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Source link: http://archive.mises.org/4345/a-misguided-defense-of-sarbanes-oxley/

A Misguided Defense of Sarbanes-Oxley

November 16, 2005 by

Alan Murray of the Wall Street Journal defends the Sarbanes Oxley Act, arguing that its costs do not explain why more companies are going private. In contrast, the CEO of Georgia Pacific explained that his company sold out to private Koch Industries in order to avoid mounting Sarbox costs. Murray claims that estimated annual auditing costs of $14 million (on average) are small compared to CEO compensation and stock options. This comparison is inappropriate. Management compensation is determined by supply and demand, while auditing costs are forced on companies by regulation. The costs of management services are set by markets, and can be consciously increased or decreased depending on whether they achieve a sufficient return on investment. Absent regulation, most companies clearly would not have spent 45% more in 2005 on wasteful, duplicative, and over-cautious audit checking activities that have no discernible benefit to shareholders. Secondly, auditing cost estimates tally up fees, insurance premiums, and other direct costs. They do not factor in related costs such as management distraction, diversion of employee man hours into time-wasting activities, and Sarbox’ general discouragement of corporate risk taking. Finally, Murray seems to misunderstand that auditing fees appear small in relation to the total revenues of a giant corporation like General Electric, but are actually a shockingly large percentage of the revenues of small businesses and start-ups seeking to go public.

Murray repeats the mantra that Sarbox has forced some companies to make needed improvements to internal controls. No doubt, a company that had poor controls may have improved them in order to comply with Sarbox. This does not mean that U.S. businesses in aggregate benefited from Sarbox. A law mandating a 45% increase in marketing spending might help some companies too, but it would cripple most others. Even companies with superior internal controls were forced by this perverse law to spend more money on internal controls. Moreover, Murray ignores opportunity costs. Perhaps a company would generate higher shareholder value by increasing its marketing spending rather than by improving auditing controls. Sarbox does not allow companies to decide for themselves how to allocate scarce resources, and hence causes inefficiency in the aggregate.

{ 8 comments }

Steve November 16, 2005 at 1:26 pm

Yes, it is sad that most people are so blind at what should be so obvious in the world of economics and business. The Sarbanes-Oxley law got started ONLY because of the failure of just two companies: Enron and Worldcom. The irony of it all is that existing laws took care of the miscreants who committed the massive frauds in the two companies. The next malfeasance committed will not be prevented by Sarbanes-Oxley, guaranteed.

MLS November 16, 2005 at 1:32 pm

The Sarbanes-Oxley Act really boils my blood. What is the purpose of this? Was the market bad at regulating insider trading? NO – I can think of several actual companies whose sole business has been providing insider information for public companies. The external shareholders acutally paid these companies to keep track and report all such insider trades. Offhand I can think of three such companies Computershare (1978), EDGAR-online (90s?), and CapitalIQ (?). They are actually linked through finance.yahoo.com. This information has been available for quite some time. It’s an abomination that the powers that be are enforcing this costly inefficient regulation across the board (hurting small players) just because there were a few bad apples in the market. Bad apples that were initially spotted in the market itself. Hmm, where is the force that prevents government insider dealings?

Grumbledook November 16, 2005 at 1:53 pm

As best as I can tell, Sarbanes-Oxley was enacted because (a) legislators wanted to be able to tell their constituents that they were doing something about corporate governance (2002 was an election year); (b) CEOs wanted political cover. The public at large, apparently, was also in favor of the legislation. But I would wager that the vast majority of workers who are actually involved in making sure their companies are complying with Sarbanes-Oxley (e.g. accountants, network administrators and other MIS types) do not think Sarbanes-Oxley was a good idea.

William November 16, 2005 at 5:48 pm

The costs are in the billions and the total cost can never be determined. The lost opportunity is so huge that it the politicians do not even want to estimate how vast. Executives simply can not take the risks that they have prior to the law. Then these executives must account for the decisions in a manner far more accurate than Wall Street needs. This double whammy is huge in terms of lost time and opportunity.

Jeff Scott November 17, 2005 at 2:29 pm

Be sure and see the NYTimes piece on the Koch and Georogia Pacific deal. My favorite part is the last paragraph: One advantage for Georgia-Pacific, Mr. Koch said, is that the deal will transform it into a private company, with less pressure on short-term performance and less need to pay out its earnings in dividend. When Mr. Correll explained that yesterday to Georgia-Pacific employees in Atlanta, one person who was there said, he received a standing ovation.

Jeff Scott November 17, 2005 at 2:33 pm
Terry November 17, 2005 at 11:32 pm

I find, as a public company CFO myself, that the greatest irony of all is just who foisted Sarbox upon us. How I wish that all the members of Congress had to personally sign off on the accuracy of all of the accounts within the US governement. Oh, how I wish they would hold themselves accountable to the precise degree that the seek to hold me accountable. The vast amount of money that disappears from the government makes both Enron and Worldcom pale in comparison.

And, lastly, Murray’s article appears to be little more than more whining about highly compensated CEOs.

Matt May 11, 2006 at 11:28 pm

“Even companies with superior internal controls were forced by this perverse law to spend more money on internal controls.”

I’d have more faith in this statement if it came with examples/explanations of how it is so. I’m not claiming that it isn’t true. I’m simply saying that I see no more reason to believe a bald statement like this than SOX supporters’ positive statements.

I followed a link to this discussion because I thought that it might shed light on the subject. Instead, I find that the most interesting parts were already quoted in the referring page.

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