EFFECTS OF MATERIAL WEAKNESS ON STOCK EXCHANGE MARKET

The impact of Sarbanes Oxley Act in companies share price

Ronnie Damonte

Month Year
School of Business Administration

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

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:

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.

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 managements 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

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. Oxleys reform bill, which was introduced in the House on February 13, was considered a business-friendly reform proposal 6

(Schroeder, February 12, 2002, Wall Street Journal). Meanwhile, Democratic Senators reportedly drafted bills that went beyond Oxleys 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.

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 notfor-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.

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 corporations 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 committees 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. 9

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 corporations 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 firms lawyers to report evidence of material breaches of securities laws or of fiduciary duty to the firms chief legal officer and to its CEO. If they do not respond with sufficient 10

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 SarbanesOxley 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

11

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 companys 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 firms 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 90s there were some instances where it appeared that stock market analysts had overstated the value of some corporations in order to 12

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-Oxleys 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;

13

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 corporations 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 corporations reporting lines (KPMG LLP, 2004. Sarbanes-Oxley Section 404: An overview of the PCAOBs 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 companys internal control system; Evaluating the effectiveness of the companys internal control system using suitable control criteria;

14

Supporting

the

evaluation

with

sufficient

evidence,

including

adequate

documentation; Presenting a written assessment of the effectiveness of the companys 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 auditors 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).

15

As explained in the previous paragraph, the companys auditor is required to attest managements assessment and also report its own conclusion regarding the effectiveness of the companys 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 16

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: Whats right and whats 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.

17

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 Bostons 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; 18

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).

19

Table 1: Companies selected for the research: Detailed Information.

Material Weaknesses In Internal Control Over Financial Reporting - Company List

COMPANY DETAILS (1)

ASSESSMENT (2)

WEAKNESSES (2) ACCOUNTING ISSUES

FY '05 Rev. Company ABM INDUSTRIES INC AES CORP AIRTRAN HOLDINGS INC ALLION HEALTHCARE INC AMERICA SERVICE GROUP INC BANK OF AMERICA CORP BELL INDUSTRIES INC BIOSCRIP, INC. BOWNE & CO INC BRADLEY PHARMACEUTICALS INC CACHE INC CAPITAL SENIOR LIVING CORP CASTLE A M & CO CDI CORP CERIDIAN CORP CHESAPEAKE CORP CHICAGO BRIDGE & IRON CO N V CNA FINANCIAL CORP CORNING INC CROSS A T CO CROWN MEDIA HOLDINGS INC CT COMMUNICATIONS INC DEVCON INTERNATIONAL CORP DRESSER-RAND GROUP INC. DYNEGY INC EMS TECHNOLOGIES INC EVCI CAREER COLLEGES HOLDING CORP GENERAL GROWTH PROPERTIES INC GENERAL MOTORS CORP H&R BLOCK INC HEMISPHERX BIOPHARMA INC HIGHWOODS PROPERTIES INC HOLLINGER INTERNATIONAL INC INPUT OUTPUT INC KANSAS CITY SOUTHERN KROGER CO LANDAMERICA FINANCIAL GROUP INC LAUREATE EDUCATION, INC. LEAP WIRELESS INTERNATIONAL INC LENNOX INTERNATIONAL INC LHC GROUP, INC LIGAND PHARMACEUTICALS INC LINN ENERGY, LLC MAGELLAN HEALTH SERVICES INC MAX RE CAPITAL LTD MEADOW VALLEY CORP MODTECH HOLDINGS INC MOLSON COORS BREWING CO MOVIE GALLERY INC MUELLER INDUSTRIES INC NATURAL HEALTH TRENDS CORP NAUTILUS, INC. OM GROUP INC ONEOK INC ORCHID CELLMARK INC OVERSTOCK.COM, INC PACIFIC CMA INC PAXSON COMMUNICATIONS CORP PERFICIENT INC PETROLEUM DEVELOPMENT CORP POPULAR INC RETAIL VENTURES INC ROCK OF AGES CORP RUSS BERRIE & CO INC SM&A STERLING CONSTRUCTION CO INC STONEMOR PARTNERS LP SUPERIOR INDUSTRIES INTERNATIONAL INC TECUMSEH PRODUCTS CO TEREX CORP TITANIUM METALS CORP USA MOBILITY, INC UTSTARCOM INC VALHI INC WORLD FUEL SERVICES CORP ZAPATA CORP Average Exch. NYSE NYSE NYSE Nasdaq NASDAQ NYSE AMEX NASDAQ NYSE NYSE NASDAQ NYSE AMEX NYSE NYSE NYSE NYSE NYSE NYSE AMEX NASDAQ NASDAQ Nasdaq NYSE NYSE NASDAQ Nasdaq NYSE NYSE NYSE AMEX NYSE NYSE NYSE NYSE NYSE NYSE NASDAQ NASDAQ NYSE NASDAQ NASDAQ NASDAQ NASDAQ NASDAQ NASDAQ NASDAQ NYSE NASDAQ NYSE Nasdaq NYSE NYSE NYSE Nasdaq NASDAQ AMEX AMEX NASDAQ NASDAQ NASDAQ NYSE Nasdaq NYSE Nasdaq NASDAQ Nasdaq NYSE NASDAQ NYSE NYSE Nasdaq NASDAQ NYSE NYSE NYSE Ticker ABM AES AAI ALLI ASGR BAC BI BIOS BNE BDY CACH CSU CAS CDI CEN CSK CBI CNA GLW PRZ CRWN CTCI DEVC DRC DYN ELMG EVCI GGP GM HRB HEM HIW HLR IO KSU KR LFG LAUR LEAP LII LHCG LGND LINE MGLN MXRE MVCO MODT TAP MOVI MLI BHIP NLS OMG OKE ORCH OSTK PAM ION PRFT PETD BPOP RVI ROAC RUS WINS STRL STON SUP TECUA TEX TIE USMO UTSI VHI INT ZAP Industry Electronics Energy & Utilities Automotive & Transport Pharmaceuticals Pharmaceuticals Financial Services Electronics Financial Services Financial Services Pharmaceuticals Consumer Services Pharmaceuticals Industrial Manufacturing Financial Services Financial Services Industrial Manufacturing Construction Financial Services Financial Services Consumer Products Manufacturers Media Electronics Construction Industrial Manufacturing Energy & Utilities Electronics Consumer Services Financial Services Automotive & Transport Consumer Services Pharmaceuticals Financial Services Media Electronics Automotive & Transport Consumer Services Financial Services Consumer services Electronics Industrial Manufacturing Pharmaceuticals Pharmaceuticals Energy & Utilities Pharmaceuticals Financial Services Construction Consumer Products Manufacturers Consumer Products Manufacturers Media Industrial Manufacturing Consumer Products Manufacturers Consumer Products Manufacturers Industrial Manufacturing Energy & Utilities Pharmaceuticals Financial Services Automotive & Transport Media Financial Services Energy & Utilities Financial Services Consumer Services Construction Consumer Products Manufacturers Financial Services Automotive & Transport Consumer Services Automotive & Transport Industrial Manufacturing Industrial Manufacturing Industrial Manufacturing Electronics Electronics Consumer Products Manufacturers Energy & Utilities Consumer Products Manufacturers (in millions) $2.587,8 $11.086,0 $1.450,5 $123,1 $562,7 $83.980,0 $130,9 $1.073,2 $694,1 $133,4 $266,3 $105,2 $959,0 $1.133,6 $1.459,0 $1.042,0 $2.257,5 $9.862,0 $4.579,0 $129,1 $197,4 $171,7 $84,9 $1.208,2 $2.313,0 $310,0 $50,7 $3.073,4 $192.604,0 $4.420,0 $1,1 $410,7 $457,9 $368,7 $1.352,0 $56.434,0 $3.959,6 $875,4 $914,7 $3.366,2 $162,5 $176,6 $49,7 $1.808,0 $1.175,0 $183,9 $230,3 $5.506,9 $1.987,2 $1.729,9 $194,5 $631,3 $2.149,6 $12.760,2 $61,6 $803,8 $125,0 $254,2 $97,0 $343,1 $3.451,1 $2.739,6 $89,5 $290,2 $76,7 $219,4 $99,7 $844,9 $1.847,0 $6.380,4 $749,8 $618,6 $2.929,3 $1.529,3 $8.733,9 $109,9 $6.017,5

