This paper seeks to determine whether Sarbanes-Oxley (SarbOx) is working by looking at its cost/benefit in practice, including its effect in policing corporate corruption and whether cost of time/labor, financial investment, government oversight, reporting etc are compensated. The paper will also assess whether there has been improved financial impact and increased competition locally and globally. It will also evaluate whether the law has indeed protected the shareholders earlier or has caused the financial markets to become more efficient.
The final part will make a recommendation whether SarbOx should be continued, modified or scrapped. 2. -Questions and Answers 2. 1 What is the cost-benefit of Sarbanes-Oxley in practice The SarbOx was passed in 2002 and was intended to restore the confidence of investors that was allegedly lost due to a number of major corporate accounting scandals including the celebrated case of Enron in the US. As viewed by the proponents said scandals have cost investors billions of dollars when the share prices of companies collapsed bringing with it loss of confidence to said investors.
Otherwise known as the Public Company Accounting Reform and Investor Protection Act of 2002, the SarbOx was passed to establish new standards for all U. S. public company boards, management and public accounting firms. Since the law consists of range of extra corporate board responsibilities to criminal punishments, additional cost to business was the necessary implication as a result of additional requirements to be complied with as implemented by the US Securities and Exchange Commission (SEC).
Whether the benefits expected have outweighed the cost that has caused to US companies in terms additional regulation appears to be not present as proved in the following sections. 2. 2 Is the US government more effective in policing corporate corruption? One way of evaluating its benefit is to look whether it has prevented corporate corruption. There seems to be no evidence to tell that the government has become more effect in policing corporate corruption as are no researchers to confirm such claim.
To put it in simpler sense, it could not be established that because of SarbOx another Enron scandal will not happen again. Since the primary purpose is more on restoring confidence with the incidental objective of policing corruption, the subsequent analysis will either deny or confirm. 2. 3 Are business practices better as a result? Although the law has the best of intentions there seems to be no evidence that it has resulted to better practices for US companies as against foreign companies.
If better practices could be equated to more confident decision makers because of the new system, it would seem there is a clear failure as it has caused the CEO to be more overly concerned about their responsibilities as if they are accountants and this caused them to risk averse. As a result their energies were misdirected (Niskanen, 2007). It therefore has caused a tighter worlds for creativity to shine hence business practices could not be said be said to have improved as a result of SarbOx. 2. 3 What has been the cost of SarbOx? Time/labor, financial investment, government oversight, reporting, etc?
Is it worth it? US companies needed additional time/labor in terms of additional personal personnel to do the works required. This needed money as a result; hence addition financial investment is also required. It is additional work for SEC hence additional government oversight and reporting arise as a result of the implementation of SarbOx. This may be seen in the increased number of accounting job requirements. Compared when the law was not there, the cost of doing business for US companies has become bigger now. The requirements have therefore caused unnecessary burdens to investors.
On whether it is worth it, one could just see the obvious failure of the law. As to how it failed to accomplish its purpose is rooted on the background of its enactment. To go back in time, the SarbOx Act of 2002 was being announced by US politicians that it has attained its purpose of restoring investors’ confidence in the securities market brought by the scandals involving Enron and WorldCom, but evidence shows otherwise. It may be stated that in first place, there is little evidence that a crisis of confidence occurred as a result of Enron and WorldCom.
Wallison (2004) investigated claim that the investors lost confidence in corporate America securities market due to the scandals that have entered the American psyche as to a result of scandals caused by Enron, WorldCom, and the other corporate scandals , which cause the SarbOx’ s birth. He was aware about the SEC official’s assertions about the need for new regulations to restore this depleted investors’ confidence that business leaders, media commentators, and politicians have spoken arising out of the corporate scandals as though it were a fact.
He however saw little evidence that said crisis actually occurred — at least among investors. The crisis of confidence was seen by him to be limited only among the political class and the media and but not in the markets. What he saw rather was a loss of confidence in the nation’s political leadership. See Figure I below. Source: Wallison (2004) A wrong view of the market that resulted in the wrong solution—that is to pass SarbOx. If indeed Wallison is correct then the problem is wrongly defined and serious consequences as to the wrong solution.
Thus SarbOx could not be responsive in return. What happened was to impose more control to companies. An example is the SEC’s proposal to augment the ability of shareholders by nominating non-management directors, while the other was the plan of the Financial Accounting Standards Board to demand from corporations to expense employee stock options. The intention was to put more control from an assumed lost confidence of investors when in fact there was none.
