the
internal control system I apply two different methods: the average variation analysis and
the Gaussian distribution analysis.
3.2.1 Average variation analysis.
The purpose of the average variation analysis is to understand if the stock value change at
the day of the material weakness announcement represents an exceptional data in
comparison with the stock trend of each company.
To achieve this result, I take into consideration the variation of stock price of each
company during a period of six months before and after the date of the announcement
(see Appendix 1).
After the calculation of the daily stock price variation, I apply the arithmetic mean to
obtain the stock price average variation during the selected period.
The mean is the arithmetic average of a set of values, or distribution. Given a set of
samples , the arithmetic mean is:
Where refers to the arithmetic mean, n refers to the sample size and x refers the value
each item.
As second step of this analysis, I compare the stock price performance at the day of the
announcement with the mean value to obtain the variation from the average.
Finally, I consolidate the data to investigate the effect of SOX material weakness on the
company share price (see Table 2).
22
The importance of this procedure can be explained using an example:
Company X at the day of the material weakness announcement has a percentage change
of stock value equal to -0,8%. This figure could lead to a conclusion that the
announcement has a negative effect on the company share price. Nevertheless, the stock
price of the same firm presents an average daily stock price difference of -1,5% during a
set period of time (e.g. six months). This fact implies that the market is not negatively
influenced by the statement of material weakness in the internal control system of
Company X, since in this case the stock price variation from the trend is + 0,7%, so a
positive difference.
Therefore, if the selected sample of companies would present a convincing negative
variation I could conclude that disclosures of a material weakness provoke negative
market reactions.
3.2.2 Gaussian distribution analysis.
Before explaining how the Gaussian distribution is applied to this research, it is essential
to provide specific theoretical information in order to understand the reasons for selecting
this statistical tool.
3.2.2.1 Theoretical framework.
The Gaussian distribution, also called normal distribution, is the most widely used family
of distributions in statistics. It is also called the bell curve because the graph of its
probability density resembles a bell.
Figure 1: The Gaussian Curve.
(Source: State University of New York, http://www.oswego.edu/)
23
Normal distribution arises in many areas of statistics. In particular the sampling
distribution of the mean is approximately normal, even if the distribution of the
population from which the sample is taken is not normal. In addition, the normal
distribution maximizes information entropy among all distributions with known mean and
variance, which makes it the natural choice of underlying distribution for data
summarized in terms of sample mean and variance, as the sample chosen for this study.
The Gaussian distribution can be actually specified by this equation:
So, the main parameters of the Gaussian distribution are the mean μ= , treated in the
previous subchapter, and the standard deviation (denoted with the letter sigma σ), which
is a measure of variability.
Now I am going to analyze the concept of standard deviation, the keystone of the normal
distribution, and the 68-95-99.7 rule, a property of the Gaussian distribution that will be
applied in the empirical research.
The standard deviation.
In statistics, the standard deviation (σ) of a population is a measure of the spread of its
values. It is defined as the square root of the variance (σ2 ). In other words, the standard
deviation is the root mean square deviation of values from their arithmetic mean.
The standard deviation is the most common measure of statistical dispersion, measuring
how widely spread the values in a data set are. If the data points are close to the mean,
then the standard deviation is small. Conversely, if many data points are far from the
mean, then the standard deviation is large.
The standard deviation of a random variable X is defined as:
Where E(X) is the expected value of X.
24
If the random variable X takes on the values x1,...,xN that are real numbers, then its
standard deviation can be computed as follows. First the mean of X , is defined as a
summation:
Where N is the number of samples taken. Next, the standard deviation simplifies to:
The standard deviation measures how far from the mean the data points tend to be.
A large standard deviation indicates that the data points are far from the mean and a small
standard deviation indicates that they are clustered closely around the mean (Barbara
Pacini & Meri Raggi, Statistica per l’analisi operativa dei dati).
68-95-99.7 rule.
The 68-95-99.7 rule states that for a normal distribution, almost all values lie within 3
standard deviations of the mean.
Figure 2: 68-95-99.7 rule.
(Source: State University of New York, http://www.oswego.edu/)
25
About 68% of the values lie within 1 standard deviation of the mean (or between the
mean minus 1 times the standard deviation, and the mean plus 1 times the standard
deviation). In statistical notation, it is represented as μ ± σ.
About 95% of the values lie within 2 standard deviations of the mean (or between the
mean minus 2 times the standard deviation, and the mean plus 2 times the standard
deviation). The statistical notation for it is: μ ± 2σ.
Almost all (actually, 99.7%) of the values lie within 3 standard deviations of the mean (or
between the mean minus 3 times the standard deviation and the mean plus 3 times the
standard deviation). Statisticians use the following notation to represent it: μ ± 3σ
(Barbara Pacini & Meri Raggi, Statistica per l’analisi operativa dei dati).
3.2.2.2 Application of the Gaussian distribution.
To comprehend the effects of announcements of a material control weakness on stock
price, I apply the Gaussian distribution and its rules to the value data of the selected
companies.
First of all, I calculate the average (μ) stock value difference at the day of the disclosure
for the whole sample. For a set of stock value differences, calculating the arithmetic mean
over a given period derives the expected increase/decrease on the stock price.
Secondly, for each individual firm I calculate the exponential difference between the
actual variation (Xi) and the expected stock price trend (μ).
Then I summarize the square differences, and dividing the result by the sample population
I obtain the variance (σ2 ).
Finally, I determine the standard deviation (σ) as the square root of the variance (σ2 ).
The standard deviation state the effect that the announcement of material weakness has on
the overall stock market - the larger the variance the greater the uncertain. The square
variance results in the measurement of global effects associated with material
weaknesses.
26
Afterward this measurement is applied to the 68-95-99.7 rule. This research is focused on
the first assertion of the rule, which states that the 68,25% of the values lie within 1
standard deviation of the mean. This is a significant data for the study, since it leads to
determine the range of stock price deviation that presents the highest probability to appear
after the announcement of a material weakness.
In this way the analysis can provide the most likelihood variation that the stock value will
present after a disclosure of material weakness.
I apply the same approach to the single types of industry and to the company dimension,
to understand if the announcement of material weakness has different impact on company
belonging to different business area or having diverse sizes.
27
4. EMPIRICAL TEST AND RESULTS
4.1 Introduction.
As the most influential regulation in decades, SOX has significant economic impact on
every listed firm. Consequently, I examine the changes of the market index around the
related announcement of material weakness in three steps:
I. The cumulative abnormal stock price variations around the announcement of
material weaknesses are examined to average variation analysis.
II. Stock price range of variation is estimated for the entire sample of companies
applying the Gaussian distribution.
III. Analysis of the effects of material weakness announcement for different types of
industries and company‟s dimension using the same methodology employed in the
step II.
The main axiom of this study is that announcements of material weaknesses can have
negative or no impact in the stock market, but never a positive impact. The reason of this
basic statement is that disclosures of material weaknesses in internal control over
financial reporting express the presence of a serious problem in the control system of the
listed firm, a problem that could lead to a misstatement of the financial reporting.
Subsequently, by definition, the announcement of internal control weaknesses cannot
have positive influence in the stock market (Zhang, Economic Consequences of the
Sarbanes-Oxley Act, 2005).
Other methodological issues related to the data selection, as well as stochastic formulas
and research strategy are discussed in detail in chapter three.
28
4.2 Results of the average variation analysis.
To examine the influence of material weakness reports on the stock value, I determine if
the stock value change at the day of the material weakness announcement represents an
exceptional data in comparison with the stock trend of each company.
4.2.1 Calculation of the company stock trend.
As first step of this research, I take into consideration the date of the disclosure of
material weakness (see Table 1).
Then, from the official NYSE website I attain the information regarding the daily stock
price of each selected company over a period of six months (the three months subsequent
and preceding the date of the announcement of a material weakness).
Consequently, I calculate for each selected firm the daily stock price variation with the
following formula.
Xpy = [P(y) - P(y-1)] / P(y-1) (1)
Where Xpy refers to the stock price variation of the day Y, P(y) refers to the stock value of
the day Y and P(y-1) refers to the stock price of the day Y-1.
For every company comprised in the sample, this formula is applied to each date of the
selected period of six months.