Disclosure Controls & Procedures Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective

Internal Control Over Financial Reporting Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective Not Effective

Date of As Of Announcement 03/28/06 04/03/06 03/09/06 04/18/06 04/03/06 03/16/06 04/16/06 03/31/06 05/09/06 05/18/06 03/21/06 03/31/06 03/31/06 03/16/06 03/16/06 03/10/06 05/31/06 03/08/06 05/08/06 03/28/06 03/28/06 03/31/06 04/16/06 04/04/06 04/30/06 04/02/06 05/14/06 03/31/06 03/28/06 03/31/06 06/06/06 06/05/06 03/31/06 04/03/06 04/06/06 04/13/06 03/09/06 03/23/06 03/27/06 03/16/06 03/31/06 04/03/06 05/30/06 03/08/06 06/06/06 03/30/06 04/03/06 03/10/06 03/24/06 03/15/06 05/08/06 03/16/06 03/09/06 03/13/06 05/23/06 03/16/06 03/31/06 03/22/06 03/31/06 05/30/06 03/15/06 04/10/06 04/17/06 04/18/06 05/15/06 03/29/06 05/15/06 03/28/06 03/15/06 05/16/06 03/24/06 05/24/06 05/31/06 03/24/06 03/16/06 04/04/06 12/31/05 12/31/04 12/31/05 12/31/05 12/31/05 09/30/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 01/01/06 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 04/30/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 01/29/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 03/02/06 12/31/05 12/25/05 01/01/06 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 06/30/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 01/29/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/31/05 12/3/105 12/31/05 12/31/05 09/30/05 12/31/05 12/31/05

Personnel: Taxes Control Inadequate Financial Lease Revenue (Income, Cash-Flow Hedges Environment Training and Procedures Accounting Recognition Payroll) Staffing X X X X X X

Other Acct. IT, Financial Vendor (M&A, etc.) Systems Contracts X X X X

Documentation X X

X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X

X X X

X X X

X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X X

(1) (2)

Source: NYSE (www.nyse.com) Compliance Week (www.complianceweek.com)

20

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).

21

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/)

22

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 = , treated in the previous subchapter, and the standard deviation (denoted with the letter sigma ), 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 () of a population is a measure of the spread of its values. It is defined as the square root of the variance (2 ). 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. 23

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 summation: of X , is defined as a

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 lanalisi 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/)

24

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 .

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: 2.

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: 3 (Barbara Pacini & Meri Raggi, Statistica per lanalisi 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 () 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 ().

Then I summarize the square differences, and dividing the result by the sample population I obtain the variance (2 ). Finally, I determine the standard deviation () as the square root of the variance (2 ).

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. 25

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.

26

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 companys 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.

27

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.

28

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 companys stock rate difference. The companys 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 companys share prices. Minimal differences between actual and expected values, as +0,07% for Laureate Education Inc., suggests that the movement of companys 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 companys 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. 29

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.

30

Table 2: Average variation analysis

Stock Price Average Variation Analysis

STOCK PRICE AVERAGE VARIATION ANALYSIS

Company ABM INDUSTRIES INC AES CORP AIRTRAN HOLDINGS INC ALLION HEALTHCARE INC AMERICA SERVICE GROUP INC BANK OF AMERICA CORP BELL INDUSTRIES INC BIOSCRIP, INC. BOWNE & CO INC BRADLEY PHARMACEUTICALS INC CACHE INC CAPITAL SENIOR LIVING CORP CASTLE A M & CO CDI CORP CERIDIAN CORP CHESAPEAKE CORP CHICAGO BRIDGE & IRON CO N V CNA FINANCIAL CORP CORNING INC CROSS A T CO CROWN MEDIA HOLDINGS INC CT COMMUNICATIONS INC DEVCON INTERNATIONAL CORP DRESSER-RAND GROUP INC. DYNEGY INC EMS TECHNOLOGIES INC EVCI CAREER COLLEGES HOLDING CORP GENERAL GROWTH PROPERTIES INC GENERAL MOTORS CORP H&R BLOCK INC HEMISPHERX BIOPHARMA INC HIGHWOODS PROPERTIES INC HOLLINGER INTERNATIONAL INC INPUT OUTPUT INC KANSAS CITY SOUTHERN KROGER CO LANDAMERICA FINANCIAL GROUP INC LAUREATE EDUCATION, INC. LEAP WIRELESS INTERNATIONAL INC LENNOX INTERNATIONAL INC LHC GROUP, INC LIGAND PHARMACEUTICALS INC LINN ENERGY, LLC MAGELLAN HEALTH SERVICES INC MAX RE CAPITAL LTD MEADOW VALLEY CORP MODTECH HOLDINGS INC MOLSON COORS BREWING CO MOVIE GALLERY INC MUELLER INDUSTRIES INC NATURAL HEALTH TRENDS CORP NAUTILUS, INC. OM GROUP INC ONEOK INC ORCHID CELLMARK INC OVERSTOCK.COM, INC PACIFIC CMA INC PAXSON COMMUNICATIONS CORP PERFICIENT INC PETROLEUM DEVELOPMENT CORP POPULAR INC RETAIL VENTURES INC ROCK OF AGES CORP RUSS BERRIE & CO INC SM&A STERLING CONSTRUCTION CO INC STONEMOR PARTNERS LP SUPERIOR INDUSTRIES INTERNATIONAL INC TECUMSEH PRODUCTS CO TEREX CORP TITANIUM METALS CORP USA MOBILITY, INC UTSTARCOM INC VALHI INC WORLD FUEL SERVICES CORP ZAPATA CORP Average

