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Source link: http://archive.mises.org/6155/dirty-sox/

Dirty SOX

January 18, 2007 by

CNet is reporting that start-ups in Silicon Valley are feeling the strangle hold of the much maligned Sarbanes-Oxley Act (SOX).

One industry veteran that recently left a web-based photo-service is Netscape co-founder Jim Clark, citing SOX as the motivating factor. As a venture capitalist and serial entrepreneur he gave up his leadership position (chairman of board) in the company he helped found, in order to maintain SOX compliance.

And other venture capitalists view the Act as a deleterious regulation, such as Andy Goldfarb, who noted that, “SOX has hampered our capital markets for start-up companies.”In addition,

“Jim Clark is not atypical and not unique,” said Steven Kaplan, a professor of entrepreneurship and finance at the University of Chicago’s Graduate School of Business. “I have friends who’ve said they won’t go on public (companies’) boards,” he added, noting that venture capitalists like Clark are often the quickest to bolt from their posts.

The problem of course is that industry veterans with keen business insights and technological acumen will stay away from joining any board, due to the potential lawsuits. In the long run, this will only harm start-ups, the Valley, and consumers because firms will not be able to attract the top management whom can offer the most effective solutions in this dynamic environment.

Ahh, but according to some pundits, there is a silver lining,

But there’s another side to the coin: yes, SOX might be less than ideal for a Silicon Valley start-up, but plenty of companies are going to have to deal with it anyway because it’s not going anywhere. Lorsch said that the Shutterfly resignation was “an extreme case” and doesn’t think that Silicon Valley will see many more Jim Clarks.

“I can’t believe there would be a lot of people resigning because of Sarbanes-Oxley,” he said. “They may complain, but I don’t think they’re going to cut off their noses to spite their faces because of it.” The situation, therefore, could be analogous to some of the Federal Aviation Administration’s limits on how much liquid can be contained in a carry-on bag: irritating and inconvenient, yes, but not enough to make the average transatlantic traveler opt to hop on an ocean liner instead.

What Lorsch misses are the unseen effects of this legislation – the unintended consequences. Frederic Bastiat noted that the difference between a good economist and bad one is that the latter can only see the visible effects of a law, whereas the good economist sees both the seen and the opportunity costs, those options foregone. And in this case, the opportunities forsaken under the rhetoric of “security” are: wisdom, knowledge, and aptitude.

Thus the reason why you would not see any more Jim Clarks leave would be the simple fact that competent individuals like him would never join a regulated firm in the first place. Just ask Tim Draper.

More on SOX: 1 2 3

{ 4 comments }

Walt D. January 19, 2007 at 12:56 am

The draconian penalties associted with SOX do influence corporate behavior in a big way. First, in the financial industries, it moves people away from in-house methods, to “accepted methods”. The rationale is that a failure using “accepted methods” is easily justified, whereas a failure associated with “in-house” methods is liable to cause problems.

The lesson to be learned from the 2000 on period is that the regulators punish failure after the fact as opposed to poor business practices before the fact. The prevailing attitude is that business failure is equivalent to malfeasance. In a free market some businesses will fail and some will succeed. That does not entail malfeasance on the part of the former and acumen on behalf of the latter.

So for the startup business about to go public, a serious question for the principals is whether they want to risk a 20 year jail sentence in the event of a meltdown.

This is behind the growing trend for US startups to go public in Europe to avoid the cost SOX compliance and capricious behaviour of the SEC.

kurtbattais January 19, 2007 at 3:11 am

Larger corporations can amortize the cost of SOX compliance much easier than start-up companies. I’m glad the media is taking some interest in this now. Did SOX actually help shareholders? At what cost?

N. Joseph Potts January 19, 2007 at 8:42 am

All this stuff about SOX costs merely points up the (mostly hidden) costs of securities regulation in the first place.

The costs of enterprises not launched and innovations not commercialized are the classic example of “what is not seen” that Frederic Bastiat first and best brought to public awareness 150 years ago (most of the public remains yet to gain this awareness, however).

SOX is only the latest affront in a long series that seems, in the US, to have begun around 1933. SOX is mooted to be rolled back somewhat after the soon-anticipated retirements of Sarbanes and Oxley from the Congress. But not rolling back any of the securities regulations that preceded it will leave the bulk of the causes of the hidden damage (what never happened, and continues not to happen) operational.

Pity.

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