The Sarbanes-Oxley Act of 2002 and Market Liquidity


  • We are grateful for the comments and suggestions from participants at the 14th Annual Conference of Financial Economics and Accounting (CFEA) at Indiana University, the 2003 Mid-South Doctoral Research consortium, the 2003 Annual Meeting of the Financial Management Association International (FMA), and the 2004 Annual Meeting of the American Accounting Association. We also appreciate the comments from two anonymous reviewers and the editor, Arnie Cowan.

* Corresponding author: Department of Economics and Finance, College of Business, Northern Kentucky University, Highland Heights, KY 41099; Phone: (859) 572-6581; Fax: (859) 572-6627; E-mail:


Investors rely heavily on the trustworthiness and accuracy of corporate information to provide liquidity to the capital markets. We find that the rash of financial scandals caused a severe deterioration in market liquidity in the form of wider spreads, lower depths, and a higher adverse selection component of spreads vis-à-vis their benchmark levels. Regulatory responses including the Sarbanes-Oxley Act of 2002 (SOX) had inconsequential short-term liquidity effects but highly significant and positive long-term liquidity effects. These liquidity improvements are positively associated with the improved quality of financial reports, several firm-specific variables (e.g., size), and market factors (e.g., price, volatility, volume).