SOX Act Slows Down Financing

SOX Impact on Corporate Financial Reporting

The Sarbanes-Oxley Act of 2002 (SOX) led to widespread changes in how governance, risk, compliance, financial reporting and decision-making are managed in publically-held coproratio9ns today. Experts in the field of governance and compliance have concluded that the SOX Act immediately redefined the scope of financial reporting and risk definition (Hagerty, 2006). This was especially prevalent in the bond markets, where forcing greater disclosure of financial performance and material events including Section 404 of the Act (Sarbanes-Oxley Act, 2002) led to more oversight of just how bond debt instruments were structured and implemented over time (Boubakri, Ghouma, 2008). The net effect of the SOX Act continues to be seen today with positive and negatives changes to corporate financing taking place, and they are analyzed in the following section.

Positive and Negative Changes to Corporate Financing from the SOX Act

The SOX Act was deliberately written to be non-prescriptive as previous legislation that had been highly prescriptive in nature failed to stop widespread corporate financial fraud as exemplified by Enron, Tyco, WorldCom and many others (Engel, Hayes, Wang, 2004). Being deliberately on-prescriptive in defining the core components of the Act gave Congress the flexibility of a more precise definition of the most critical sections to corporate governance, risk and compliance (GRC) as they relate to corporate finance. These sections include the following, and each has a significant role in defining the current and future role of corporate finance within publically-traded companies listed on American-based stock exchanges:

Section 302: Corporate Responsibility for Financial Reports

This section of the act require that firms be proactive in how they define their audit, verification and corrective action/preventative action (CAPA) workflows to ensure traceability and clarity (Engel, Hayes, Wang, 2004). Follow on studies have shown the strengths of requiring audit and verifications have a complementary effect on bond performance and the ability of enterprises to anticipate demand for specific bond issuances (Boubakri, Ghouma, 2008). Another advantage of this specific section is that it forces a high level of standardization throughout an entity to ensure consistency of audit performance. This saves a significant amount of time and reduces confusion while streamlining the periodic reporting now required as part of the Act (Hagerty, 2006). A third positive change of this section is that it also provides investors with a much clearer focus of how companies offering securities are managing variations in specific reporting requirements, which ties to Section 404 (Engel, Hayes, Wang, 2004). Downsides of this section include the additional cost required to put systems in place that can manage the overall workflows. There is also the educational time and system costs for implementing corrective acitio9n systems and reporting standards (Hagerty, 2006). Third, change management is often the most difficult area of all to navigate when ti comes to reporting accounting variances (Engel, Hayes, Wang, 2004). This is the longest-term challenge many of the companies working to streamline SOX reporting face today, and is the most difficult as it requires a change in behavior and beliefs of the people working with the systems that provide audit data (Hagerty, 2006).

Section 404: Management Assessment of Internal Controls. This section specifically calls out the need for internal controls over the financial reporting systems of a company, ensuring they are auditable by a third party. Section 404 also defines the requirement of reporting a material event by the corporation and its officers (Sarbanes-Oxley Act, 2002). These two factors of auditabil8ty and definition of material event is far outside the boundaries of process and system definition for many companies (Hagerty, 2006). As a result, it has been a strong source of revenue for outsourcing providers. The positive changes to corporate financing Section 404 has created include greater accountability for material financial events, more focus on cost and reporting controls, and personal accountability to the C-level for all financial reporting. The negative changes include much greater reliance on outside service providers for the expertise to manage this reporting (Hagerty, 2006), loss of control over process redefinition and new system development (Engel, Hayes, Wang, 2004), and greater reliance on funding sources that don't require so much reporting and incremental costs to be in compliance.