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In most European countries, U.S.-owned subsidiaries are required by law to file separate entity financial statements in local GAAP. We use this unique institutional setting to examine whether the Sarbanes-Oxley Act of 2002 (SOX) had a flow-through effect on the earnings quality of local GAAP financial reports for a sample of Belgian subsidiaries owned by U.S.-listed firms. Belgium has weaker institutions relative to the U.S. and this is a setting where the spillover effects of SOX might be expected to improve local GAAP earnings quality. Using a difference-in-differences research design, we compare changes in earnings quality before and after SOX for a treatment sample of Belgian subsidiaries owned by U.S.-listed companies (which are subject to SOX), with a control sample of Belgian-owned subsidiaries whose owners are not subject to SOX regulations. We find that the earnings quality of the U.S.-owned subsidiaries improved after SOX (smaller abnormal accruals and more timely loss recognition). In contrast, the earnings quality of the control sample was either unchanged or declined in the pre- versus post-SOX periods. These results suggest that SOX did have a flow-through effect on earnings quality in a non-U.S. jurisdiction, and that SOX has had a broader international effect beyond the original legislative intent.
