The costs and benefits of Sarbanes.docx

1、The costs and benefits of SarbanesThe costs and benefits of Sarbanes-OxleyBy Xuying ChenSan Francisco State UniversityCollege of businessxuyingsfsu.eduMay, 2010IntroductionScandals are unavoidable while the society is progressing and the economic is developing. But scandals have big impacts of, some

2、times destroy, peoples normal life, especially economic scandals. The dotcom bubbles and accounting scandals trigger last recession, and the financial and accounting scandals cause the recent recession. The disasters were so painful that even the free market value is doubted. It is the right time to

3、 reregulate after a long period of deregulation. As the reflection of accounting scandals, such as Arthur Andersen, Enron, WorldCom, The Sarbanes-Oxley Act (SOX) which aim at enhance public confidence of capital market by promoting better ethical behavior and accountability of greater executives was

4、 enacted in 2002, at the end of last recession. The eight years practices mostly achieve the goal of advocators, for example less accounting scandals, more market confidence and more investments. However, raise many opposite voices, like the act is too costly to comply, the financial performance of

5、the SEC-registered companies are worse than before, the complex regulation cripples the competitive power of the financial market in United States.Although the compliance of the SOX is very expensive and the results are not as perfect as expected, a more healthy market and public confidence that att

6、racts more investments are advantages which can overwhelm its defects.The costs of the SOXThe costs of the SOX are a huge number and very complex to be defined. The costs not only include direct cost, like compliance cost of the SEC-registered companies, and the oversight cost of government and its

7、agents, but also include indirect costs, for example the shareholders loss due to the profit, the financial industry loss due to the declined competitive power of financial market. First, the compliance cost of the SOX used by companies is the most direct cost that can be traced, and it is mainly fr

8、om complying with the SOX 404. The compliance costs can be classified into three categories: internal labor costs, external consulting and technology expenses, and auditor attestation charges. (Krishnan, Rama, and Zhang, 2008) The highest cost of the SOX, the Security exchange committee (SEC) said,

9、is the internal labor costs, followed by audit fees, and then costs related to another third party, such as a consultancy (SEC 2009).Finance Executives International (FEI) provides consistent studies and annual surveys on the SOX. In July 2004, FEI survey indicated the total cost of compliance was e

10、stimated to be 62% more than the January 2004 survey (2004b). A 2005 study indicated a 39% increase from the July 2004 survey (FEI 2005). In a 2007 study those companies with market capitalizations more than $75 million had an average cost of internal control compliance to be $2.9 million during fis

11、cal year 2006 (FEI 2007). Also the SEC concluded that companies paid a mean total of $2.87 million when they first began following the SOX, and expect to pay a mean cost of $2.03 million for their next internal-controls report (SEC 2009). Other studies found similar issues. The research paper by Kri

12、shnan states that the mean total compliance costs for Section 404 is $2.2 ($1.2) million, during the period from January 2003 to September 2005 (Krishnan, Rama, and Zhang, 2008). The research also point out that, based on the regression analyses, the total compliance costs are positively associated

13、with firm size (Krishnan, Rama, and Zhang, 2008). The 2007 Foley & Lardner Survey demonstrates that the total costs of being a U.S. public company affected by the SOX were significantly increased from 2001 to 2006. Such costs include external auditor fees, directors and officers insurance, board com

14、pensation, lost productivity, and legal costs. (Foley & Lardner, 2007)However, the compliance costs of the SOX 404 have continued to decline relative to revenues since 2004. The 2007 survey indicated that, for 168 companies with average revenues of $4.7 billion, the average compliance costs were $1.

15、7 million, as 0.036% of revenue (FEI 2008). The 2006 survey indicated that, for 200 companies with average revenues of $6.8 billion, the average compliance costs were $2.9 million, as 0.043% of revenue (FEI 2007). The SEC believes that over time, the expense of complying has decreased as companies g

16、ot more used to following the rules and as the regulators tweaked them (SEC 2009). Second, the SOX is costly to administer. Both the Public Company Accounting Oversight Board (PCAOB) and the SEC are adding staff to deal with the additional work necessary to implement the Act. PCAOB was established w

