Did Japanese-SOX have an impact on earnings management and earnings quality?

Purpose – The purpose of this paper is to investigate whether Japanese Sarbanes – Oxley Act (J-SOX) impacted earnings management and earnings quality of public firms in Japan. Design/methodology/approach – This archival study compares earnings management and earnings quality of firms that disclose at least one material weakness with a sample matched on size and industry without a material weakness. Findings – The authors investigate whether the differences in regulations, corporate governance and regulatory environment acceptance influence earnings management and earnings management of Japanese listed firms, relative to findings in the USA. They found the Japanese results to be slightly different from the results found in previous USA studies. First, the time-series observations suggest that while accruals management and real earnings management remained unchanged for control firms, accruals management and real earnings management increased for material weaknesses disclosing firms following J-SOX. The regression analyses suggest that accruals management for both the groups is significant in the pre-and post-J-SOX periods, but that real earnings management declined for both the groups post-J-SOX. Second, while, both accruals quality and accuracy of cash flow predictions improved in the post-J-SOX period. Research limitations/implications – The sample of Japanese firms disclosing a material weakness is small because the number of firms that disclose internal control deficiencies is decreasing in Japan. The authors have no evidence that their results are not generalizable to a larger sample and leave this for future research. Practical implications – The authors provide evidence that J-SOX, which does not have a direct reporting system, does not constrain earnings management. Their results drive the regulator to reconsider whether the reporting system works in the Japanese business environment. Additionally, their results show that J-SOX has no effect on earnings management; thus, regulators need to reconsider the governance function of directors and internal auditors. This paper communicates to the world how J-SOX works in Japan through changes in earnings quality and management post J-SOX and the root problems. Originality/value – This paper is the first (of which the authors are aware) to examine whether J-SOX impacted both earnings management and earnings quality in Japan. This paper discusses how the differences in regulations and corporate governance as well as the differences between USA-SOX and J-SOX may explain the results observed in Japan. This paper provides results regarding whether J-SOX improved earnings quality.