Sarbanes Oxley Act and corporate governance

Sarbanes-Oxley Act & Corporate Governance

The Sarbanes-Oxley Act, also known as the Public Company Accounting Reform and Investor Protection Act of 2002, was enacted on July 30, 2002, as a response to a plethora of accounting scandals that had recently plagued corporate America.

Powerful companies such as Tyco International, Enron, Adelphia, and WorldCom had fraudulently adjusted financial records that ended up costing shareholders billions of dollars, when the truth came to light and their stock prices plummeted. Sarbanes-Oxley is one of the most comprehensive pieces of accounting reforms, since the days of Franklin D. Roosevelt (Bumiller, 2002; Wegman, 2007). The aims of this legislature was to prevent future fraudulent corporate finance reporting, by tightening corporate governance regulations (Grumet, 2007).

Sarbanes-Oxley Act & Corporate Governance

Introduction:

The Sarbanes-Oxley Act (the Act), also known as the Public Company Accounting Reform and Investor Protection Act of 2002, or simply SOX, was enacted on July 30, 2002, as a response to a plethora of accounting scandals that had recently plagued corporate America.

Powerful companies such as Tyco International, Enron, Adelphia, and WorldCom had fraudulently adjusted financial records that ended up costing shareholders billions of dollars, when the truth came to light and their stock prices plummeted. Sarbanes-Oxley is one of the most comprehensive pieces of accounting reforms, since the days of Franklin D. Roosevelt (Bumiller, 2002; Wegman, 2007). The aims of this legislature was to prevent future fraudulent corporate finance reporting, by tightening corporate governance regulations (Grumet, 2007).

Sarbanes-Oxley Act & Corporate Governance:

As far as legislation is concerned, Sarbanes-Oxley is still a fairly recent enactment. The Act was designed with a series of procedures to make certain that publicly traded companies implemented adequate financial controls, in hopes of avoiding future accounting scandals, such had been experienced with Enron, WorldCom, and the like, which had shaken investor confidence to the bone. In addition to the implementation of these controls, the Act also requires documentation and certification of these controls, to ensure accuracy. These requirements are strictly enforced with more severe punishment than in previous corporate history, including: personal liability, as well as criminal penalties possibly applied to corporate financial officers, according to Montana (2007).

It marks a notable change in accounting history, taking away the industry's ability to self-regulate, that it once enjoyed, instead placing regulation in the hands of the Public Company Accounting Oversight Board (Wegman, 2007). As a new piece of legislation, the intricacies are just now coming to light, as corporations fully implement the requirements.

Cost of Corporate Governance Due to SOX:

As in any revolutionary piece of legislation, there are those naysayers that look beyond the important overall goals of the Act and instead have focused on the less than attractive challenges specifics of implementation. One such issue is the cost of compliance, with the Act, which has been considerably higher than originally anticipated. In particular is the cost of compliance with Section 404.

Section 404 specifies the internal control systems now required for public companies, via the Act.

Section 404 "requires management at (...) companies to assess the effectiveness of their internal controls over financial reporting and issue their findings in a public report. The legislation also mandates that auditors attest to management's findings, perform an independent assessment of control reliability, and issue their own report" (Bradford & Brazel, 2007).

However, because of the costliness of this requirement, many believe it is especially unfair to small businesses who are already struggling to be competitive in an increasingly hypercompetitive, globalized economy.

As such, small, public companies have been given a temporary reprieve from some of Section 404's strict and costly requirements. In addition, there have been new guidelines set forth for auditors, with a hopes of reducing the cost of compliance of the Section, for all companies (Basilio, 2007; Grumet, 2007).

Bradford and Brazel (2007) note that these costs due indeed seem to be decreasing. In research they quote from AMR, organizations spent $4.5 million on compliance with the Act, in 2004. This was reduced to $3.8 million in 2005, and further decreased to $2.9 million in 2006.

However, despite these decreasing total costs of compliance, the Act is still a costly requirement for public companies. Bradford and Brazel (2007) further cite a study by Foley and Lardner, LLP, in 2005, that indicated costs of corporate governance for smaller publicly traded companies had increased by 233%. And, due primarily to compliance with Section 404 of the Act, large corporations paid $14.3 million in efforts to comply, on average.

These exorbitant costs have led many corporations to reconsider there position as a public organization. From 1998 through 2004, 920 companies voluntarily deregistered their organizational securities, with the SEC. Of that figure, nearly half (450) deregistered in 2003 and 2004, following the implementation of the Act (Bradford & Brazel, 2007).

It becomes increasingly clear that the Act has become a deterrent for corporations considering going public, as they must seriously consider whether these costs of corporate governance are worth the benefits of becoming a public corporation.