Actual Stock Price Variation (1)

Expected Stock Price Variation (2)

Stock Rate Difference

0,63% -2,23% -1,68% -4,33% -2,07% 0,78% -0,38% 0,28% 0,06% 0,00% -2,24% 3,80% -0,94% 0,22% -0,15% 0,23% -1,00% 0,26% -1,27% 0,00% 6,51% 2,27% 0,50% -1,62% -1,01% 0,55% 0,00% -1,27% -0,78% -1,90% -0,83% 2,86% 0,84% 0,93% -0,37% 0,61% -2,17% -0,04% -0,44% 0,09% 1,20% -1,01% 0,05% 2,41% 0,75% 0,56% 0,11% -0,01% -2,48% 1,27% 4,86% -1,83% -1,24% 0,58% -4,40% -0,78% -1,25% -1,05% -2,93% -0,51% 0,65% -2,32% 5,45% 5,40% -2,67% -3,20% 5,48% -0,31% 1,83% 1,38% 2,75% -1,43% 1,27% -0,23% 1,10% 0,00%

-0,11% 0,14% 0,11% -0,30% 0,03% 0,02% 0,17% -0,22% -0,05% 0,08% -0,05% 0,02% 0,37% -0,01% -0,02% -0,07% 0,11% -0,02% -0,19% -0,36% -0,54% 0,50% -0,37% -0,05% 0,05% 0,08% -1,29% -0,03% 0,32% -0,01% -0,19% 0,13% -0,08% 0,29% 0,07% 0,13% 0,01% -0,11% 0,11% -0,13% 0,13% -0,20% 0,10% 0,33% -0,03% 0,01% -0,22% 0,04% 0,38% 0,14% -0,75% -0,11% 0,41% 0,15% -0,76% -0,40% -0,03% 0,01% 0,27% 0,01% -0,11% 0,27% 0,08% 0,01% -0,09% 0,45% 0,00% -0,12% -0,09% 0,16% 0,63% -0,14% 0,24% 0,23% 0,21% 0,14%

0,74% -2,37% -1,79% -4,03% -2,10% 0,76% -0,55% 0,49% 0,11% -0,08% -2,18% 3,78% -1,31% 0,22% -0,13% 0,30% -1,11% 0,29% -1,09% 0,36% 7,05% 1,76% 0,87% -1,57% -1,06% 0,48% 1,29% -1,25% -1,10% -1,90% -0,63% 2,72% 0,93% 0,64% -0,45% 0,48% -2,18% 0,07% -0,55% 0,23% 1,07% -0,81% -0,05% 2,08% 0,78% 0,55% 0,33% -0,05% -2,86% 1,14% 5,61% -1,73% -1,66% 0,43% -3,64% -0,38% -1,22% -1,06% -3,20% -0,52% 0,76% -2,59% 5,37% 5,38% -2,58% -3,65% 5,48% -0,19% 1,92% 1,22% 2,12% -1,29% 1,03% -0,46% 0,89% -0,14%
0,06%

OVERALL STOCK RATE DIFFERENCE 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).

0,06%

31

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 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

32

stock price actual variations are far from the estimation 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.

33

Table 3: Gaussian distribution analysis.

Stock Price Analysis - Gauss Distribution Analysis

STOCK PRICE ANALYSIS - GAUSS DISTRIBUTION ANALYSIS

Xi Company ABM INDUSTRIES INC AES CORP AIRTRAN HOLDINGS INC ALLION HEALTHCARE INC AMERICA SERVICE GROUP INC BANK OF AMERICA CORP BELL INDUSTRIES INC BIOSCRIP, INC. BOWNE & CO INC BRADLEY PHARMACEUTICALS INC CACHE INC CAPITAL SENIOR LIVING CORP CASTLE A M & CO CDI CORP CERIDIAN CORP CHESAPEAKE CORP CHICAGO BRIDGE & IRON CO N V CNA FINANCIAL CORP CORNING INC CROSS A T CO CROWN MEDIA HOLDINGS INC CT COMMUNICATIONS INC DEVCON INTERNATIONAL CORP DRESSER-RAND GROUP INC. DYNEGY INC EMS TECHNOLOGIES INC EVCI CAREER COLLEGES HOLDING CORP GENERAL GROWTH PROPERTIES INC GENERAL MOTORS CORP H&R BLOCK INC HEMISPHERX BIOPHARMA INC HIGHWOODS PROPERTIES INC HOLLINGER INTERNATIONAL INC INPUT OUTPUT INC KANSAS CITY SOUTHERN KROGER CO LANDAMERICA FINANCIAL GROUP INC LAUREATE EDUCATION, INC. LEAP WIRELESS INTERNATIONAL INC LENNOX INTERNATIONAL INC LHC GROUP, INC LIGAND PHARMACEUTICALS INC LINN ENERGY, LLC MAGELLAN HEALTH SERVICES INC MAX RE CAPITAL LTD MEADOW VALLEY CORP MODTECH HOLDINGS INC MOLSON COORS BREWING CO MOVIE GALLERY INC MUELLER INDUSTRIES INC NATURAL HEALTH TRENDS CORP NAUTILUS, INC. OM GROUP INC ONEOK INC ORCHID CELLMARK INC OVERSTOCK.COM, INC PACIFIC CMA INC PAXSON COMMUNICATIONS CORP PERFICIENT INC PETROLEUM DEVELOPMENT CORP POPULAR INC RETAIL VENTURES INC ROCK OF AGES CORP RUSS BERRIE & CO INC SM&A STERLING CONSTRUCTION CO INC STONEMOR PARTNERS LP SUPERIOR INDUSTRIES INTERNATIONAL INC TECUMSEH PRODUCTS CO TEREX CORP TITANIUM METALS CORP USA MOBILITY, INC UTSTARCOM INC VALHI INC WORLD FUEL SERVICES CORP ZAPATA CORP Actual Stock Price Variation (1)

Expected Stock Price Variation (Average)

