Sarbanes-Oxley Act: Impact on Corporate Governance

Introduction: SOX and Corporate Governance Regulation

The Sarbanes-Oxley Act of 2002, along with altered exchange listing requirements, enforces uniformly high levels of external director supervision across all companies. Nevertheless, research indicates that corporate governance structures — comprising boards of directors and related bodies — are elected endogenously by companies in response to their singular contracting and operating environments. Using the relative benefits and expenses of external director supervision as a benchmark, one can identify major cross-sectional differences in the wealth effects surrounding the announcement and passage of such regulations and standards.

What this means is that companies incurring high supervision costs and receiving fewer benefits from external oversight were the ones that benefited least from the act. Specifically, firm age and size are positively associated with the passage of these regulations, while growth opportunities and uncertainty in a company's operational environment are negatively associated with wealth effects. As Wintoki observes: "The results suggest that a blanket 'one size fits all' governance regulation may be detrimental to certain firms, particularly young, small, growth firms operating in uncertain business environments, that are costly for outsiders to monitor." (Wintoki 229)

Effects on Board Composition and Director Supply

Research examining the impact of the Sarbanes-Oxley Act of 2002, along with other modern reforms, on boards and directors — studied through their effects on the supply and demand for directors — suggests that SOX has had a negative effect on director workload and risk, increasing both by reducing the supply of directors while simultaneously augmenting demand through the mandate that more firms increase their number of external directors.

Firm size produced both cross-sectional and broad-based modifications. Among these changes, board committees increased their number of meetings following SOX, and Director and Officer insurance premiums approximately doubled. Post-SOX directors are now more likely to be consultants, lawyers, retired executives, or financial experts, while current executives are less likely to serve in director roles. Additionally, SOX generated larger and more independent boards overall. As Linck concludes: "Finally, we find significant increases in director pay and overall director costs, particularly among smaller firms." (Linck 3287)

Legislative Origins and the Case Against SOX

To further evaluate the Sarbanes-Oxley Act, one must examine the literature surrounding both its efficacy and its origins. As Romano argues, the act was ill conceived: "SOX's corporate governance provisions were ill conceived. The political environment explains why Congress would enact legislation with such mismatched means and ends. SOX was enacted as emergency legislation amid a free-falling stock market and media frenzy over corporate scandals shortly before midterm congressional elections." (Romano 1521)

During the final stages of the Senate legislative process, governance provisions were introduced late and received little focused deliberation. The interaction between the Senate Banking Committee chairman and election-year politics — stirred on by the interests of policy entrepreneurs — drove the inclusion and creation of SOX. Literature that opposed the provisions brought forward by the act was not brought to Congress's attention until much later, and was in fact ignored whenever such information was referenced. Unfortunately, this kind of decision-making is not an isolated occurrence within Congress.

As Romano further notes: "Much of the expansion of federal regulation of financial markets has occurred after significant market turmoil. The Article concludes that SOX's corporate governance provisions should be stripped of their mandatory force and rendered optional." (Romano 1521) SOX is widely considered a legislative mistake. To help mitigate future errors of this nature, crisis-mode or emergency legislation must include provisions for reassessment at a future date, when more thorough deliberation can be performed.

Conclusion

Both negative and positive aspects of SOX's impact on American companies have been examined here. Although the negative effects outweigh the positive, the act has not been a complete waste. Increased disclosure helps regulate businesses and allows for greater supervision. Furthermore, SOX and acts like it in the future must be carefully reflected upon before being implemented. Congress has, in the past, made many mistakes in passing legislation.