17、ith eight staffs in 2003. By the end of 2005, the budget excess $150 million, while hiring more than 450 staff members. Also, SEC hired an additional 1,000 staff due to the SOX. (Rouse, 2005) Third, the stock prices and the U.S. capital markets suffer losses, because the compliance costs of SOX gene

18、rate negative effects on profitability. The research by OShaughnessy indicates that the mean of both return on assets (ROA) and return on equity (ROE) have a marked negative divergence for SEC-registered companies as opposed to those companies that do not report to the SEC in the banking industry fo

19、r the period 2000 through 2005 (OShaughnessy, 2008). Also, Zhang find out that estimated SOX compliance costs $1.4 trillion, based on the assumption that SOX was the cause of related short-duration market value changes. On the other hand, news of potential relief from the law pushes up US stock pric

20、es (Zhang, 2005). Moreover, a new finding has a view that because of the SOX, U.S. firms reduced their investments in capital expenditures and research of development compared to firms in the U.K. and Canada (Bargeron, Lehn, and Zutter). It will ultimately harm stock price, because the SOX discourag

21、es directors from approving risky investments that are costly to monitor. However, the stock price declined might cause by SEC-registered companies reserve earnings to avoid potential lawsuit risk from the SOX. Iliev find out that the SOX 404 indeed led to conservative reported earnings (Iliev, 2007

22、).Forth, the financial industry suffers loss, because the US capital market becomes less attractive than before, especially the foreign and small companies are hindered by the SOX to participate in the capital market. SEC study states that a majority in a survey say that Section 404 has motivated th

23、em to consider de-listing from U.S. exchanges, and a staggering 77% of smaller foreign firms say that the law has motivated them to consider abandoning their American listings (SEC 2009). According to the National Venture Capital Association, in all of 2008 there have been just 6 companies gone publ

24、ic. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986 (Freeman, 2009). Fifth, smaller firms seek to deregister from SEC in order to avoid expansive complain cost, and it might be hidden cost of obeying the goal of the act. In the same research as mention before, although the complain

25、cost are positively associated with firm size, smaller firms do incur higher costs per dollar of assets or revenues than larger firms do (Krishnan, Rama, and Zhang, 2008). Also, another study by SEC conclude that small, publicly traded companies have to pay a disproportionately higher amount to comp

26、ly with the internal-controls portions of the Sarbanes-Oxley Act than larger companies (SEC 2009).The benefits of the SOX The SOX receive much more challenges than supporting, because most of its benefits are difficult to be proved. First, the SOX can benefit the society and the economic by avoiding

27、 accounting scandals. The act is build to avoid risk, but normally, when the risk didnt happen, no one can calculate the cost of the risk. It means the main benefit from avoiding accounting scandals is hard to be proved, especially the impact to society. But still some facts can address the benefit

28、did exist. A list of big business scandals reported by media show that there are significantly less accounting scandals after 2003. Second, the companies can benefit from The SOX by more transparency, better internal control, and get loans at a lower interest rate. A paper indicates that borrowing c

29、osts are lower for companies that improved their internal control, by between 50 and 150 basis points (Skaife, Collins, Kinney, and LaFond, 2006). Also SEC survey demonstrate that half of the 2,907 SEC-registered companies said that they get direct benefits such as improved financial reporting, and

30、a better ability to raise capital.(SEC 2009)Third, the SOX help to rebuilt market confidence, and attract more capital. FEI Survey finds out that the SOX have positive effect on investor confidence, because of reliability of financial statements, and fraud prevention continue to rise (FEI 2007). Bas

31、ed on the static from U.S. Bureau of Economic Analysis, the foreign direct investment in U.S. securities other than U.S. Treasury securities strongly growth since 2002(Nguyen, 2009).Year20002001200220032004200520062007 Investment (billion)2,6232,8212,7793,4233,9964,3535,3726,190Growth rate8%-1%23%17

32、%9%23%15%Conclusion Although there are more studies and evidence in the cost-benefit analysis support that the cost of the SOX exceed the benefit, the non business concerns cannot be ignore. Business or economic should take social responsibility. Based on the social contract ethic theory, minors should be take care as to harmonize with the whole society. Compare to big player, the small investors are the main benefiters of the SOX, because they are weak to get information and the SOX made market information more accurate. Furthermore, the