Xi- Delta

(Xi-)^2 Square Delta

0,63% -2,23% -1,68% -4,33% -2,07% 0,78% -0,38% 0,28% 0,06% 0,00% -2,24% 3,80% -0,94% 0,22% -0,15% 0,23% -1,00% 0,26% -1,27% 0,00% 6,51% 2,27% 0,50% -1,62% -1,01% 0,55% 0,00% -1,27% -0,78% -1,90% -0,83% 2,86% 0,84% 0,93% -0,37% 0,61% -2,17% -0,04% -0,44% 0,09% 1,20% -1,01% 0,05% 2,41% 0,75% 0,56% 0,11% -0,01% -2,48% 1,27% 4,86% -1,83% -1,24% 0,58% -4,40% -0,78% -1,25% -1,05% -2,93% -0,51% 0,65% -2,32% 5,45% 5,40% -2,67% -3,20% 5,48% -0,31% 1,83% 1,38% 2,75% -1,43% 1,27% -0,23% 1,10% 0,00%
VARIANCE ( ^2

0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05% 0,05%

0,57% -2,28% -1,73% -4,38% -2,13% 0,72% -0,43% 0,22% 0,01% -0,05% -2,29% 3,75% -0,99% 0,16% -0,21% 0,17% -1,06% 0,21% -1,33% -0,05% 6,46% 2,22% 0,45% -1,67% -1,06% 0,50% -0,05% -1,33% -0,84% -1,96% -0,88% 2,80% 0,79% 0,87% -0,43% 0,56% -2,22% -0,09% -0,49% 0,04% 1,15% -1,07% 0,00% 2,36% 0,69% 0,51% 0,06% -0,07% -2,53% 1,22% 4,81% -1,89% -1,30% 0,53% -4,46% -0,83% -1,30% -1,11% -2,98% -0,56% 0,59% -2,38% 5,39% 5,34% -2,73% -3,25% 5,43% -0,37% 1,77% 1,32% 2,69% -1,49% 1,22% -0,29% 1,04% -0,05%

0,0033% 0,0521% 0,0301% 0,1922% 0,0452% 0,0052% 0,0019% 0,0005% 0,0000% 0,0000% 0,0524% 0,1403% 0,0099% 0,0003% 0,0004% 0,0003% 0,0112% 0,0004% 0,0177% 0,0000% 0,4173% 0,0491% 0,0020% 0,0280% 0,0112% 0,0025% 0,0000% 0,0176% 0,0070% 0,0383% 0,0078% 0,0785% 0,0062% 0,0076% 0,0018% 0,0031% 0,0493% 0,0001% 0,0024% 0,0000% 0,0132% 0,0114% 0,0000% 0,0557% 0,0048% 0,0026% 0,0000% 0,0000% 0,0642% 0,0149% 0,2313% 0,0356% 0,0168% 0,0028% 0,1988% 0,0069% 0,0170% 0,0123% 0,0888% 0,0032% 0,0035% 0,0564% 0,2908% 0,2854% 0,0744% 0,1058% 0,2943% 0,0013% 0,0314% 0,0175% 0,0725% 0,0221% 0,0148% 0,0008% 0,0109% 0,0000%
3,3558% 0,0442% 2,1013% -2,0470% 2,1556%

Sum [(Xi-)^2] ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

STANDARD DEVIATION () GAUSS CURVE ANALISIS

(2)

34

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.

35

Table 4: Gaussian distribution analysis. Industry: Automotive & Transport.

Stock Price Analysis: Automotive & Transport- Gauss Distrbution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company AIRTRAN HOLDINGS INC GENERAL MOTORS CORP KANSAS CITY SOUTHERN PACIFIC CMA INC STERLING CONSTRUCTION CO INC SUPERIOR INDUSTRIES INTERNATIONAL INC Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-1,68% -0,78% -0,37% -1,25% -3,20% -0,31%

-1,26641% -1,26641% -1,26641% -1,26641% -1,26641% -1,26641%

-0,41% 0,48% 0,89% 0,02% -1,93% 0,96%

0,0017% 0,0023% 0,0080% 0,0000% 0,0373% 0,0091%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N]

0,0585% 0,0097% 0,9871%

GAUSS CURVE ANALISIS

- +

-2,25355% -0,27928%

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.

36

Table 5: Gaussian distribution analysis. Industry: Construction.

Stock Price Analysis: Construction- Gauss Distrbution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company CHICAGO BRIDGE & IRON CO N V DEVCON INTERNATIONAL CORP MEADOW VALLEY CORP ROCK OF AGES CORP Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-1,00% 0,50% 0,56% 5,45%

1,38% 1,38% 1,38% 1,38%

-2,38% -0,87% -0,81% 4,07%

0,0567% 0,0076% 0,0066% 0,1656%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,2365% 0,0591% 2,4318% -1,0542% 3,8094%

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.

37

Table 6: Gaussian distribution analysis. Industry: Consumer product manufactures.

Stock Price Analysis: Consumer Product Manufactures- Gauss Distrbution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company CROSS A T CO MODTECH HOLDINGS INC MOLSON COORS BREWING CO NATURAL HEALTH TRENDS CORP NAUTILUS, INC. RUSS BERRIE & CO INC VALHI INC ZAPATA CORP Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

0,00% 0,11% -0,01% 4,86% -1,83% 5,40% -0,23% 0,00%

1,04% 1,04% 1,04% 1,04% 1,04% 1,04% 1,04% 1,04%

-1,04% -0,92% -1,05% 3,83% -2,87% 4,36% -1,27% -1,04%

0,0107% 0,0085% 0,0110% 0,1464% 0,0824% 0,1901% 0,0161% 0,0107%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,4761% 0,0595% 2,4396% -1,4031% 3,4761%

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.

38

Table 7: Gaussian distribution analysis. Industry: Consumer services.

Stock Price Analysis: Consumer Services- Gauss Distrbution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company CACHE INC EVCI CAREER COLLEGES HOLDING CORP H&R BLOCK INC KROGER CO LAUREATE EDUCATION, INC. RETAIL VENTURES INC STONEMOR PARTNERS LP Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-2,24% 0,00% -1,90% 0,61% -0,04% -2,32% 5,48%

-0,06% -0,06% -0,06% -0,06% -0,06% -0,06% -0,06%

-2,18% 0,06% -1,85% 0,67% 0,02% -2,26% 5,54%

0,0474% 0,0000% 0,0341% 0,0045% 0,0000% 0,0512% 0,3066%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,4438% 0,0634% 2,5180% -2,5758% 2,4603%

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.

39

Table 8: Gaussian distribution analysis. Industry: Electronics.

Stock Price Analysis: Electronics- Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company ABM INDUSTRIES INC BELL INDUSTRIES INC CT COMMUNICATIONS INC EMS TECHNOLOGIES INC INPUT OUTPUT INC LEAP WIRELESS INTERNATIONAL INC USA MOBILITY, INC UTSTARCOM INC Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

0,63% -0,38% 2,27% 0,55% 0,93% -0,44% -1,43% 1,27%

0,42% 0,42% 0,42% 0,42% 0,42% 0,42% 0,42% 0,42%

0,20% -0,80% 1,84% 0,13% 0,50% -0,86% -1,86% 0,85%

0,0004% 0,0065% 0,0340% 0,0002% 0,0025% 0,0075% 0,0345% 0,0071%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,0927% 0,0116% 1,0765% -0,6518% 1,5012%

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.