Finally, I calculate the expected stock price variation, applying for each firm the
arithmetical mean of the stock price variation Xpy over the selected period (see Appendix
1).
The expected stock price variation represents the stock market trend of the selected
company, since it indicates the movement of share prices within the space of six months.
29
4.2.3 Calculation of the average variation.
To obtain the actual stock price variation necessary for the calculation of the average
variation, I focused on the date of the disclosure of material weakness (see Table 1).
Then, from the official NYSE website I obtain the stock price of each selected company
at the date of the announcement of a material weakness (source: www.nyse.com). Then,
utilizing the previous formula (1), I calculate for each selected firm the daily actual stock
price variation at the date of the disclosure of material weakness.
Afterwards, the daily actual stock price variation is confronted with the expected share
price variation for every selected firm, obtaining the company‟s stock rate difference.
The company‟s stock rate difference expresses the deviation from the share price trend
that is caused by the announcement of material weaknesses. Extremely negative
difference between actual and expected value, as -4.03% for Allion Healthcare Inc.,
indicates that the announcement of material weakness has a negative impact on investors
and consequently on movement of company‟s share prices. Minimal differences between
actual and expected values, as +0,07% for Laureate Education Inc., suggests that the
movement of company‟s stock prices is not influenced by the disclosures of material
weakness.
Finally, I identify the overall stock rate difference through the calculation of the
arithmetic mean of the companies‟ stock rate differences.
The overall stock rate difference expresses a measure of volatility of the stock price
movement from the expected price variation at the date of the disclosures of material
weaknesses. This figure is particularly interesting, since it indicates if the announcement
of material weaknesses in the internal control has affected the market share value.
In fact, an exceptionally negative result of the aggregation of individual company‟s stock
rate difference, as example -2,00%, would mean that the actual variation of share prices
of companies presenting material weaknesses is on average less than the company share
price trend.
In this example, I could conclude that the announcement of material weaknesses has
globally a negative impact on the stock market.
30
Instead, the overall stock rate difference that I have calculated for the sample of
companies is equal to 0,06% (see Table 2).
The result tells that the discrepancy between the expected price variation and the actual
price movement at the day of the material weakness disclosure is just 0,06%.
Hence, despite announcements of material weaknesses, companies that present these
deficiencies in the internal control over financial reporting follow the price variation
trend.
Thus, the average variation analysis leads us to the conclusion that, although the
announcement of material weakness can have extremely negative effects on movement of
share price for individual companies, as Allion Helthcare Inc., the statement of material
weaknesses has globally little or no impact on the stock market, since the price share
follows the estimated trend.
31
Table 2: Average variation analysis
Company Actual Stock Price Variation (1) Expected Stock Price Variation (2) Stock Rate Difference
ABM INDUSTRIES INC 0,63% -0,11% 0,74%
AES CORP -2,23% 0,14% -2,37%
AIRTRAN HOLDINGS INC -1,68% 0,11% -1,79%ALLION HEALTHCARE INC -4,33% -0,30% -4,03%
AMERICA SERVICE GROUP INC -2,07% 0,03% -2,10%
BANK OF AMERICA CORP 0,78% 0,02% 0,76%
BELL INDUSTRIES INC -0,38% 0,17% -0,55%
BIOSCRIP, INC. 0,28% -0,22% 0,49%
BOWNE & CO INC 0,06% -0,05% 0,11%
BRADLEY PHARMACEUTICALS INC 0,00% 0,08% -0,08%
CACHE INC -2,24% -0,05% -2,18%
CAPITAL SENIOR LIVING CORP 3,80% 0,02% 3,78%
CASTLE A M & CO -0,94% 0,37% -1,31%
CDI CORP 0,22% -0,01% 0,22%
CERIDIAN CORP -0,15% -0,02% -0,13%
CHESAPEAKE CORP 0,23% -0,07% 0,30%
CHICAGO BRIDGE & IRON CO N V -1,00% 0,11% -1,11%
CNA FINANCIAL CORP 0,26% -0,02% 0,29%
CORNING INC -1,27% -0,19% -1,09%
CROSS A T CO 0,00% -0,36% 0,36%
CROWN MEDIA HOLDINGS INC 6,51% -0,54% 7,05%
CT COMMUNICATIONS INC 2,27% 0,50% 1,76%
DEVCON INTERNATIONAL CORP 0,50% -0,37% 0,87%
DRESSER-RAND GROUP INC. -1,62% -0,05% -1,57%
DYNEGY INC -1,01% 0,05% -1,06%
EMS TECHNOLOGIES INC 0,55% 0,08% 0,48%
EVCI CAREER COLLEGES HOLDING CORP 0,00% -1,29% 1,29%
GENERAL GROWTH PROPERTIES INC -1,27% -0,03% -1,25%
GENERAL MOTORS CORP -0,78% 0,32% -1,10%
H&R BLOCK INC -1,90% -0,01% -1,90%
HEMISPHERX BIOPHARMA INC -0,83% -0,19% -0,63%
HIGHWOODS PROPERTIES INC 2,86% 0,13% 2,72%
HOLLINGER INTERNATIONAL INC 0,84% -0,08% 0,93%
INPUT OUTPUT INC 0,93% 0,29% 0,64%
KANSAS CITY SOUTHERN -0,37% 0,07% -0,45%KROGER CO 0,61% 0,13% 0,48%
LANDAMERICA FINANCIAL GROUP INC -2,17% 0,01% -2,18%
LAUREATE EDUCATION, INC. -0,04% -0,11% 0,07%
LEAP WIRELESS INTERNATIONAL INC -0,44% 0,11% -0,55%
LENNOX INTERNATIONAL INC 0,09% -0,13% 0,23%
LHC GROUP, INC 1,20% 0,13% 1,07%
LIGAND PHARMACEUTICALS INC -1,01% -0,20% -0,81%
LINN ENERGY, LLC 0,05% 0,10% -0,05%
MAGELLAN HEALTH SERVICES INC 2,41% 0,33% 2,08%
MAX RE CAPITAL LTD 0,75% -0,03% 0,78%
MEADOW VALLEY CORP 0,56% 0,01% 0,55%
MODTECH HOLDINGS INC 0,11% -0,22% 0,33%
MOLSON COORS BREWING CO -0,01% 0,04% -0,05%
MOVIE GALLERY INC -2,48% 0,38% -2,86%
MUELLER INDUSTRIES INC 1,27% 0,14% 1,14%
NATURAL HEALTH TRENDS CORP 4,86% -0,75% 5,61%
NAUTILUS, INC. -1,83% -0,11% -1,73%
OM GROUP INC -1,24% 0,41% -1,66%
ONEOK INC 0,58% 0,15% 0,43%
ORCHID CELLMARK INC -4,40% -0,76% -3,64%
OVERSTOCK.COM, INC -0,78% -0,40% -0,38%
PACIFIC CMA INC -1,25% -0,03% -1,22%
PAXSON COMMUNICATIONS CORP -1,05% 0,01% -1,06%
PERFICIENT INC -2,93% 0,27% -3,20%
PETROLEUM DEVELOPMENT CORP -0,51% 0,01% -0,52%
POPULAR INC 0,65% -0,11% 0,76%
RETAIL VENTURES INC -2,32% 0,27% -2,59%
ROCK OF AGES CORP 5,45% 0,08% 5,37%
RUSS BERRIE & CO INC 5,40% 0,01% 5,38%
SM&A -2,67% -0,09% -2,58%
STERLING CONSTRUCTION CO INC -3,20% 0,45% -3,65%
STONEMOR PARTNERS LP 5,48% 0,00% 5,48%
SUPERIOR INDUSTRIES INTERNATIONAL INC -0,31% -0,12% -0,19%
TECUMSEH PRODUCTS CO 1,83% -0,09% 1,92%
TEREX CORP 1,38% 0,16% 1,22%
TITANIUM METALS CORP 2,75% 0,63% 2,12%
USA MOBILITY, INC -1,43% -0,14% -1,29%
UTSTARCOM INC 1,27% 0,24% 1,03%
VALHI INC -0,23% 0,23% -0,46%
WORLD FUEL SERVICES CORP 1,10% 0,21% 0,89%
ZAPATA CORP 0,00% 0,14% -0,14%Average 0,06%
OVERALL STOCK RATE DIFFERENCE 0,06%
Note:
(1) Percentage difference between the day before
and the day of the announcement of material
weaknesses.(2) Average percentage change of stock value
regardig a period of six months (three before and
three after the disclosures announcement).
