Effectiveness of the Sarbanes-Oxley Act

The Sarbanes-Oxley Act was passed, in part, to fight the evils of unethical behavior. Has it been worth the cost? The verdict on the efficacy of S-Ox is still an open question, though preliminary indications have been that §404 has been prosperous in enhancing the transparency of financial reports along with the reliability of financial reports. These benefits have not come without costs, however, including an growth in privatization, smaller profit margins, and an growth in redundancy costs. This analysis seeks to balance some of those costs against their benefits.

Retained Profits

A trend towards increased privatization of at one time public companies was apparent even before S-Ox was signed (Megginson & Netter, 2001), though there has been some venture that privatization has increased even more because of S-Ox (Dodwell, 2008). There have been some benefits, Dodwell asserts: transparency and reliability of financial reports has increased, motivation to enhance transaction controls out of fear of failing an audit, emphasis on the control environment and mindset, and even the use of S-Ox documentation as a training tool for new employees and a backup and transportation device (2008, p. 40).

One of the largest inexpressive companies in America, Hospital Corporation of America (Hca), owns, manages, or operates 169 hospitals, along with many surgery, imaging, radiation, and recovery centers, was public from 1990 to 2006, when it was taken private. Like Henry Ford taking Ford Motor Car inexpressive in 1916 after being ordered by a court to pay out retained wage to shareholders (Dodge v. Ford Motor Co., 204 Mich. 459 (1919)), Hca did not want to live by the Sarbanes-Oxley rules.

The whole of companies having to change their business practices has been large; Hermanson, Ivancevich, and Ivancevich have noted that 55% of public companies have changed wage recognition policies, and 8% have had to file wage restatements (2008). They do note, though, that internal control frailness reports have been declining among larger companies, and that this is a demonstration of the effectiveness of S-Ox, particularly § 404 (Hermanson, et al., 2008).

However, the benefits have not come without a cost. Dodwell notes the costs as including smaller profit margins due to increased compliancy costs, chance costs of choosing not to pursue some otherwise economically significant opportunities, redundancy costs, increased costs to hire auditors (whose hourly rates have increased due to greater demand), and an growth in the whole of companies choosing not to be listed on the U.S. Stock exchanges but instead seeking foreign listing (2008).

In the long run, will the benefits of the Sarbanes-Oxley Act prove to be worth the costs? The preliminary reports propose that the rejoinder may be a marvelous yes.

References:

Dodwell, W.J. (2008, August). Six years of the Sarbanes-Oxley Act: Are we great off? The Cpa Journal, 78(8),38-43.
Hermanson, D.R., Ivancevich, D.M., & Ivancevich, S.H. (2008, October). Sox section 404 material weaknesses related to wage recognition. The Cpa Journal, 78(10), 40-45.
Megginson, W.L. And Netter, J.M. (2001, June). From state to market: A observe of empirical studies on privatization. Journal of Economic Literature.