40

Table 9: Gaussian distribution analysis. Industry: Energy and Utilities.

Stock Price Analysis: Energy & Utilites - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company AES CORP DYNEGY INC LINN ENERGY, LLC ONEOK INC PETROLEUM DEVELOPMENT CORP WORLD FUEL SERVICES CORP Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-2,23% -1,01% 0,05% 0,58% -0,51% 1,10%

-0,34% -0,34% -0,34% -0,34% -0,34% -0,34%

-1,89% -0,67% 0,39% 0,92% -0,17% 1,43%

0,0358% 0,0045% 0,0015% 0,0084% 0,0003% 0,0205%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,0710% 0,0118% 1,0879% -1,4238% 0,7521%

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.

41

Table 10: Gaussian distribution analysis. Industry: Financial services.

Stock Price Analysis: Financial Services - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company BANK OF AMERICA CORP BIOSCRIP, INC. BOWNE & CO INC CDI CORP CERIDIAN CORP CNA FINANCIAL CORP CORNING INC GENERAL GROWTH PROPERTIES INC HIGHWOODS PROPERTIES INC LANDAMERICA FINANCIAL GROUP INC MAX RE CAPITAL LTD OVERSTOCK.COM, INC PERFICIENT INC POPULAR INC SM&A Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

0,78% 0,28% 0,06% 0,22% -0,15% 0,26% -1,27% -1,27% 2,86% -2,17% 0,75% -0,78% -2,93% 0,65% -2,67%

-0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36% -0,36%

1,14% 0,64% 0,42% 0,58% 0,21% 0,62% -0,91% -0,91% 3,22% -1,81% 1,11% -0,42% -2,57% 1,01% -2,31%

0,0129% 0,0041% 0,0018% 0,0033% 0,0004% 0,0039% 0,0084% 0,0083% 0,1034% 0,0326% 0,0123% 0,0018% 0,0659% 0,0101% 0,0535%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,3227% 0,0215% 1,4667% -1,8265% 1,1070%

4.4.8 Industrial manufacturing. Standard deviation 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.

42

Table 11: Gaussian distribution analysis. Industry: Industrial manufacturing.

Stock Price Analysis: Industrial Manufacturing - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company CASTLE A M & CO CHESAPEAKE CORP DRESSER-RAND GROUP INC. LENNOX INTERNATIONAL INC MUELLER INDUSTRIES INC OM GROUP INC TECUMSEH PRODUCTS CO TEREX CORP TITANIUM METALS CORP Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-0,94% 0,23% -1,62% 0,09% 1,27% -1,24% 1,83% 1,38% 2,75%

0,42% 0,42% 0,42% 0,42% 0,42% 0,42% 0,42% 0,42% 0,42%

-1,36% -0,19% -2,03% -0,32% 0,86% -1,66% 1,41% 0,96% 2,33%

0,0184% 0,0004% 0,0414% 0,0010% 0,0074% 0,0275% 0,0199% 0,0092% 0,0544%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,1795% 0,0199% 1,4124% -0,9965% 1,8283%

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.

43

Table 12: Gaussian distribution analysis. Industry: Media.

Stock Price Analysis: Media - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company CROWN MEDIA HOLDINGS INC HOLLINGER INTERNATIONAL INC MOVIE GALLERY INC PAXSON COMMUNICATIONS CORP Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-3,89% 0,84% -2,48% -1,05%

-1,65% -1,65% -1,65% -1,65%

-2,25% 2,49% -0,83% 0,59%

0,0505% 0,0619% 0,0070% 0,0035%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,1228% 0,0307% 1,7523% -3,3976% 0,1069%

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.

44

Table 13: Gaussian distribution analysis. Industry: Pharmaceuticals.

Stock Price Analysis: Pharmaceuticals - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

Xi Company ALLION HEALTHCARE INC AMERICA SERVICE GROUP INC BRADLEY PHARMACEUTICALS INC CAPITAL SENIOR LIVING CORP HEMISPHERX BIOPHARMA INC LHC GROUP, INC LIGAND PHARMACEUTICALS INC MAGELLAN HEALTH SERVICES INC ORCHID CELLMARK INC Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-4,33% -2,07% 0,00% 3,80% -0,83% 1,20% -1,01% 2,41% -4,40%

-0,58% -0,58% -0,58% -0,58% -0,58% -0,58% -0,58% -0,58% -0,58%

-3,75% -1,49% 0,58% 4,38% -0,25% 1,78% -0,43% 3,00% -3,82%

0,1406% 0,0222% 0,0034% 0,1919% 0,0006% 0,0318% 0,0019% 0,0897% 0,1462%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,6282% 0,0698% 2,6420% -3,2229% 2,0611%

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.

45

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.

46

Table 14: Gaussian distribution analysis. Category: Small size companies.

Stock Price Analysis: Small Companies - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

FY '05 Rev. Company HEMISPHERX BIOPHARMA INC LINN ENERGY, LLC EVCI CAREER COLLEGES HOLDING CORP ORCHID CELLMARK INC SM&A DEVCON INTERNATIONAL CORP ROCK OF AGES CORP PERFICIENT INC STONEMOR PARTNERS LP CAPITAL SENIOR LIVING CORP ZAPATA CORP ALLION HEALTHCARE INC PACIFIC CMA INC CROSS A T CO BELL INDUSTRIES INC BRADLEY PHARMACEUTICALS INC LHC GROUP, INC CT COMMUNICATIONS INC LIGAND PHARMACEUTICALS INC MEADOW VALLEY CORP NATURAL HEALTH TRENDS CORP CROWN MEDIA HOLDINGS INC STERLING CONSTRUCTION CO INC MODTECH HOLDINGS INC PAXSON COMMUNICATIONS CORP CACHE INC RUSS BERRIE & CO INC EMS TECHNOLOGIES INC PETROLEUM DEVELOPMENT CORP INPUT OUTPUT INC HIGHWOODS PROPERTIES INC HOLLINGER INTERNATIONAL INC AMERICA SERVICE GROUP INC USA MOBILITY, INC NAUTILUS, INC. BOWNE & CO INC TITANIUM METALS CORP OVERSTOCK.COM, INC SUPERIOR INDUSTRIES INTERNATIONAL INC LAUREATE EDUCATION, INC. LEAP WIRELESS INTERNATIONAL INC CASTLE A M & CO (in millions) $1,1 $49,7 $50,7 $61,6 $76,7 $84,9 $89,5 $97,0 $99,7 $105,2 $109,9 $123,1 $125,0 $129,1 $130,9 $133,4 $162,5 $171,7 $176,6 $183,9 $194,5 $197,4 $219,4 $230,3 $254,2 $266,3 $290,2 $310,0 $343,1 $368,7 $410,7 $457,9 $562,7 $618,6 $631,3 $694,1 $749,8 $803,8 $844,9 $875,4 $914,7 $959,0