STOCK PRICE AVERAGE VARIATION ANALYSIS
Stock Price Average Variation Analysis
32
4.3 Results of the Gaussian distribution analysis for the entire sample.
To investigate the impact on the stock market index of the auditors‟ declaration of
material weaknesses, I determine the range of share price variation that presents the major
probability to occur after the announcement of material weaknesses.
At the first stage of this analysis, I consider the date of the disclosure of material
weakness (see Table 1).
Then, from the official NYSE website I attain the stock value of each selected firm at the
date of the announcement of a material weakness (source: www.nyse.com). Then,
applying the formula (1) explained in the subchapter 4.2.1, I calculate for each selected
firm the daily actual stock price variation at the date of the disclosure of material
weakness.
After that, I specify an expected stock price model for the market index in order to
examine the abnormal returns of the actual stock market price. This model is different
from the esteem that was applied in the average variation analysis. In fact, the coefficient
μ used in the Gaussian distribution analysis indicates the market stock price variation at
the date of the disclosure.
It is calculated through the arithmetical mean of the daily stock price variation of each
company and it is equal to 0,05% (see Table 3).
The figure is really interesting, since for a set of stock value differences, calculating the
arithmetic mean over a given period derives the expected increase/decrease on the stock
price. So, the price variation esteem suggests that at the day of the statement of material
weaknesses the average effect on the share price is +0,05%.
After this passage, I calculate the standard deviation from the estimated stock price
variation, which is equivalent to 2,1013%.
The standard deviation measures statistical dispersion, determining how widely spread
the values in a data set are. A large standard deviation, as in this case, denotes that the
33
stock price actual variations are far from the estimation μ and that the price volatility is
rather elevated.
This assumption is confirmed by the consequent application of the Gaussian distribution
68-95-99.7 rule.
In fact, I utilized the 68-95-99.7 rule, since if I discovered that the 68,25% of the share
price variations fall, as example, between -2,00% and -1,00%, then I could conclude that
the announcement of material weaknesses has a negative impact on investors and on the
market. This conclusion would be caused by the evidence that the majority of the share
price variation (68,25%) is negative, between -2,00% and -1,00%.
However, this is not the case, since the result of the study states that the 68,25% of stock
price variations fall between -2,0470% and 2,1556% (see Table 3), a wide range of stock
price variation that comprise equally negative and positive values.
Consequently, the analysis performed using the Gaussian distribution over the whole
population suggests that globally the announcement of a material weakness has little or
no impact on the stock price variation.
34
Table 3: Gaussian distribution analysis.
Stock Price Analysis - Gauss Distribution Analysis
Xi μ Xi-μ (Xi-μ)^2
Company Actual Stock Price Variation (1) Expected Stock Price Variation (Average) Delta Square Delta
ABM INDUSTRIES INC 0,63% 0,05% 0,57% 0,0033%
AES CORP -2,23% 0,05% -2,28% 0,0521%
AIRTRAN HOLDINGS INC -1,68% 0,05% -1,73% 0,0301%ALLION HEALTHCARE INC -4,33% 0,05% -4,38% 0,1922%
AMERICA SERVICE GROUP INC -2,07% 0,05% -2,13% 0,0452%
BANK OF AMERICA CORP 0,78% 0,05% 0,72% 0,0052%
BELL INDUSTRIES INC -0,38% 0,05% -0,43% 0,0019%
BIOSCRIP, INC. 0,28% 0,05% 0,22% 0,0005%
BOWNE & CO INC 0,06% 0,05% 0,01% 0,0000%
BRADLEY PHARMACEUTICALS INC 0,00% 0,05% -0,05% 0,0000%
CACHE INC -2,24% 0,05% -2,29% 0,0524%
CAPITAL SENIOR LIVING CORP 3,80% 0,05% 3,75% 0,1403%
CASTLE A M & CO -0,94% 0,05% -0,99% 0,0099%
CDI CORP 0,22% 0,05% 0,16% 0,0003%
CERIDIAN CORP -0,15% 0,05% -0,21% 0,0004%
CHESAPEAKE CORP 0,23% 0,05% 0,17% 0,0003%
CHICAGO BRIDGE & IRON CO N V -1,00% 0,05% -1,06% 0,0112%
CNA FINANCIAL CORP 0,26% 0,05% 0,21% 0,0004%
CORNING INC -1,27% 0,05% -1,33% 0,0177%
CROSS A T CO 0,00% 0,05% -0,05% 0,0000%
CROWN MEDIA HOLDINGS INC 6,51% 0,05% 6,46% 0,4173%
CT COMMUNICATIONS INC 2,27% 0,05% 2,22% 0,0491%
DEVCON INTERNATIONAL CORP 0,50% 0,05% 0,45% 0,0020%
DRESSER-RAND GROUP INC. -1,62% 0,05% -1,67% 0,0280%
DYNEGY INC -1,01% 0,05% -1,06% 0,0112%
EMS TECHNOLOGIES INC 0,55% 0,05% 0,50% 0,0025%
EVCI CAREER COLLEGES HOLDING CORP 0,00% 0,05% -0,05% 0,0000%
GENERAL GROWTH PROPERTIES INC -1,27% 0,05% -1,33% 0,0176%
GENERAL MOTORS CORP -0,78% 0,05% -0,84% 0,0070%
H&R BLOCK INC -1,90% 0,05% -1,96% 0,0383%
HEMISPHERX BIOPHARMA INC -0,83% 0,05% -0,88% 0,0078%
HIGHWOODS PROPERTIES INC 2,86% 0,05% 2,80% 0,0785%
HOLLINGER INTERNATIONAL INC 0,84% 0,05% 0,79% 0,0062%
INPUT OUTPUT INC 0,93% 0,05% 0,87% 0,0076%
KANSAS CITY SOUTHERN -0,37% 0,05% -0,43% 0,0018%KROGER CO 0,61% 0,05% 0,56% 0,0031%
LANDAMERICA FINANCIAL GROUP INC -2,17% 0,05% -2,22% 0,0493%
LAUREATE EDUCATION, INC. -0,04% 0,05% -0,09% 0,0001%
LEAP WIRELESS INTERNATIONAL INC -0,44% 0,05% -0,49% 0,0024%
LENNOX INTERNATIONAL INC 0,09% 0,05% 0,04% 0,0000%
LHC GROUP, INC 1,20% 0,05% 1,15% 0,0132%
LIGAND PHARMACEUTICALS INC -1,01% 0,05% -1,07% 0,0114%
LINN ENERGY, LLC 0,05% 0,05% 0,00% 0,0000%
MAGELLAN HEALTH SERVICES INC 2,41% 0,05% 2,36% 0,0557%
MAX RE CAPITAL LTD 0,75% 0,05% 0,69% 0,0048%
MEADOW VALLEY CORP 0,56% 0,05% 0,51% 0,0026%
MODTECH HOLDINGS INC 0,11% 0,05% 0,06% 0,0000%
MOLSON COORS BREWING CO -0,01% 0,05% -0,07% 0,0000%
MOVIE GALLERY INC -2,48% 0,05% -2,53% 0,0642%
MUELLER INDUSTRIES INC 1,27% 0,05% 1,22% 0,0149%
NATURAL HEALTH TRENDS CORP 4,86% 0,05% 4,81% 0,2313%
NAUTILUS, INC. -1,83% 0,05% -1,89% 0,0356%
OM GROUP INC -1,24% 0,05% -1,30% 0,0168%
ONEOK INC 0,58% 0,05% 0,53% 0,0028%
ORCHID CELLMARK INC -4,40% 0,05% -4,46% 0,1988%
OVERSTOCK.COM, INC -0,78% 0,05% -0,83% 0,0069%
PACIFIC CMA INC -1,25% 0,05% -1,30% 0,0170%
PAXSON COMMUNICATIONS CORP -1,05% 0,05% -1,11% 0,0123%
PERFICIENT INC -2,93% 0,05% -2,98% 0,0888%
PETROLEUM DEVELOPMENT CORP -0,51% 0,05% -0,56% 0,0032%
POPULAR INC 0,65% 0,05% 0,59% 0,0035%
RETAIL VENTURES INC -2,32% 0,05% -2,38% 0,0564%
ROCK OF AGES CORP 5,45% 0,05% 5,39% 0,2908%
RUSS BERRIE & CO INC 5,40% 0,05% 5,34% 0,2854%
SM&A -2,67% 0,05% -2,73% 0,0744%
STERLING CONSTRUCTION CO INC -3,20% 0,05% -3,25% 0,1058%
STONEMOR PARTNERS LP 5,48% 0,05% 5,43% 0,2943%
SUPERIOR INDUSTRIES INTERNATIONAL INC -0,31% 0,05% -0,37% 0,0013%
TECUMSEH PRODUCTS CO 1,83% 0,05% 1,77% 0,0314%
TEREX CORP 1,38% 0,05% 1,32% 0,0175%
TITANIUM METALS CORP 2,75% 0,05% 2,69% 0,0725%
USA MOBILITY, INC -1,43% 0,05% -1,49% 0,0221%
UTSTARCOM INC 1,27% 0,05% 1,22% 0,0148%
VALHI INC -0,23% 0,05% -0,29% 0,0008%
WORLD FUEL SERVICES CORP 1,10% 0,05% 1,04% 0,0109%
ZAPATA CORP 0,00% 0,05% -0,05% 0,0000%
Sum [(Xi-μ)^2] 3,3558%VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0442%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 2,1013%
