Restraining bad news hoarding from managerial overconfidence: Evidence from the Sarbanes-Oxley Act

Abstract

This study examines the impact of the Sarbanes-Oxley Act (SOX) on the association between managerial overconfidence and stock price crash risk. The literature posits that overconfident CEOs are more likely to hoard bad news than others, leading to a higher crash risk. Our findings indicate that SOX restrains bad news hoarding from managerial overconfidence. As a result, the difference in crash risk between firms with overconfident and non-overconfident CEOs is significant before SOX but almost disappears after SOX. We provide supportive evidence that SOX reduces crash risk through the bad-news-hoarding channel, using financial restatements and analysts' forecasting. We also find that the effectiveness of SOX is more pronounced for firms with weaker external governance mechanisms and those that are financially constrained. Overall, this study suggests that SOX helps mitigate overconfident managerial behavior, such as bad news hoarding.