Prevalence of the Zero-Earnings Discontinuity in Quarterly Reported Earnings

We examine the persistence of the zero-earnings discontinuity in quarterly earnings around the adoption of the Sarbanes-Oxley Act in 2002. Previous studies find that the zero-earnings discontinuity in annual earnings disappears after the adoption of the Act, likely due to the stricter regulatory environment. We hypothesize that the adoption coincides with a relatively smaller reduction in the zero-earnings discontinuity in quarterly earnings, since interim financial statements are unaudited. Consistent herewith, we find that the zero-earnings discontinuity in quarterly earnings persists after the adoption of the Act. This is driven by the reduction in the zero-earnings discontinuities being weaker in magnitude for quarterly earnings compared to annual earnings. We find similar results using changes in earnings as well as analysts’ earnings forecast errors. Our findings are relevant for both regulators and academics in assessing the role of auditors in the adoption of SOX.