GAUSS CURVE ANALISIS (2) μ-σ -2,0470%
μ+σ 2,1556%
STOCK PRICE ANALYSIS - GAUSS DISTRIBUTION ANALYSIS
35
4.4 Results of the Gaussian distribution analysis applied to the type of industry.
The purpose of this subchapter is to analyze the relation between announcement of
material control weakness over financial reporting, stock price variation and type of
industry.
In order to perform this study I have divided the sample companies in nine industries, and
I have applied for each sector the Gaussian distribution analysis.
4.4.1 Automotive and transport.
The application of the Gaussian distribution analysis over a sample of six companies
belonging to the automotive and transport industry shows two interesting results (see
Table 4):
1. An expected share price variation is equal to -1,26641%. An expected share price
variation of -1,26641% means that at the day of the announcement the average
share value change in companies belonging to this industry is highly negative.
2. The 68,25% of share price variation falls between -2,25355% and -0,27928%.
This data indicates that at the day of the disclosure of material weaknesses the
majority of share price variations of companies belonging to this category are
negative.
These results lead to the conclusion that the announcement of material weaknesses over
financial reporting has a negative effect on stock price variation of automotive and
transportation firms.
36
Table 4: Gaussian distribution analysis. Industry: Automotive & Transport.
Stock Price Analysis: Automotive & Transport- Gauss Distrbution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
AIRTRAN HOLDINGS INC -1,68% -1,26641% -0,41% 0,0017%
GENERAL MOTORS CORP -0,78% -1,26641% 0,48% 0,0023%KANSAS CITY SOUTHERN -0,37% -1,26641% 0,89% 0,0080%
PACIFIC CMA INC -1,25% -1,26641% 0,02% 0,0000%
STERLING CONSTRUCTION CO INC -3,20% -1,26641% -1,93% 0,0373%
SUPERIOR INDUSTRIES INTERNATIONAL INC -0,31% -1,26641% 0,96% 0,0091%
Sum [(Xi-μ)^2] 0,0585%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0097%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 0,9871%
GAUSS CURVE ANALISIS μ-σ -2,25355%
μ+σ -0,27928%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.2 Construction.
In the construction industry the Gaussian distribution analysis is applied on a sample of
four companies.
As we can seen in Table 5, the expected share price variation is +1,38%, which means
that at the day of the announcement the average share value change in companies
belonging to this industry is positive.
Then I have calculated that the 68,25% of share price variation falls between -1,0542%
and +3,8084%. Hence, these data suggests that the major part of share value changes of
companies belonging to this category is positive at the date of material weakness
disclosure.
Since the axiom of this study states that in any case announcements of material
weaknesses can have just negative or no impact in the stock market, these results imply
that the announcement of material weaknesses over financial reporting has no impact on
stock price variation of construction firms.
37
Table 5: Gaussian distribution analysis. Industry: Construction.
Stock Price Analysis: Construction- Gauss Distrbution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
CHICAGO BRIDGE & IRON CO N V -1,00% 1,38% -2,38% 0,0567%
DEVCON INTERNATIONAL CORP 0,50% 1,38% -0,87% 0,0076%
MEADOW VALLEY CORP 0,56% 1,38% -0,81% 0,0066%
ROCK OF AGES CORP 5,45% 1,38% 4,07% 0,1656%
Sum [(Xi-μ)^2] 0,2365%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0591%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 2,4318%
GAUSS CURVE ANALISIS μ-σ -1,0542%
μ+σ 3,8094%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.3 Consumer product manufacturers.
The application of the Gaussian distribution analysis over a sample of eight companies
belonging to the consumer product manufacturer industry (see Table 6) provides the same
results that were seen in the construction business.
As matter of fact, the expected share price variation equals to +1,04%, showing a positive
value change at the day of the disclosures of material weaknesses.
At the same time, the 68,25% of share price variation is between -1,4031% and
+3,4761%, meaning that majority of share price variations of companies belonging to
this category are positive at the date of the announcement.
Finally, these facts suggest that the announcement of material weaknesses over financial
reporting has no impact on stock price variation of consumer product manufactures
firms.
38
Table 6: Gaussian distribution analysis. Industry: Consumer product manufactures.
Stock Price Analysis: Consumer Product Manufactures- Gauss Distrbution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
CROSS A T CO 0,00% 1,04% -1,04% 0,0107%
MODTECH HOLDINGS INC 0,11% 1,04% -0,92% 0,0085%
MOLSON COORS BREWING CO -0,01% 1,04% -1,05% 0,0110%
NATURAL HEALTH TRENDS CORP 4,86% 1,04% 3,83% 0,1464%
NAUTILUS, INC. -1,83% 1,04% -2,87% 0,0824%
RUSS BERRIE & CO INC 5,40% 1,04% 4,36% 0,1901%
VALHI INC -0,23% 1,04% -1,27% 0,0161%
ZAPATA CORP 0,00% 1,04% -1,04% 0,0107%
Sum [(Xi-μ)^2] 0,4761%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0595%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 2,4396%
GAUSS CURVE ANALISIS μ-σ -1,4031%
μ+σ 3,4761%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.4 Consumer services.
The analysis of the consumer services business through the Gaussian distribution shows
equilibrium between positive and negative price variation.
Actually, the expected share price variation is equal to -0,06%, denoting that the
announcement of material weaknesses does not affect the share value change in consumer
service companies.
Moreover, the 68,25% of share price variation falls between -2,5758% and +2,4603%,
indicating that the majority of share price variations is equally positive and negative.
These outcomes lead to the conclusion that the announcement of a material weakness has
little or no impact on the stock price variation of consumer services firms.
39
Table 7: Gaussian distribution analysis. Industry: Consumer services.
Stock Price Analysis: Consumer Services- Gauss Distrbution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
CACHE INC -2,24% -0,06% -2,18% 0,0474%
EVCI CAREER COLLEGES HOLDING CORP 0,00% -0,06% 0,06% 0,0000%
H&R BLOCK INC -1,90% -0,06% -1,85% 0,0341%
KROGER CO 0,61% -0,06% 0,67% 0,0045%
LAUREATE EDUCATION, INC. -0,04% -0,06% 0,02% 0,0000%
RETAIL VENTURES INC -2,32% -0,06% -2,26% 0,0512%
STONEMOR PARTNERS LP 5,48% -0,06% 5,54% 0,3066%
Sum [(Xi-μ)^2] 0,4438%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0634%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 2,5180%
GAUSS CURVE ANALISIS μ-σ -2,5758%
μ+σ 2,4603%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.5 Electronics.
