Does being Ethical Pay? Evidence from the Implementation of SOX Section 406

Firms that adopt a ‘code of ethics’ targeted towards senior financial officers (CEFO firms) in response to SOX Act Section 406 have higher valuations (Tobin’s q) than a matched sample of firms of similar size, operating in the same industry that have not yet adopted such a code of ethics (non-CEFO firms). Tracing the mechanism, higher valuations for CEFO firms result from both low risk-adjusted rates and higher cash flows. In turn, higher cash flows for CEFO firms result from increased profitability and lower compliance costs. CEFO firms also benefit from a lower probability of shareholder disputes and shareholder concerns. These results are consistent with models of integrity that predict that firms’ commitment to ethical behavior is associated with better performance.