The Sarbanes Oxley Act, named after its two main sponsors, Senator Paul Sarbanes and Congressman Mike Oxley is a legislation that must be complied by all business in the U.S. The act consists of 11 titles and 66 sections and was drafted after the stock market disaster in the 1990’s. The act has its positives and negatives but the focus on this assignment would be on the negatives mainly the burdens it puts on companies trading on the stock exchange.
Introduction
Ever since the introduction of the Sarbanes-Oxley Act (SOX) in 2002 there have been debates over the benefits and drawbacks of such a legislation. While they really isn’t much we can do about it now as its being already enforced the arguments still stands. Signed into law in July 2002, the Sarbanes Oxley Act encourages managers and auditors to ensure that the information on the financial statements were accurate. Due to this many companies have had to re-evaluate their accounting practises before subjecting those practises to the standards required by SOX.
Sarbanes Oxley Act 2002: The Burden it places on companies
Many economist and financial personnel believe it’s just another burden on business and I can’t help but listen to their dispute seeing as it was made to protect businesses from having misleading information on their accounts. It’s a funny dispute as one of Sarbanes key objectives was to restore investors’ confidence after the whole Enron scandal and others which took place. This fraudulent actions were the catalysts for this act to be enforced. Now I will try and state the negatives experienced through the initiation of the Sarbanes Oxley Act: Cost of Compliance
Galvor Company Business Plan
Case 10-3: Galvor Company Background Galvor Company was founded in 1946 by owner, and president M. Georges Latour. The company had acted as a fabricator, buying parts and assembling them into high quality, moderate-cost electric and electronic measuring and test equipment. Latour had always been personally involved in every detail of the firm's operations as in most family businesses. Fiscal ...
They are direct and indirect cost to compliance to SOX regulations such as the increase in personal liability obligations, costs associated with internal control and improvements and also the costs to the U.S financial market. A study by CRA International brought the result that in the 1st year of the SOX implementation, for larger companies (those with a value of at least $700 million), the cost of Section 404 was around the region of $8.5 million. For smaller companies (valued between $75-$700m), the average cost was near $1.2 million. Companies valued lower than $75 million have not been asked to comply with Section 404. Although Section 404 costs are supposed to significantly reduce during the 2nd year the costs are still higher than first expected, although the cost might not be high if you are a big company but for small firms the cost might seem a significant amount and their percentage in comparison to the value of the company are higher.
Cost to Financial Market: U.S Companies
The SOX is forcing many companies to consider going private due to the high costs and burdens. This could lead to less companies being traded on the stock exchange or rather than going private some companies are deregistering from exchange which is a process which takes away the need for them to disclose their financial information. These companies can still buy and sell shares however their prices will be listed on the National Quotation Bureau’s list of daily quotes for companies not trading on the stock exchange.
As a result of this fewer companies would be willing to trade in the U.S market. The SOX make trading publicly very costly for firms and the
maintenance required high which also has the effect of making companies look to other means and ways to raise capital. For many foreign companies the cost of trading in the U.S market would now look bleaker thus making them hesitant so commit. Furthermore it pushes U.S investor to invest more in foreign markets.
Foreign companies are also hesitant about the requirements that SOX regulations would impose and are reluctant to commit to the U.S. capital markets. U.S. institutional investors are becoming more willing to invest in foreign markets. Fees and Audit
The Essay on Types of Cost Audit
* Cost Audit to assist Management : The main object of this type of cost audit is to make available accurate, relevant and prompt information to management to assist it in taking important managerial decisions. * Cost Audit on behalf of the Government: The government may appoint a cost auditor to conduct cost audit where it is necessary(a) to do so in the opinion of the government under section ...
Due to the need of companies to perform extra work in the auditing of their accounts in order to gain knowledge and partly due to the loss of income from higher margin consulting work, audit fees will see an increase. This will not just affect some companies like those involved in fraudulent behaviours; instead all companies will experience higher costs. An article in CFO.com cited 23% audit hike in a sample of North and South Carolina firms, with one company incurring over 120% increase. A Financial Executives International (FEI) survey revealed the first year compliance cost to anything in the region of $2 million to $5 million with many companies seeing more hours devoted to compliance work and less on other major activities.