At the date of the announcement of material weaknesses, the movement of share prices in
the electronics industries (see Table 8) presents the same patter that was found in the
construction and consumer manufacturing business.
Also in this case the expected share price variation is positive (+0,42%), as well as the
majority of share value changes, where the application of the 68 rule shows a range of
data that falls between -0,6518% and +1,5012%.
Consequently, these figures indicate that the announcement of material weaknesses over
financial reporting has no impact on stock price variation of electronics firms.
40
Table 8: Gaussian distribution analysis. Industry: Electronics.
Stock Price Analysis: Electronics- Gauss Distribution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
ABM INDUSTRIES INC 0,63% 0,42% 0,20% 0,0004%
BELL INDUSTRIES INC -0,38% 0,42% -0,80% 0,0065%
CT COMMUNICATIONS INC 2,27% 0,42% 1,84% 0,0340%
EMS TECHNOLOGIES INC 0,55% 0,42% 0,13% 0,0002%
INPUT OUTPUT INC 0,93% 0,42% 0,50% 0,0025%
LEAP WIRELESS INTERNATIONAL INC -0,44% 0,42% -0,86% 0,0075%
USA MOBILITY, INC -1,43% 0,42% -1,86% 0,0345%
UTSTARCOM INC 1,27% 0,42% 0,85% 0,0071%
Sum [(Xi-μ)^2] 0,0927%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0116%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 1,0765%
GAUSS CURVE ANALISIS μ-σ -0,6518%
μ+σ 1,5012%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.6 Energy and utilities.
In the energy and utilities industry, as in the automotive business, the application
Gaussian distribution analysis (see Table 9) shows a direct negative correlation between
the announcement of material weaknesses and share price variation.
In fact, the expected share price variation equals to -0,34%, stating that at the date of the
disclosure of material weaknesses the average share value change is negative.
Furthermore, the 68,25% of share price variation is between -1,4238% and +0,7621%,
which means that at the day of the announcement the majority of share price variations is
negative in this category.
Subsequently, these facts demonstrate that the announcement of material weaknesses over
financial reporting has a negative impact on stock price variation of energy and
utilities firms.
41
Table 9: Gaussian distribution analysis. Industry: Energy and Utilities.
Stock Price Analysis: Energy & Utilites - Gauss Distribution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
AES CORP -2,23% -0,34% -1,89% 0,0358%
DYNEGY INC -1,01% -0,34% -0,67% 0,0045%LINN ENERGY, LLC 0,05% -0,34% 0,39% 0,0015%
ONEOK INC 0,58% -0,34% 0,92% 0,0084%
PETROLEUM DEVELOPMENT CORP -0,51% -0,34% -0,17% 0,0003%
WORLD FUEL SERVICES CORP 1,10% -0,34% 1,43% 0,0205%
Sum [(Xi-μ)^2] 0,0710%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0118%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 1,0879%
GAUSS CURVE ANALISIS μ-σ -1,4238%
μ+σ 0,7521%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.7 Financial services.
The application of the Gaussian distribution analysis over a sample of fifteen companies
belonging to the financial services industry (see Table 10) suggests a weak correlation
between disclosure of material weaknesses and share price variation.
As matter of fact, the expected share price variation of -0,36% already shows slightly
negative esteem of share value change at the day of the announcement.
Moreover, a small majority of share price variations of financial service companies is
negative, falling between -1,8265% and +1,1070%.
Consequently, these data denote that the announcement of material weaknesses over
financial reporting has a slightly negative effect on stock price variation of financial
services firms.
42
Table 10: Gaussian distribution analysis. Industry: Financial services.
Stock Price Analysis: Financial Services - Gauss Distribution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
BANK OF AMERICA CORP 0,78% -0,36% 1,14% 0,0129%
BIOSCRIP, INC. 0,28% -0,36% 0,64% 0,0041%
BOWNE & CO INC 0,06% -0,36% 0,42% 0,0018%
CDI CORP 0,22% -0,36% 0,58% 0,0033%
CERIDIAN CORP -0,15% -0,36% 0,21% 0,0004%
CNA FINANCIAL CORP 0,26% -0,36% 0,62% 0,0039%
CORNING INC -1,27% -0,36% -0,91% 0,0084%
GENERAL GROWTH PROPERTIES INC -1,27% -0,36% -0,91% 0,0083%
HIGHWOODS PROPERTIES INC 2,86% -0,36% 3,22% 0,1034%
LANDAMERICA FINANCIAL GROUP INC -2,17% -0,36% -1,81% 0,0326%
MAX RE CAPITAL LTD 0,75% -0,36% 1,11% 0,0123%
OVERSTOCK.COM, INC -0,78% -0,36% -0,42% 0,0018%
PERFICIENT INC -2,93% -0,36% -2,57% 0,0659%
POPULAR INC 0,65% -0,36% 1,01% 0,0101%
SM&A -2,67% -0,36% -2,31% 0,0535%
Sum [(Xi-μ)^2] 0,3227%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0215%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 1,4667%
GAUSS CURVE ANALISIS μ-σ -1,8265%
μ+σ 1,1070%
Standard deviation
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.8 Industrial manufacturing.
The movement of share prices in the industrial manufacturing industry (see Table 11)
shows the same results that were obtained through the application of the Gaussian
distribution analysis to the construction, consumer manufacturing and electronic
businesses.
The expected share price variation is equal to +0,42%, indicating a positive average share
value change in companies belonging to this industry.
Furthermore, the 68,25% of share price variation is between -0,9965% and +1,8283%,
which means that at the day of the disclosure of material weaknesses the majority of share
price variations is positive.
Consequently, these figures suggest that the announcement of material weaknesses over
financial reporting has no impact on stock price variation of industrial manufactirung
firms.
43
Table 11: Gaussian distribution analysis. Industry: Industrial manufacturing.
Stock Price Analysis: Industrial Manufacturing - Gauss Distribution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
CASTLE A M & CO -0,94% 0,42% -1,36% 0,0184%
CHESAPEAKE CORP 0,23% 0,42% -0,19% 0,0004%
DRESSER-RAND GROUP INC. -1,62% 0,42% -2,03% 0,0414%
LENNOX INTERNATIONAL INC 0,09% 0,42% -0,32% 0,0010%
MUELLER INDUSTRIES INC 1,27% 0,42% 0,86% 0,0074%
OM GROUP INC -1,24% 0,42% -1,66% 0,0275%
TECUMSEH PRODUCTS CO 1,83% 0,42% 1,41% 0,0199%
TEREX CORP 1,38% 0,42% 0,96% 0,0092%
TITANIUM METALS CORP 2,75% 0,42% 2,33% 0,0544%
Sum [(Xi-μ)^2] 0,1795%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0199%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 1,4124%
GAUSS CURVE ANALISIS μ-σ -0,9965%
μ+σ 1,8283%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.9 Media.
The application of the Gaussian distribution analysis over a sample of four companies
belonging to the media industry (see Table 12) denotes a direct negative correlation
between the announcement of material weaknesses and share price variation.
As matter of fact, the expected share price variation equals to -1,65%., stating that at the
date of the disclosure of material weaknesses the average share value change is negative.
This result is strengthen by the fact that the majority of share price variations, 68,25%, of
media companies falls between -3,3976% and +0,1069%
These results lead to the conclusion that the announcement of material weaknesses over
financial reporting has a negative effect on stock price variation of media firms.
44
Table 12: Gaussian distribution analysis. Industry: Media.
Stock Price Analysis: Media - Gauss Distribution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
CROWN MEDIA HOLDINGS INC -3,89% -1,65% -2,25% 0,0505%
HOLLINGER INTERNATIONAL INC 0,84% -1,65% 2,49% 0,0619%
MOVIE GALLERY INC -2,48% -1,65% -0,83% 0,0070%
PAXSON COMMUNICATIONS CORP -1,05% -1,65% 0,59% 0,0035%
Sum [(Xi-μ)^2] 0,1228%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0307%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 1,7523%
GAUSS CURVE ANALISIS μ-σ -3,3976%
μ+σ 0,1069%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.4.10 Pharmaceutical.
