Pendulum Effects

Extant theories in sociology, criminal justice, economics, and even political science posit the existence of periodicity in human affairs which exhibits the characteristics of a pendulum which swings from one extreme to the other. We examine in this study whether such a phenomenon exists in financial reporting, with periods of lax financial reporting followed by legislation which corrects the pendulum swing to the other direction, and eventually a reversal back to laxity. This phenomenon might be expected to exist because of the tension between management incentive to manage earnings and the desire of the public (through legislative action) to maintain some probity in financial statements.
        Focusing on the period from 1973 to 2017, we examine the effects of the three major legislations intended to address internal controls and greater probity in financial reporting, namely the Foreign Corrupt Practices Act (FCPA, 1977), the Omnibus Trade and Competitiveness Act of 1988 (OTCA, 1988), and the Sarbanes-Oxley Act (SOX, 2002). For this purpose, we focus on the longitudinal behavior of an accrual quality index as a proxy for financial reporting probity. Our findings essentially support a pendulum effect, but the periodicity expected of a pendulum (a movement in one direction followed by a counter-movement) is missing. Our results indicate that the successive laws appear to have had a cumulative deterrence effect. However, only the Sarbanes-Oxley Act has had a demonstrably sustained effect on aggregate corporate behavior towards greater financial probity in financial reporting.