Xi Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-0,83% 0,05% 0,00% -4,40% -2,67% 0,50% 5,45% -2,93% 5,48% 3,80% 0,00% -4,33% -1,25% 0,00% -0,38% 0,00% 1,20% 2,27% -1,01% 0,56% 4,86% 6,51% -3,20% 0,11% -1,05% -2,24% 5,40% 0,55% -0,51% 0,93% 2,86% 0,84% -2,07% -1,43% -1,83% 0,06% 2,75% -0,78% -0,31% -0,04% -0,44% -0,94%

0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28% 0,28%

-1,10% -0,22% -0,28% -4,68% -2,95% 0,23% 5,17% -3,20% 5,20% 3,52% -0,28% -4,61% -1,53% -0,28% -0,65% -0,28% 0,93% 1,99% -1,29% 0,29% 4,59% 6,24% -3,47% -0,16% -1,33% -2,51% 5,12% 0,28% -0,79% 0,65% 2,58% 0,57% -2,35% -1,71% -2,11% -0,21% 2,47% -1,05% -0,59% -0,31% -0,71% -1,22%

0,0121% 0,0005% 0,0008% 0,2189% 0,0869% 0,0005% 0,2675% 0,1025% 0,2709% 0,1242% 0,0008% 0,2121% 0,0233% 0,0008% 0,0043% 0,0008% 0,0086% 0,0398% 0,0166% 0,0008% 0,2105% 0,3893% 0,1207% 0,0003% 0,0176% 0,0630% 0,2623% 0,0008% 0,0062% 0,0042% 0,0666% 0,0032% 0,0551% 0,0292% 0,0445% 0,0005% 0,0611% 0,0111% 0,0034% 0,0010% 0,0051% 0,0148%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

2,7629% 0,0658% 2,5648% -2,2898% 2,8398%

47

Table 15: Gaussian distribution analysis. Category: Medium size companies.

Stock Price Analysis: Medium Companies - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

FY '05 Rev. Company CHESAPEAKE CORP BIOSCRIP, INC. CDI CORP MAX RE CAPITAL LTD DRESSER-RAND GROUP INC. KANSAS CITY SOUTHERN AIRTRAN HOLDINGS INC CERIDIAN CORP VALHI INC MUELLER INDUSTRIES INC MAGELLAN HEALTH SERVICES INC TECUMSEH PRODUCTS CO MOVIE GALLERY INC OM GROUP INC CHICAGO BRIDGE & IRON CO N V DYNEGY INC ABM INDUSTRIES INC RETAIL VENTURES INC UTSTARCOM INC GENERAL GROWTH PROPERTIES INC LENNOX INTERNATIONAL INC POPULAR INC LANDAMERICA FINANCIAL GROUP INC (in millions) $1.042,0 $1.073,2 $1.133,6 $1.175,0 $1.208,2 $1.352,0 $1.450,5 $1.459,0 $1.529,3 $1.729,9 $1.808,0 $1.847,0 $1.987,2 $2.149,6 $2.257,5 $2.313,0 $2.587,8 $2.739,6 $2.929,3 $3.073,4 $3.366,2 $3.451,1 $3.959,6

Xi Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

0,23% 0,28% 0,22% 0,75% -1,62% -0,37% -1,68% -0,15% -0,23% 1,27% 2,41% 1,83% -2,48% -1,24% -1,00% -1,01% 0,63% -2,32% 1,27% -1,27% 0,09% 0,65% -2,17%

-0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26% -0,26%

0,48% 0,54% 0,47% 1,01% -1,36% -0,12% -1,42% 0,10% 0,02% 1,53% 2,67% 2,08% -2,22% -0,99% -0,75% -0,75% 0,89% -2,06% 1,53% -1,01% 0,35% 0,90% -1,91%

0,0023% 0,0029% 0,0022% 0,0101% 0,0185% 0,0001% 0,0202% 0,0001% 0,0000% 0,0235% 0,0714% 0,0434% 0,0494% 0,0097% 0,0056% 0,0056% 0,0079% 0,0426% 0,0233% 0,0103% 0,0012% 0,0082% 0,0364%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,3950% 0,0120% 1,0941% -1,3518% 0,8363%

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.

48

Table 16: Gaussian distribution analysis. Category: Large size companies.

Stock Price Analysis: Large Companies - Gauss Distribution

STOCK PRICE ANALYSIS - GAUSS CURVE

FY '05 Rev. Company H&R BLOCK INC CORNING INC MOLSON COORS BREWING CO TEREX CORP WORLD FUEL SERVICES CORP CNA FINANCIAL CORP AES CORP ONEOK INC KROGER CO BANK OF AMERICA CORP GENERAL MOTORS CORP (in millions) $4.420,0 $4.579,0 $5.506,9 $6.380,4 $8.733,9 $9.862,0 $11.086,0 $12.760,2 $56.434,0 $83.980,0 $192.604,0

Xi Stock Value Difference

Average Difference

Xi- Delta

(Xi-)^2 Delta^2

-1,90% -1,27% -0,01% 1,38% 1,10% 0,26% -2,23% 0,58% 0,61% 0,78% -0,78%

-0,14% -0,14% -0,14% -0,14% -0,14% -0,14% -0,14% -0,14% -0,14% -0,14% -0,14%

-1,77% -1,14% 0,12% 1,51% 1,23% 0,40% -2,09% 0,72% 0,75% 0,91% -0,65%

0,0312% 0,0130% 0,0001% 0,0229% 0,0152% 0,0016% 0,0437% 0,0051% 0,0056% 0,0083% 0,0042%

Sum [(Xi-)^2] VARIANCE ( ^2 ) STANDARD DEVIATION () GAUSS CURVE ANALISIS ^2=Sum [(Xi-)^2] / N = Sqr[Sum [(Xi-)^2] / N] - +

0,1510% 0,0137% 1,1717% -1,3079% 1,0355%

49

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 papers 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).

50

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 companys 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.

51

REFERENCES

Anne M. Marchetti, 2005, Beyond Sarbanes-Oxley Compliance: Effective Enterprise Risk Management, Wiley.

Alan D. Morrison, 2004, Sarbanes Oxley, Corporate Governance and Operational Risk, Sarbanes-Oxford Seminar, University of Oxford. Barbara Pacini & Meri Raggi, 2005, Statistica per lanalisi operativa dei dati, Feltrinelli.