The analysis of share price variation in the pharmaceutical industry (see Table 13), like in
the financial services industry, suggests a weak correlation between disclosure of material
weaknesses and share price variation.
In fact, the expected share price variation of -0,36% indicates slightly negative esteem of
share value change at the day of the announcement.
Additionally, a small majority of share price variations of financial service companies is
negative, falling between -3,2229% and +2,0611%.
These results lead to the conclusion that the announcement of material weaknesses over
financial reporting has a slightly negative effect on stock price variation of
pharmaceutical firms.
45
Table 13: Gaussian distribution analysis. Industry: Pharmaceuticals.
Stock Price Analysis: Pharmaceuticals - Gauss Distribution
Xi μ Xi-μ (Xi-μ)^2
Company Stock Value Difference Average Difference Delta Delta^2
ALLION HEALTHCARE INC -4,33% -0,58% -3,75% 0,1406%
AMERICA SERVICE GROUP INC -2,07% -0,58% -1,49% 0,0222%
BRADLEY PHARMACEUTICALS INC 0,00% -0,58% 0,58% 0,0034%
CAPITAL SENIOR LIVING CORP 3,80% -0,58% 4,38% 0,1919%
HEMISPHERX BIOPHARMA INC -0,83% -0,58% -0,25% 0,0006%
LHC GROUP, INC 1,20% -0,58% 1,78% 0,0318%
LIGAND PHARMACEUTICALS INC -1,01% -0,58% -0,43% 0,0019%
MAGELLAN HEALTH SERVICES INC 2,41% -0,58% 3,00% 0,0897%
ORCHID CELLMARK INC -4,40% -0,58% -3,82% 0,1462%
Sum [(Xi-μ)^2] 0,6282%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0698%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 2,6420%
GAUSS CURVE ANALISIS μ-σ -3,2229%
μ+σ 2,0611%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.5 Results of the Gaussian distribution analysis applied to the company size.
The aim of this subchapter is to examine the relation between announcement of material
control weakness over financial reporting, stock price variation and company size.
To complete this research I have grouped the companies, which were chosen as study
sample, in the following three categories based on the revenues achieved during the fiscal
year 2005:
1. Small size companies: defined as firms presenting figures of total revenues under
1 billion of dollars;
2. Medium size companies: defined as firms presenting figures of total revenues
between 1 and 4 billions of dollars;
3. Large size companies: defined as firms presenting figures of total revenues up to 4
billions of dollars
The Gaussian distribution analysis is applied for each category.
46
4.5.1 Small size companies.
The application of the Gaussian distribution analysis over a sample of forty-four small
size companies shows two results (see Table 14):
1. An expected share price variation is equal to +0,28%, which means, as we have
previously seen, that the announcement of material weaknesses does not affect the
share value change in companies belonging to this group.
2. The 68,25% of share price variation falls between -2,2898% and +2,8398%,
indicating that at the day of the disclosure of material weaknesses the majority of
share price variations are equally positive and negative.
These results lead to the conclusion that the announcement of a material weakness has
little or no impact on the stock price variation of small size firms.
4.5.2 Medium size companies.
The movement of share price variation in medium size companies (see Table 15),
indicates a weak correlation between disclosure of material weaknesses and share price
variation.
As matter of fact, the expected share price variation is -0,26%, denoting a slightly
negative share value change at the day of the announcement.
Moreover, I notice that a small majority of share value changes is negative through the
application of the 68 rule that shows a range of data between -1,3518% and +0,8363%..
These facts suggest that the announcement of material weaknesses over financial
reporting has a slightly negative effect on stock price variation of medium size firms.
47
Table 14: Gaussian distribution analysis. Category: Small size companies.
Stock Price Analysis: Small Companies - Gauss Distribution
FY '05 Rev. Xi μ Xi-μ (Xi-μ)^2
Company (in millions) Stock Value Difference Average Difference Delta Delta^2
HEMISPHERX BIOPHARMA INC $1,1 -0,83% 0,28% -1,10% 0,0121%
LINN ENERGY, LLC $49,7 0,05% 0,28% -0,22% 0,0005%
EVCI CAREER COLLEGES HOLDING CORP $50,7 0,00% 0,28% -0,28% 0,0008%ORCHID CELLMARK INC $61,6 -4,40% 0,28% -4,68% 0,2189%
SM&A $76,7 -2,67% 0,28% -2,95% 0,0869%
DEVCON INTERNATIONAL CORP $84,9 0,50% 0,28% 0,23% 0,0005%
ROCK OF AGES CORP $89,5 5,45% 0,28% 5,17% 0,2675%
PERFICIENT INC $97,0 -2,93% 0,28% -3,20% 0,1025%
STONEMOR PARTNERS LP $99,7 5,48% 0,28% 5,20% 0,2709%
CAPITAL SENIOR LIVING CORP $105,2 3,80% 0,28% 3,52% 0,1242%
ZAPATA CORP $109,9 0,00% 0,28% -0,28% 0,0008%
ALLION HEALTHCARE INC $123,1 -4,33% 0,28% -4,61% 0,2121%
PACIFIC CMA INC $125,0 -1,25% 0,28% -1,53% 0,0233%
CROSS A T CO $129,1 0,00% 0,28% -0,28% 0,0008%
BELL INDUSTRIES INC $130,9 -0,38% 0,28% -0,65% 0,0043%
BRADLEY PHARMACEUTICALS INC $133,4 0,00% 0,28% -0,28% 0,0008%
LHC GROUP, INC $162,5 1,20% 0,28% 0,93% 0,0086%
CT COMMUNICATIONS INC $171,7 2,27% 0,28% 1,99% 0,0398%
LIGAND PHARMACEUTICALS INC $176,6 -1,01% 0,28% -1,29% 0,0166%
MEADOW VALLEY CORP $183,9 0,56% 0,28% 0,29% 0,0008%
NATURAL HEALTH TRENDS CORP $194,5 4,86% 0,28% 4,59% 0,2105%
CROWN MEDIA HOLDINGS INC $197,4 6,51% 0,28% 6,24% 0,3893%
STERLING CONSTRUCTION CO INC $219,4 -3,20% 0,28% -3,47% 0,1207%
MODTECH HOLDINGS INC $230,3 0,11% 0,28% -0,16% 0,0003%
PAXSON COMMUNICATIONS CORP $254,2 -1,05% 0,28% -1,33% 0,0176%
CACHE INC $266,3 -2,24% 0,28% -2,51% 0,0630%
RUSS BERRIE & CO INC $290,2 5,40% 0,28% 5,12% 0,2623%
EMS TECHNOLOGIES INC $310,0 0,55% 0,28% 0,28% 0,0008%
PETROLEUM DEVELOPMENT CORP $343,1 -0,51% 0,28% -0,79% 0,0062%
INPUT OUTPUT INC $368,7 0,93% 0,28% 0,65% 0,0042%
HIGHWOODS PROPERTIES INC $410,7 2,86% 0,28% 2,58% 0,0666%
HOLLINGER INTERNATIONAL INC $457,9 0,84% 0,28% 0,57% 0,0032%
AMERICA SERVICE GROUP INC $562,7 -2,07% 0,28% -2,35% 0,0551%
USA MOBILITY, INC $618,6 -1,43% 0,28% -1,71% 0,0292%
NAUTILUS, INC. $631,3 -1,83% 0,28% -2,11% 0,0445%BOWNE & CO INC $694,1 0,06% 0,28% -0,21% 0,0005%
TITANIUM METALS CORP $749,8 2,75% 0,28% 2,47% 0,0611%
OVERSTOCK.COM, INC $803,8 -0,78% 0,28% -1,05% 0,0111%
SUPERIOR INDUSTRIES INTERNATIONAL INC $844,9 -0,31% 0,28% -0,59% 0,0034%
LAUREATE EDUCATION, INC. $875,4 -0,04% 0,28% -0,31% 0,0010%
LEAP WIRELESS INTERNATIONAL INC $914,7 -0,44% 0,28% -0,71% 0,0051%
CASTLE A M & CO $959,0 -0,94% 0,28% -1,22% 0,0148%
Sum [(Xi-μ)^2] 2,7629%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0658%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 2,5648%
GAUSS CURVE ANALISIS μ-σ -2,2898%
μ+σ 2,8398%
STOCK PRICE ANALYSIS - GAUSS CURVE
48
Table 15: Gaussian distribution analysis. Category: Medium size companies.