It was not established through lower prices of stocks as measured by Dow Jones because of the Enron scandal, yet the proponent made a sweeping generalization and hence came up with an unresponsive solution. The simple solution could simply be done by prosecuting the guilty parties instead of passing a law that would make it a burden for every body. A poll result made in July 2002 by NBC News and Wall Street Journal whether respondent would favor new laws to prevent fraud or focus instead on enforcing existing laws produced 33% for the first question and 63% for the second question (Wallison, 2004). . 4 What has been the financial impact? To determine whether there was a financial impact, there should be some basis whether the numbers of investments have actually increased in the stock market or whether more investments were put in the economy because of the restoration of the alleged loss of confidence from these investors. The primary purpose of the law to restore investor confidence by making it sure that reporting earnings are reliable.
To test this must be measured in higher price of stock in the stock market using the S;P 500-stock index. A continuous decline was however noted since the SarbOx Act was drafted in 2002. An objective evidence therefore is lacking to show that equity values have increase of companies on US stock exchanges. The figure below (Figure II) shows the stock price graph of Ford Motors, a US company, whose stocks are listed with the U. S. (Niskanen, 2007). Figure II : The behavior of US Stock after the SarbOx was passed in 2002 Source: Yahoo Finance (2008)
It may be observed above the stocks of a US company in the US stock exchanges has shown a continuous decline for the fast five years from 2002 when the law was drafted. Could it be that the SarbOx has not really benefited US companies because of added cost of doing business. Wallison (2004) had a closer study of the events in the stock market before and after Enron and WorldCom and he found little support for the proposition that investors having suffered any loss of the confidence in the stock market as a result of these events.
Finding the events not surprising, he set straight that dishonestly and manipulation of financial reports have always been inevitable of free markets. Such free market in the end reflects all aspect of human behaviour, good and bad. He maintained the possibility that a number of companies may have misstated their financial results and said misstatements were probably already priced into the market. He was in sense arguing that such things were normal in the marker that to expect investors to lose confidence in the securities market as a whole would be an overstatement.
What happens therefore was not a loss of confidence and therefore there was nothing to address and necessarily the law constituted as additional burden to investors and what could be expected is less investment in the US stock exchanges. Wallison (2004) explained the sophisticated investors’ was of understanding the deficiencies of generally accepted accounting principles (GAAP) as a financial disclosure mechanism and s for this reason that said investors have resorted to using cash flows rather than balance sheet numbers and earning per share to value companies.
The author was arguing on the use of cash flows rather than the book value income. He downplayed the belief that that investors would be shaken by the news that GAAP financial statements might be overstated, or that auditors might have committed some mistake in overlooking errors that allow corporate management to hide adverse results and display constructive ones (Whittington ; Pany, 1995). 2. 6 Has it improved competition locally and globally? It appears that it has not improved competition locally and globally.
It has instead driven foreign companies that would have been investors in the US. Investors instead located for securities market outside the US like the London Stock Exchange (World Net Daily, 2008). How could it improve competition when American investors have become more risk- averse? How could it improve competition when it has added to cost of doing business in the US. The answer is really very obvious. SarbOx Act was an overreaction to solve a wrongly perceived loss of confidence of investors.
No wonder because of wrong definition of the problem, the press and the political class succumbed into panic, imposing that that the act was necessary to fight a crisis of investor confidence in the stock market. The appearance on cable news and talk shows of Former SEC chairman Arthur Levitt, would confirm this since the latter kept repeating that that accountants had been tempted by the consulting work they did for their auditing clients. Every work of the accountant was doubted on the accuracy of their audit reports and certifications.
However, Wallison (2004) on the other hand, saw that the close movements of the Dow at that time that SEC chairman was making those talks could be used to indicate the actual reaction of investors. He found mo relationship between key events in the Enron-WorldCom- Sarbanes-Oxley story and the performance of the markets. An objective mind may easily the point of Wallison as a closer look at the market fluctuations reveals a different story. There was stock market stability until July 9 and 10, when President Bush and Congress called for immediate action to deal with the corporate fraud.
Thus Wallison (2004) saw the Senate having rushing the Sarbanes bill to the floor, and had it unanimously passed on July 10. From these two days, the Dow fell by 179 points on the day President Bush has delivered a speech followed by another 283 points on the following day, July 10. It was really clear to see that from that moment there was no indication that SOX restored investors’ confidence. With more difficulty to see the effect for the last five years then than when the law was improved. See Figure below.
Wallison (2004) explained that the president’s speech and the Senate action were clear indications that tough and heavily demanding bill was coming, so to interpret the huge declines in the Dow on July 9 and 10 has basis in fact that investors’ reaction to the new legislation was negative. He pointed the fact that that news media thought that the declines on these two days to be extra evidence of a crisis of investor confidence. Nothing could be more illogical indeed to see negative reaction when the solution was made with resolve.
What was seen indeed was lost confidence in the country’s political leadership than in the stock market since politicians are reacting as if they understood everything about the market. To prove this point Wallison (2004) found the claim of restored investors’ confidence due to the enactment of SarbOx as merely outrageous. This is due to the development of the following two weeks, from July 10 to July 24, when the Sarbanes bill had it way to approval via the congressional process, yet he found no increase in increase in the Dow Jones index.