Cohen, Daniel A., Aiyesha Dey, and Thomas Z. Lys, 2005, Trends in earnings management and informativeness of earnings announcements in the pre- and postSarbanes Oxley periods, Working paper, New York University.

Compliance Week, www.complianceweek.com.

Deloitte Intranet, www.deloitteresources.com.

Financial Accounting Standards Board Statement No. 5, Accounting for Contingencies ("FAS No. 5"), Deloitte FAQ, 2005.

Financial Executive International (FEI), 2004. Section 404 costs survey.

Financial Reporting Council, 2004, The Turnbull guidance as an evaluation framework for the purposes of Section 404(a) of the Sarbanes-Oxley Act.

Guy P. Lander, 2004, What is Sarbanes-Oxley? Mc Graw Hill. KPMG LLP, 2004. Sarbanes-Oxley Section 404: An overview of the PCAOBs requirements.

52

Holmstrom, B. and S. Kaplan, 2003. The state of U.S. Corporate governance: Whats right and whats wrong? Journal of Applied Corporate Finance 15, 8-20.

Leftwich, R., 1981. Evidence of the impact of mandatory changes in accounting principles on corporate loan agreements. Journal of Accounting and Economics 3, 3-36.

Li, H., M. Pincus, and S. Rego, 2004. Market reaction to events surrounding the Sarbanes-Oxley Act of 2002. Working paper, University of Iowa.

Michael F. Holt, 2006, The Sarbanes-Oxley Act: Overview and Implementation Procedures Manual, CIMA Publishing.

NYSE, www.nyse.com.

Protiviti Inc., 2003, Guide to the Sarbanes-Oxley Act: Internal Control Reporting Requirements, www.protivity.com.

Robert A Prentice, 2004, Guide to the Sarbanes-Oxley Act: What Business Needs to Know Now That it is Implemented, South-Western College/West.

Robert Charles Clark, 2005, Corporate governance changes in the wake if the Sarbanes Oxley Act, Discussion Paper, University of Harvard.

Scott Green, 2004, Sarbanes-Oxley and the Board of Directors: Techniques and Best Practices for Corporate Governance, Wiley.

State University of New York, http://www.oswego.edu/

Zhang, Economic Consequences of the Sarbanes-Oxley Act, 2005, Working Paper, University of Rochester.

Articles from The Wall Street Journal or The Washington Post to identify the legislative events: 53

Burns, J. and M. Schroeder, 2002. SEC Proposes Rules to Tighten Companies Financial Controls. Wall Street Journal, October 17, 2002.

Bryan-Low, 2003. Securities Threat: Bush Crackdown on Business Fraud Signals New Era. Wall Street Journal, October 08, 2003.

Day, K. and A.B. Crenshaw, 2002. SEC, Accounting Firms Redrafting Audit Rules; Agency Chairman Draws Fire for Role in Effort. The Washington Post, January 16, 2002.

Day, K. and K. Williams, 2002. CEO Deadline Brings Some Restatements; Accounting Certifications Overload SEC Staff. The Washington Post, August 15, 2002.

Hamburger, T., 2002. House Committee Postpones Vote on Oversight of Auditors. Wall Street Journal, April 12, 2002.

Hilzenrath, D.S., 2002. Hill Begins Search for Compromise on Accounting Rules. The Washington Post, July 20, 2002.

Hilzenrath, D.S. and H. Dewar, 2002. Senate Votes 97-0 TO Rein In Firms; Bill Targets Auditors and Executives. The Washington Post, July 16, 2002. Hilzenrath, D.S., J. Weisman, and J. Vandehei, 2002. How Congress Rode a Storm to Corporate Reform. The Washington Post, July 28, 2002.

Hitt, Gregg, 2002. Democrats in Senate Unite on Accounting-Overhaul Bill. Wall Street Journal, June 11, 2002.

Norris, F., 2004. Too Much Regulation? Corporate Bosses Sing the Sarbanes-Oxley Blues. New York Times, January 23, 2004.

54

Schroeder, M., 2002. Lawmakers Plan More Financial Oversight Accounting Industry Faces Stepped-up Regulation and Limits on Services. Wall Street Journal, February 12, 2002.

Schroeder, M., 2002. Senate Panel Seeks Sweeping Change for Auditors. Wall Street Journal, March 7, 2002.

Schroeder, M., 2002. The Economy: Congress Seeks Harsher Penalties For Violations of Accounting Laws. Wall Street Journal, April 23, 2002.

Schroeder, M., 2003. SEC proposes Rules to Strengthen Boards. Wall Street Journal, January 9, 2003. Solomon, D., 2003. Fraud Detector: SEC Sets a New Rule Aimed at Companies Internal Controls. Wall Street Journal, May 28, 2003.

Solomon, D., 2006. Why does material weaknesses do not crash the market? Wall Street Journal, June 25, 2006. VandeHei, J., 2002. House GOPs Leaders Fight Audit Plan; Lawmakers Seek to Dilute Some Senate-Passed Reforms. The Washington Post, July 17, 2002.

VandeHei, J. and D.S., Hilzenrath, 2002. Hill Leaders Agree on Corporate Curbs; Attack on Fraud Includes Auditing Control and Jail Terms. The Washington Post, July 25, 2002.

Wallison, P., 2003. Blame Sarbanes-Oxley. Wall Street Journal, September 3, 2003.

55

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.xls

ABM INDUSTRIES INC

NYSE

ABM

AES.xls

AES CORP

NYSE

AES

AAI.xls

AIRTRAN HOLDINGS INC

NYSE

AAI

ALLI.xls

ALLION HEALTHCARE INC

Nasdaq

ALLI

ASGR.xls

AMERICA SERVICE GROUP INC

NASDAQ

ASGR

BAC.xls

BANK OF AMERICA CORP

NYSE

BAC

BI.xls

BELL INDUSTRIES INC

AMEX

BI

BIOS.xls

BIOSCRIP, INC.

NASDAQ

BIOS

BNE.xls

BOWNE & CO INC

NYSE

BNE

BDY.xls

BRADLEY PHARMACEUTICALS INC

NYSE

BDY

CACH.xls

CACHE INC

NASDAQ

CACH

CSU.xls

CAPITAL SENIOR LIVING CORP

NYSE

CSU

CAS.xls

CASTLE A M & CO

AMEX

CAS

CDI.xls

CDI CORP

NYSE

CDI

CEN.xls

CERIDIAN CORP

NYSE

CEN

CSK.xls

CHESAPEAKE CORP

NYSE

CSK

CBI.xls

CHICAGO BRIDGE & IRON CO N V

NYSE

CBI

CNA.xls

CNA FINANCIAL CORP

NYSE

CNA

GLW.xls

CORNING INC

NYSE

GLW

Source of stock price: NYSE (www.nyse.com) Source of the list of companies: Compliance Week (www.complianceweek.com)

56

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

CACH.xls ASGR.xls BIOS.xls GLW.xls CNA.xls CEN.xls CAS.xls CSU.xls BAC.xls ALLI.xls ABM.xls PRZ.xls CSK.xls CDI.xls BDY.xls BNE.xls AAI.xls AES.xls CBI.xls BI.xls

CROSS A T CO

AMEX

PRZ

CRWN.xls

CROWN MEDIA HOLDINGS INC

NASDAQ

CRWN

CTCI.xls

CT COMMUNICATIONS INC

NASDAQ

CTCI

DEVC.xls

DEVCON INTERNATIONAL CORP

Nasdaq

DEVC

DRC.xls

DRESSER-RAND GROUP INC.