Stock Price Analysis: Medium Companies - Gauss Distribution
FY '05 Rev. Xi μ Xi-μ (Xi-μ)^2
Company (in millions) Stock Value Difference Average Difference Delta Delta^2
CHESAPEAKE CORP $1.042,0 0,23% -0,26% 0,48% 0,0023%
BIOSCRIP, INC. $1.073,2 0,28% -0,26% 0,54% 0,0029%
CDI CORP $1.133,6 0,22% -0,26% 0,47% 0,0022%
MAX RE CAPITAL LTD $1.175,0 0,75% -0,26% 1,01% 0,0101%
DRESSER-RAND GROUP INC. $1.208,2 -1,62% -0,26% -1,36% 0,0185%
KANSAS CITY SOUTHERN $1.352,0 -0,37% -0,26% -0,12% 0,0001%
AIRTRAN HOLDINGS INC $1.450,5 -1,68% -0,26% -1,42% 0,0202%
CERIDIAN CORP $1.459,0 -0,15% -0,26% 0,10% 0,0001%
VALHI INC $1.529,3 -0,23% -0,26% 0,02% 0,0000%
MUELLER INDUSTRIES INC $1.729,9 1,27% -0,26% 1,53% 0,0235%
MAGELLAN HEALTH SERVICES INC $1.808,0 2,41% -0,26% 2,67% 0,0714%
TECUMSEH PRODUCTS CO $1.847,0 1,83% -0,26% 2,08% 0,0434%
MOVIE GALLERY INC $1.987,2 -2,48% -0,26% -2,22% 0,0494%
OM GROUP INC $2.149,6 -1,24% -0,26% -0,99% 0,0097%
CHICAGO BRIDGE & IRON CO N V $2.257,5 -1,00% -0,26% -0,75% 0,0056%
DYNEGY INC $2.313,0 -1,01% -0,26% -0,75% 0,0056%
ABM INDUSTRIES INC $2.587,8 0,63% -0,26% 0,89% 0,0079%
RETAIL VENTURES INC $2.739,6 -2,32% -0,26% -2,06% 0,0426%
UTSTARCOM INC $2.929,3 1,27% -0,26% 1,53% 0,0233%
GENERAL GROWTH PROPERTIES INC $3.073,4 -1,27% -0,26% -1,01% 0,0103%
LENNOX INTERNATIONAL INC $3.366,2 0,09% -0,26% 0,35% 0,0012%
POPULAR INC $3.451,1 0,65% -0,26% 0,90% 0,0082%
LANDAMERICA FINANCIAL GROUP INC $3.959,6 -2,17% -0,26% -1,91% 0,0364%
Sum [(Xi-μ)^2] 0,3950%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0120%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 1,0941%
GAUSS CURVE ANALISIS μ-σ -1,3518%
μ+σ 0,8363%
STOCK PRICE ANALYSIS - GAUSS CURVE
4.5.3 Large size companies.
The Gaussian distribution analysis applied in large size companies (see Table 16)
provides results that are similar to the ones that were obtained in medium size firms.
Also in this case the expected share price variation is slightly negative (-0,14%) and the
small majority of stock price variations is negative, since the 68,25% of stock value
change falls between -1,3079% and +1,0355%. egative.
Consequently, these data indicates that the announcement of material weaknesses over
financial reporting has a slightly negative effect on stock price variation of large size
firms.
49
Table 16: Gaussian distribution analysis. Category: Large size companies.
Stock Price Analysis: Large Companies - Gauss Distribution
FY '05 Rev. Xi μ Xi-μ (Xi-μ)^2
Company (in millions) Stock Value Difference Average Difference Delta Delta^2
H&R BLOCK INC $4.420,0 -1,90% -0,14% -1,77% 0,0312%
CORNING INC $4.579,0 -1,27% -0,14% -1,14% 0,0130%
MOLSON COORS BREWING CO $5.506,9 -0,01% -0,14% 0,12% 0,0001%
TEREX CORP $6.380,4 1,38% -0,14% 1,51% 0,0229%
WORLD FUEL SERVICES CORP $8.733,9 1,10% -0,14% 1,23% 0,0152%
CNA FINANCIAL CORP $9.862,0 0,26% -0,14% 0,40% 0,0016%
AES CORP $11.086,0 -2,23% -0,14% -2,09% 0,0437%
ONEOK INC $12.760,2 0,58% -0,14% 0,72% 0,0051%
KROGER CO $56.434,0 0,61% -0,14% 0,75% 0,0056%
BANK OF AMERICA CORP $83.980,0 0,78% -0,14% 0,91% 0,0083%
GENERAL MOTORS CORP $192.604,0 -0,78% -0,14% -0,65% 0,0042%
Sum [(Xi-μ)^2] 0,1510%
VARIANCE ( σ^2 ) σ^2=Sum [(Xi-μ)^2] / N 0,0137%
STANDARD DEVIATION (σ) σ= Sqr[Sum [(Xi-μ)^2] / N] 1,1717%
GAUSS CURVE ANALISIS μ-σ -1,3079%
μ+σ 1,0355%
STOCK PRICE ANALYSIS - GAUSS CURVE
50
5. CONCLUSIONS
One of the fundamental limitations of event studies in the stock exchange market is that
the measured stock price performance could also capture other information released at the
same calendar date (Leftwich, 1981).
This problem particularly stands out in this paper‟s setting. The market abnormal returns
likely incorporate investors‟ reactions to news releases about other legislative activities,
accounting scandals, and economic statistics.
This paper investigates the effects of the Sarbanes Oxley Act in the stock exchange
market, through the examination of market reactions to the disclosures of a material
weakness during the evaluation of company internal control system.
I have found out that the cumulative abnormal return around the announcement of
material control weakness is not relevant.
Both the average variation study and the Gaussian distribution analysis underline that
variation of the share price at the date of the disclosure follows the expected value models
established for each of the two research methods.
But why such serious information, expressing the possibility of a material misstatement
of the financial reporting, does not influence the stock market?
According to Solomon, normally the knowledge about the possible material weaknesses
in the internal control system of one company is already known by the market and by
investors prior to the final disclosures of the auditors. This is mainly caused by the fact
that interim audit reports are released during the year and they contain data about internal
control difficulties or potential problems (Solomon, June 25, 2006, Wall Street Journal).
51
For this reason, there is a really high likelihood that at the date of the official disclosure
regarding material weaknesses in the internal control system, the company‟s stock value
already reflects the uncertainty of the internal control over financial reporting.
Probably this is why the final result of this thesis shows no influence by the
announcement of the material weaknesses in the stock value market.
The same consideration can be applied in the relation between announcements of material
control weaknesses over financial reporting, stock price variation and company size. In
fact the study of the three different size categories illustrates that the effects on auditors‟
disclosures of material control weaknesses are largely insignificant.
A different observation must be highlighted concerning the reaction of the stock exchange
market in relation to the type of industry.
Despite the fact that in six industries the research suggests little or no influence by the
announcement of material weaknesses in the stock price variation, the study demonstrates
also a direct negative correlation between the disclosures of material control weaknesses
and stock market value in three categories: automotive and transport, energy and utilities,
media.
This research could be continued in future by producing further tests over new audit
opinions and using different statistical tools. Furthermore, the results of this final
dissertation could be utilized to extend the investigation about the relation between
different types of industries and market reactions to the disclosures of material
weaknesses.
52
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events:
54
Burns, J. and M. Schroeder, 2002. SEC Proposes Rules to Tighten Companies‟ Financial
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56
APPENDICES
Appendix 1: Share price analysis per each selected company over a period of six months.
