A test of the loan prohibition of the Sarbanes-Oxley Act: Are firms that grant loans to executives more likely to misstate their financial results?

The Sarbanes-Oxley Act of 2002 was designed to improve the accuracy and reliability of financial reporting and prohibits public companies from granting loans to executives. Without considering the effects of executive loans on financial reporting, some researchers have questioned the appropriateness of the Act’s loan prohibition [Kahle, K., Shastri, K., 2004. Executive loans. Journal of Financial and Quantitative Analysis 39 (4), 791–811; Henderson, M., Spindler, J., 2005. Corporate Heroin: A defense of perks, executive loans, and conspicuous consumption. The Georgetown Law Journal 93 (6)]. We examine whether executive loans are associated with financial misstatements. We find a significant association between executive loans and financial misstatements. Our results suggest that a relationship exists between the Sarbanes-Oxley Act’s loan prohibition and the Act’s objective of improving the accuracy and reliability of financial reporting.