NYSE

DRC

DYN.xls

DYNEGY INC

NYSE

DYN

ELMG.xls

EMS TECHNOLOGIES INC

NASDAQ

ELMG

EVCI.xls

EVCI CAREER COLLEGES HOLDING CORP

Nasdaq

EVCI

GGP.xls

GENERAL GROWTH PROPERTIES INC

NYSE

GGP

GM.xls

GENERAL MOTORS CORP

NYSE

GM

HRB.xls

H&R BLOCK INC

NYSE

HRB

HEM.xls

HEMISPHERX BIOPHARMA INC

AMEX

HEM

HIW.xls

HIGHWOODS PROPERTIES INC

NYSE

HIW

HLR.xls

HOLLINGER INTERNATIONAL INC

NYSE

HLR

IO.xls

INPUT OUTPUT INC

NYSE

IO

KSU.xls

KANSAS CITY SOUTHERN

NYSE

KSU

KR.xls

KROGER CO

NYSE

KR

LFG.xls

LANDAMERICA FINANCIAL GROUP INC

NYSE

LFG

LAUR.xls

LAUREATE EDUCATION, INC.

NASDAQ

LAUR

Source of stock price: NYSE (www.nyse.com) Source of the list of companies: Compliance Week (www.complianceweek.com)

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

CRWN.xls CACH.xls LAUR.xls ELMG.xls DEVC.xls ASGR.xls LEAP.xls CTCI.xls BIOS.xls EVCI.xls GLW.xls HIW.xls HEM.xls HRB.xls GGP.xls DYN.xls DRC.xls CNA.xls CEN.xls CAS.xls CSU.xls BAC.xls ALLI.xls ABM.xls LFG.xls KSU.xls HLR.xls PRZ.xls CSK.xls CDI.xls BDY.xls BNE.xls AAI.xls AES.xls CBI.xls GM.xls KR.xls IO.xls BI.xls

LEAP WIRELESS INTERNATIONAL INC

NASDAQ

LEAP

LII.xls

LENNOX INTERNATIONAL INC

NYSE

LII

LHCG.xls

LHC GROUP, INC

NASDAQ

LHCG

LGND.xls

LIGAND PHARMACEUTICALS INC

NASDAQ

LGND

LINE.xls

LINN ENERGY, LLC

NASDAQ

LINE

MGLN.xls

MAGELLAN HEALTH SERVICES INC

NASDAQ

MGLN

MXRE.xls

MAX RE CAPITAL LTD

NASDAQ

MXRE

MVCO.xls

MEADOW VALLEY CORP

NASDAQ

MVCO

MODT.xls

MODTECH HOLDINGS INC

NASDAQ

MODT

TAP.xls

MOLSON COORS BREWING CO

NYSE

TAP

MOVI.xls

MOVIE GALLERY INC

NASDAQ

MOVI

MLI.xls

MUELLER INDUSTRIES INC

NYSE

MLI

BHIP.xls

NATURAL HEALTH TRENDS CORP

Nasdaq

BHIP

NLS.xls

NAUTILUS, INC.

NYSE

NLS

OMG.xls

OM GROUP INC

NYSE

OMG

OKE.xls

ONEOK INC

NYSE

OKE

ORCH.xls

ORCHID CELLMARK INC

Nasdaq

ORCH

OSTK.xls

OVERSTOCK.COM, INC

NASDAQ

OSTK

PAM.xls

PACIFIC CMA INC

AMEX

PAM

Source of stock price: NYSE (www.nyse.com) Source of the list of companies: Compliance Week (www.complianceweek.com)

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

CRWN.xls ORCH.xls MODT.xls MVCO.xls CACH.xls OSTK.xls MOVI.xls MXRE.xls MGLN.xls LGND.xls LHCG.xls LAUR.xls ELMG.xls DEVC.xls ASGR.xls LEAP.xls CTCI.xls BIOS.xls OMG.xls BHIP.xls LINE.xls EVCI.xls GLW.xls PAM.xls OKE.xls HIW.xls HEM.xls HRB.xls GGP.xls DYN.xls DRC.xls CNA.xls CEN.xls CAS.xls CSU.xls BAC.xls ALLI.xls ABM.xls ION.xls NLS.xls TAP.xls LFG.xls KSU.xls HLR.xls PRZ.xls CSK.xls CDI.xls BDY.xls BNE.xls AAI.xls AES.xls MLI.xls CBI.xls GM.xls LII.xls KR.xls IO.xls BI.xls

PAXSON COMMUNICATIONS CORP

AMEX

ION

PRFT.xls

PERFICIENT INC

NASDAQ

PRFT

PETD.xls

PETROLEUM DEVELOPMENT CORP

NASDAQ

PETD

BPOP.xls

POPULAR INC

NASDAQ

BPOP

RVI.xls

RETAIL VENTURES INC

NYSE

RVI

ROAC.xls

ROCK OF AGES CORP

Nasdaq

ROAC

RUS.xls

RUSS BERRIE & CO INC

NYSE

RUS

WINS.xls

SM&A

Nasdaq

WINS

STRL.xls

STERLING CONSTRUCTION CO INC

NASDAQ

STRL

STON.xls

STONEMOR PARTNERS LP

Nasdaq

STON

SUP.xls

SUPERIOR INDUSTRIES INTERNATIONAL INC

NYSE

SUP

TECUA.xls

TECUMSEH PRODUCTS CO

NASDAQ

TECUA

TEX.xls

TEREX CORP

NYSE

TEX

TIE.xls

TITANIUM METALS CORP

NYSE

TIE

USMO.xls

USA MOBILITY, INC

Nasdaq

USMO

UTSI.xls

UTSTARCOM INC

NASDAQ

UTSI

VHI.xls

VALHI INC

NYSE

VHI

INT.xls

WORLD FUEL SERVICES CORP

NYSE

INT

ZAP.xls

ZAPATA CORP

NYSE

ZAP

Source of stock price: NYSE (www.nyse.com) Source of the list of companies: Compliance Week (www.complianceweek.com)

59