Preliminary work: Share price analysis per each selected company over a period of six months
Company Exch. Ticker Share price analisys over a period of six months
ABM INDUSTRIES INC NYSE ABM
AES CORP NYSE AES
AIRTRAN HOLDINGS INC NYSE AAI
ALLION HEALTHCARE INC Nasdaq ALLI
AMERICA SERVICE GROUP INC NASDAQ ASGR
BANK OF AMERICA CORP NYSE BAC
BELL INDUSTRIES INC AMEX BI
BIOSCRIP, INC. NASDAQ BIOS
BOWNE & CO INC NYSE BNE
BRADLEY PHARMACEUTICALS INC NYSE BDY
CACHE INC NASDAQ CACH
CAPITAL SENIOR LIVING CORP NYSE CSU
CASTLE A M & CO AMEX CAS
CDI CORP NYSE CDI
CERIDIAN CORP NYSE CEN
CHESAPEAKE CORP NYSE CSK
CHICAGO BRIDGE & IRON CO N V NYSE CBI
CNA FINANCIAL CORP NYSE CNA
CORNING INC NYSE GLW
Source of stock price:
NYSE (www.nyse.com)
Source of the list of companies:
Compliance Week (www.complianceweek.com)
ABM.xls
AES.xls
AAI.xls
ALLI.xls
ASGR.xls
BAC.xls
BI.xls
BIOS.xls
BNE.xls
BDY.xls
CACH.xls
CSU.xls
CAS.xls
CDI.xls
CEN.xls
CSK.xls
CBI.xls
CNA.xls
GLW.xls
57
Preliminary work: Share price analysis per each selected company over a period of six months
Company Exch. Ticker Share price analisys over a period of six months
CROSS A T CO AMEX PRZ
CROWN MEDIA HOLDINGS INC NASDAQ CRWN
CT COMMUNICATIONS INC NASDAQ CTCI
DEVCON INTERNATIONAL CORP Nasdaq DEVC
DRESSER-RAND GROUP INC. NYSE DRC
DYNEGY INC NYSE DYN
EMS TECHNOLOGIES INC NASDAQ ELMG
EVCI CAREER COLLEGES HOLDING CORP Nasdaq EVCI
GENERAL GROWTH PROPERTIES INC NYSE GGP
GENERAL MOTORS CORP NYSE GM
H&R BLOCK INC NYSE HRB
HEMISPHERX BIOPHARMA INC AMEX HEM
HIGHWOODS PROPERTIES INC NYSE HIW
HOLLINGER INTERNATIONAL INC NYSE HLR
INPUT OUTPUT INC NYSE IO
KANSAS CITY SOUTHERN NYSE KSU
KROGER CO NYSE KR
LANDAMERICA FINANCIAL GROUP INC NYSE LFG
LAUREATE EDUCATION, INC. NASDAQ LAUR
Source of stock price:
NYSE (www.nyse.com)
Source of the list of companies:
Compliance Week (www.complianceweek.com)
ABM.xlsAES.xlsAAI.xlsALLI.xlsASGR.xlsBAC.xlsBI.xlsBIOS.xlsBNE.xlsBDY.xlsCACH.xlsCSU.xlsCAS.xlsCDI.xlsCEN.xlsCSK.xlsCBI.xlsCNA.xlsGLW.xlsPRZ.xls
CRWN.xls
CTCI.xls
DEVC.xls
DRC.xls
DYN.xls
ELMG.xls
EVCI.xls
GGP.xls
GM.xls
HRB.xls
HEM.xls
HIW.xls
HLR.xls
IO.xls
KSU.xls
KR.xls
LFG.xls
LAUR.xls
58
Preliminary work: Share price analysis per each selected company over a period of six months
Company Exch. Ticker Share price analisys over a period of six months
LEAP WIRELESS INTERNATIONAL INC NASDAQ LEAP
LENNOX INTERNATIONAL INC NYSE LII
LHC GROUP, INC NASDAQ LHCG
LIGAND PHARMACEUTICALS INC NASDAQ LGND
LINN ENERGY, LLC NASDAQ LINE
MAGELLAN HEALTH SERVICES INC NASDAQ MGLN
MAX RE CAPITAL LTD NASDAQ MXRE
MEADOW VALLEY CORP NASDAQ MVCO
MODTECH HOLDINGS INC NASDAQ MODT
MOLSON COORS BREWING CO NYSE TAP
MOVIE GALLERY INC NASDAQ MOVI
MUELLER INDUSTRIES INC NYSE MLI
NATURAL HEALTH TRENDS CORP Nasdaq BHIP
NAUTILUS, INC. NYSE NLS
OM GROUP INC NYSE OMG
ONEOK INC NYSE OKE
ORCHID CELLMARK INC Nasdaq ORCH
OVERSTOCK.COM, INC NASDAQ OSTK
PACIFIC CMA INC AMEX PAM
Source of stock price:
NYSE (www.nyse.com)
Source of the list of companies:
Compliance Week (www.complianceweek.com)
ABM.xlsAES.xlsAAI.xlsALLI.xlsASGR.xlsBAC.xlsBI.xlsBIOS.xlsBNE.xlsBDY.xlsCACH.xlsCSU.xlsCAS.xlsCDI.xlsCEN.xlsCSK.xlsCBI.xlsCNA.xlsGLW.xlsPRZ.xlsCRWN.xlsCTCI.xlsDEVC.xlsDRC.xlsDYN.xlsELMG.xlsEVCI.xlsGGP.xlsGM.xlsHRB.xlsHEM.xlsHIW.xlsHLR.xlsIO.xlsKSU.xlsKR.xlsLFG.xlsLAUR.xlsLEAP.xls
LII.xls
LHCG.xls
LGND.xls
LINE.xls
MGLN.xls
MXRE.xls
MVCO.xls
MODT.xls
TAP.xls
MOVI.xls
MLI.xls
BHIP.xls
NLS.xls
OMG.xls
OKE.xls
ORCH.xls
OSTK.xls
PAM.xls
59
Preliminary work: Share price analysis per each selected company over a period of six months
Company Exch. Ticker Share price analisys over a period of six months
PAXSON COMMUNICATIONS CORP AMEX ION
PERFICIENT INC NASDAQ PRFT
PETROLEUM DEVELOPMENT CORP NASDAQ PETD
POPULAR INC NASDAQ BPOP
RETAIL VENTURES INC NYSE RVI
ROCK OF AGES CORP Nasdaq ROAC
RUSS BERRIE & CO INC NYSE RUS
SM&A Nasdaq WINS
STERLING CONSTRUCTION CO INC NASDAQ STRL
STONEMOR PARTNERS LP Nasdaq STON
SUPERIOR INDUSTRIES INTERNATIONAL INC NYSE SUP
TECUMSEH PRODUCTS CO NASDAQ TECUA
TEREX CORP NYSE TEX
TITANIUM METALS CORP NYSE TIE
USA MOBILITY, INC Nasdaq USMO
UTSTARCOM INC NASDAQ UTSI
VALHI INC NYSE VHI
WORLD FUEL SERVICES CORP NYSE INT
ZAPATA CORP NYSE ZAP
Source of stock price:
NYSE (www.nyse.com)
Source of the list of companies:
Compliance Week (www.complianceweek.com)
ABM.xlsAES.xlsAAI.xlsALLI.xlsASGR.xlsBAC.xlsBI.xlsBIOS.xlsBNE.xlsBDY.xlsCACH.xlsCSU.xlsCAS.xlsCDI.xlsCEN.xlsCSK.xlsCBI.xlsCNA.xlsGLW.xlsPRZ.xlsCRWN.xlsCTCI.xlsDEVC.xlsDRC.xlsDYN.xlsELMG.xlsEVCI.xlsGGP.xlsGM.xlsHRB.xlsHEM.xlsHIW.xlsHLR.xlsIO.xlsKSU.xlsKR.xlsLFG.xlsLAUR.xlsLEAP.xlsLII.xlsLHCG.xlsLGND.xlsLINE.xlsMGLN.xlsMXRE.xlsMVCO.xlsMODT.xlsTAP.xlsMOVI.xlsMLI.xlsBHIP.xlsNLS.xlsOMG.xlsOKE.xlsORCH.xlsOSTK.xlsPAM.xlsION.xls
PRFT.xls
PETD.xls
BPOP.xls
RVI.xls
ROAC.xls
RUS.xls
WINS.xls
STRL.xls
STON.xls
SUP.xls
TECUA.xls
TEX.xls
TIE.xls
USMO.xls
UTSI.xls
VHI.xls
INT.xls
ZAP.xls