- Truthfulness, Transparency and Incentives: Making Financial Reporting More Honest
- What are affecting earnings quality
- HK opens doors to Chinese Accounting Standards
- Mind the GAAP
- SOX Section 404 - is it really effective ?
- Are Foreign Issuers Shunning the U.S.?
- Sarbanes-Oxley: A price worth paying?
- Value is in the Eye of the Beholder
- Sarbanes-Oxley: A Price Worth Paying? - Sumesh
- The Sarbanes-Oxley Act-Is it Worth Paying the Price?
Category Archives: Sarbanes Oxley
The 2006 article in Financial Executive by Jeffrey Marshall discusses the cost-benefit analysis of Sarbanes-Oxley Section 404 for non-U.S. issuers. The article lists the benefits of being listed in U.S. exchanges for international companies, the costs of SOX regulations for these companies, and the reasons why companies choose not to go public in U.S.
After witnessing the huge scandals regarding internal control and corporate governance issues and the enormous impacts of these scandals, I believe SOX is a very important protective measure that should not be negotiated about. These protective measures are important not only for internal control, but also for other processes such as risk management.
During the 2001 economic crisis in Turkey, approximately 1 in every 4 banks went bankrupt. This massive fall was based on various reasons. The most important reasons were the lack of effective company management, the lack of the reserved capitals of the banks, and the lack of effective internal controls. After the crisis, the government put several regulations in action and made the banks’ lives miserable during the transition process. Although each player in the market was complaining about the burden and negative aspects of the new regulations, during the 2008 global recession Turkey was one of the few countries where the banking system was not affected terribly.
The takeaway of this recent example is the importance of strengthening the control and risk management processes. Both U.S. companies and non-U.S. companies should perceive the SOX measures as a seatbelt and/or an airbag for a possible accident coming up.
The article mentions two large Chinese companies that chose to be listed in the Hong Kong exchange as a cheaper and less burdensome way (compared to be listed in U.S.). I hope that these companies do not learn to comply with the strict rules of SOX through a much harder and costly way.
The subject matter of the Economist article “Sarbanes-Oxley: A price worth paying?” is a fantastic Rorschach test for the business community. That is to say, the Sarbanes-Oxley bill is such a complicated piece of legislation that any attempt to analyze it results in the author communicating more about herself than the law. For example, early in the article the author of this piece mentions Alan Greenspan’s praise of the law, but immediately qualifies it as “faint praise” since quickly passed laws that address complex subjects “can normally be expected to fail abjectly.” The author does not explain why this is the case though. Have there been objective historical studies on the efficacy of laws based on the time it took to pass them and the complexity of their subject matter? Or is this, as I suspect, just a free-market believer’s skepticism of government coming out?
On a larger level the Rorschach effect of Sarbanes-Oxley can be perceived in an individual’s cost-benefit evaluation of the bill. On the benefits side, the law created an accounting oversight board; banned auditors from providing non-audit work to clients they audit, thus removing an obvious conflict of interest; required companies to establish independent audit committees; forbade company loans to company executives; forced top executives to certify company accounts, thus creating more accountability; and extended protection for whistleblowers. All of these rules should provide significant comfort for shareholders who have no choice but to rely on the validity of company financial reports when making investing decisions.
On the cost side, implementing the changes required by the law has been financially expensive for corporations.
It seems to me that it is impossible to quantify the value of the benefits, therefore rendering it equally impossible to ever come up with an objective cost-benefit analysis. Instead, we must acknowledge that a person’s position on the value of the law will be predominantly based on their previously established beliefs regarding regulation, corporate integrity, and the relative need for corporate oversight. The author correctly states that people will be debating the value of Sarbanes-Oxley for many years; as long as people have clashing views on regulation, corporate integrity, and corporate oversight, this debate will not end.
When do the benefits that come with regulation become an undue burden? The Economist’s article, A Price Worth Paying, examines this question about the Sarbanes-Oxley statute. In the wake of scandals in the early 2000’s, like those at Enron and WorldCom, congress needed to act to calm the public’s fears and the economy. But in doing so, many worry that they went to far and imposed burdensome regulations on publicly traded firms.
The main point of contention is regarding section 404 of the statute, which states that managers are responsible for maintaining an: “adequate internal control structure and procedures for financial reporting” and that their accountants must certify these controls and disclose any “material weaknesses.” Failure to do so could result in criminal penalties.
This section has cost publicly traded companies billions in compliance fees, most of which were paid to their accountants and auditors who, ironically, were the ones responsible for the problems in the first place. As the article highlights that while there may be benefits in having these controls in place, they will probably never reach the anticipated $1.4 trillion. In addition, the Big Four accounting firms are loosing clients because with the increased annual costs to their audits, many firms are looking into smaller accounting practices to handle their books. While many will delight if the accounting field is leveled, one of the Big Four failing would hurt the economy tremendously. We are already seeing negative economic impacts due to Sarbanes-Oxley as many companies are deciding not to go public and foreign companies are choosing not to be listed on American exchanges.
Sarbanes-Oxley, as many laws, was a response to a troubling trend in American businesses. However, at the end of the day, will it actually prevent firms from failing? And if it does, will the economic hardships borne by companies in the meantime be worth it? Unfortunately we are a long way away from even beginning to answer these questions and only time will tell if the price is worth paying.