The market even plunged ironically. So where is the claim of restored confidence at that early part of the game? Why need to wait for five years to see the effect when at the moment, the error was glaring. See Figure I above. Congress passed the bill on July 24 and after which it was sent to the president for his signature but Wallison (2004) asserted that it was already forgone conclusion. This is based on the 936 points gained by Dow between July 24 and July 29 which he explained to be an unlikely result of the congressional action on the bill.
For him, the law had become a virtual certainty as early as July 10 since there was no political opposition to the said legislation and therefore the same could be considered approved. His point was that it could not be the reaction of investors to react positively on the approval of the SarbOx associated with Dow increase from July 24 and July 29 since he believed that July 10, was the more substantial date to react on the basis of lack of opposition at that time which was known to the public.
When analyzed further, it should sound very convincing to witness a Dow Jones’ fall by another 700 points shortly after the president signed the law, on July 30. This contradicts the claim the investor’s lost confidence being restored by SarbOx (Wallison, 2004). See Figure I above. 2. 7 Has it protected shareholder earlier? The issue on whether it has protected the stockholder still remains to be seen there it could not be readily concluded that the absence of scandal has in fact resulted due to the passage of a law. It would be modest to state that the time has not yet come.
But the amount reduced investment caused by SarbOx, there is great chance the investor has in fact been protected but it has also reduced the amount of investment that was expected to increase as effect of the intended protection caused by the law. Therefore on the overall it could not be said that investors are protected since it did not work for their advantage. 2. 8 Have the financial markets become more efficient as a result? There is no evidence that financial markets become more efficient as a result. It can be concluded that the SarbOx is not working.
The analysis revealed that there was a wrong definition of the problem and what could be expected was a wrong solution to the wrong problem. There is not basis to the claim that the SOX has restored investors’ confidence as a way of addressing problems caused by Enron scandal if the Dow Jones Industrial Average is used as basis. Evidence is lacking that the Enron Scandal has caused declined in the Dow Jones Industrial Average and no evidence is also available to indicate the sure passage of Sarbanes-Oxley Act on July 10, 2002 resulted to increase in the Dow Jones.
The signing of therefore of the SarbOx in 2002 was not even an occurrence to prove its claim on July 30, as the Dow fell another 700 points at that time. Lacking therefore basis to have restored investor’s confidence, it could be concluded that its effect was contrary to the claim. A decline of the number of companies wanting to enlist in US stock exchanges was a proof of the failure of SarbOx to address the problem. It was the just overzealousness of the proponents that that they got attracted to the many requirements of the law and this has caused an added cost of about a trillion dollar to American companies.
This has caused foreign companies to choose other securities market outside US, such as the London Stock Exchange. Knowing the real effects of SarbOx would perhaps put things better perspective. Since Wallison (2004) found very little evidence that Enron, WorldCom, or Sarbanes-Oxley had anything another than a short-term and significant effect on stock prices, it could not be easily accepted that the law had indeed made markets more efficient.
He even clarified that even said seeming influence is ambiguous and unclear. He argued that if Enron and WorldCom had indeed caused crisis in investor confidence, investors should have witnessed a sharp and sustained fall after the news. He discovered instead choppiness as shown by the Dow Jones’ swelling by large percentages over a brief period after WorldCom. At that Congress reacted by legislating while the media was telling investors that the investors had lost confidence in American corporations.
He described the two months following the said period, when the market resumed a long-term downward trend that he rather associated with the then oncoming war in Iraq by the US. In SarbOx was indeed effective, it could have shown so for a period of nearly eight months after the bill was made into law yet the evidence did not show. Not being consistent with the claim of restoring investors’ confidence, the SarbOx Act of 2002 made American companies to spend about $1. 2 trillion or higher in terms of additional business cost.
Compliance with the Act’s requirements necessarily fulfils the incurrent of added cost for doing business. Because of it, a capital flight from US stock exchanges to London Stock exchanges and while favoring the latter to become the new hub for capital markets (World Net Daily, 2008) are factual events. One particular example that is causing headache to investor is requirement for the SEC to adopt rules governing independence and roles of audit committees which other countries seem not to require and hence making the latter more attractive (Cunningham, 2003). 2. Final recommendation It is therefore recommended that the law should be scrapped since it failed to address the problem. Instead of adding benefit, it has resulted worse locally and internationally. Locally, it is disadvantageous in the sense that it was more costly for the domestic companies to operate due to the added cost of doing business. The law has also made US companies less competitive as compared to other foreign companies as their counterpart in other countries. Mere modification is not recommended because the law was made to answer for wrongly defined problem.