The act also applies to firms that audit U.S companies on the stock exchange. This could result in foreign subsidiaries or accounting firms choosing not to become involved in with a client’s operation in its home country due to the strict regulation being enforced in the U.S. This would result in the U.S companies having to audit the foreign subsidiaries of the clients which just adds more to the cost they are already incurring.
Auditors are also asked to report on the effectiveness of internal controls over financial reporting and management assessment as part of the audit, this itself would lead to increased charges as audit firms would have to spend more time evaluating controls or audit areas with low reliance on controls. It is very unlikely that all this additional work will go uncompensated which is why most audit firms can charge more to the public companies as opposed to their original charge prior to the SOX act. Other Risks
Through new requirements and increased penalties and enforcement, SOX has created a risk that corporate and directors will be subject to personal and criminal liability. This risk has transferred into increased legal fees as well as compensations for the executives, board and officers. Also another adverse effect of this would be higher premiums and outsourcing fees to help monitor internal audits. Reduced Competition
The Term Paper on Audit Firm Size And Going-Concern Reporting Accuracy
... increase the audit effort of non-Big firms relative to Big 4 firms because smaller audit firms cannot obtain a similar level of backing from insurance companies. ... study focuses on changes in reporting surrounding the Sarbanes-Oxley Act of 2002; and the Geiger et al. (2006) ... Securities Litigation Reform Act. Accordingly, while prior research generally finds a consistent Big 4 audit quality effect in ...
Certified Public Accountants (CPA) have an oligopoly in the provision of audit services. As a result of the SOX the numbers of firms that offer audit services to these public companies will reduce as many companies will find it better to concentrate on other aspects of their business such as consulting and in time exit the auditing field due to the stringent requirement of SOX. This would create a monopoly in audit services furthermore increasing the price they charge to public companies.
Conclusion
While the Sarbanes Oxley act had good intention as it was drafted to restore investor confidence in the U.S market after the Enron, WorldCom and other scandals that took place. In trying to avoid such scandals taking place the SOX act has made things much harder for public traded companies. Much of the blame for the high prices should be directed towards accounting firms as they have become one of the businesses to benefit from this act much to the surprise of everyone seeing as they were the culprits in the Enron and WorldCom scandals. Accounting and audit firms are more than happy to comply with Section 404 as it strengthens their reputation and minimises the chances of them getting sued over irregularities. These companies are earning a lot of money by selling their services. A company can be exhausted in its effort to comply with the stringent regulations while at the same maintaining spread sheet-reliant financial and information systems. Furthermore it might be a key determinant in foreign companies trading in the U.S market as it might discourage them from listing in the U.S market as the benefits may not outweigh the costs of the U.S regulatory and legal compliance. Also small public companies with similar concerns might try and converge to private markets.
References
The Impact Of Sarbanes Oxley On Companies, Investors, & Financial Markets. [ONLINE] Available at: http://www.s-ox.com/dsp_getFeaturesDetails.cfm?CID=1141. [Accessed 4March 2011]. Shottenkirk, Jerry, Daily Journal of Commerce, “Sarbanes-Oxley complex, burdensome to companies” | North America > United States from AllBusiness.com. [ONLINE] Available at: http://www.allbusiness.com/north-america/united-states-oregon/1060655-1.html. [Accessed 6 March 2011]. Gifford. Richard, Howe.Harry, Regulation and Unintended Consequences: Thoughts on Sarbanes-Oxley. [ONLINE] Available at: http://www.nysscpa.org/cpajournal/2004/604/perspectives/p6.htm. [Accessed 6 March 2011]. Cieselski. Jack, Weirch. Thomas, Ups and Downs of Audit Fees Since the Sarbanes-Oxley Act. [ONLINE] Available at: http://www.nysscpa.org/cpajournal/2006/1006/essentials/p28.htm. [Accessed 6 March 2011]. Regulating business: The trial of Sarbanes-Oxley | The Economist. [ONLINE] Available at: http://www.economist.com/node/6838442. [Accessed 8 March 2011].
Sarbanes Oxley Act Research Paper
Abstract The purpose of the Sarbanes-Oxley Act is to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities law, and for other purposes. (Lander, 2004) The Act created new standards for public companies and accounting firms to abide by. After multiple business failures due to fraudulent activities and embezzlement at companies such as ...
