Business Essays - Sarbanes-Oxley Act


Sarbanes-Oxley Act

In the aftermath of the post-boom financial scandals in the U.S., Congress revised significantly federal securities laws and ratified the Sarbanes-Oxley Act in 2002 (SOX). As noted by Coffee (2006, p. 16), the intent of the new legislation was to “protect the integrity of financial reporting by redesigning the network of institutions and intermediaries who served investors in order that the capital markets would not be systematically deceived again.” SOX imposes several changes to the governance and regulatory environment in the U.S. including, (1) heightened disclosure, (2) separation of analysts from underwriters, (3) requiring attorneys to report crimes or fraud without delay, and (4) requiring senior management to personally certify their corporations’ quarterly financial results. In addition, audit committees were given enhanced powers, with a new quasi-public self-regulatory system put in place.

Some observers have concluded that the overall impact of SOX is beneficial as a consequence of improved transparency and disclosure, with heightened monitoring providing better control of agency costs. Indeed, a governance metrics international survey (GMI) claims that U.S. companies have gone up to the top of an international comparison of corporate governance standards, leave behind the U.K. The report suggests due to SOX and similar reforms, the performance of large U.S. increased by over 10%.

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However, opponents of SOX have argued that the costs of compliance are excessive. For example, a survey of corporate board members by Korn/Ferry International estimates that the costs of compliance average $5.1 million, while Parsons Consulting estimates that costs average $12.28 million for 70 British headquartered businesses. (Lorne N. Switze, 2007)The annual survey of Foley & Lardner LLP suggests that the costs associated with SOX are particularly onerous for small and medium-sized companies, with smaller firms lacking the requisite compliance infrastructure. Adherence to Sarbanes-Oxley Section 404 (Management Assessment of Internal Controls) is deemed in their survey to be the most problematic, with estimated compliance costs ranging from $350,000 to $1 million to assess and document the scope, adequacy, and overall effectiveness of the internal control structure and procedures. According to the most recent Foley & Lardner survey, since the enactment of SOX the average cost of compliance for companies with under $1 billion in annual revenue has increased more than $1.8 million to approximately $2.9 million, representing a 174% overall increase. (Lorne N. Switze, 2007)The U.S. Government Accountability Office also has suggested that small businesses’ costs for implementing the disclosure requirements of SOX rules are disproportionately higher than large firms. Recently, the high costs of compliance have been alleged to the impetus for several international companies to delist from U.S. exchanges.

The Sarbanes-Oxley Act is the single most significant piece of legislation embracing corporate governance since the U.S. securities laws of the 1930s. At the forefront of this legislation, is the intent to restore public confidence and interest at a time when there was an avalanche of corporate scandals. The cost and financial cost of implementing the act will, no doubt, be significant. Two-thirds of IT executives surveyed explain that future investment in financial technologies is targeted to comply with the Sarbanes-Oxley Act (Strempel, 2004). A recent study indicated the average cost of being publicly traded for a company with less than $1 billion in annual revenue shot up $1.6 million due to this act. There is ground swell of objections to the act's implementation. However, the effort to restore public confidence and interest is priceless. Of interest is that despite the swelling of complaints by companies concerning the burden imposed by the act, 56% of a recent survey explained that they do not track and report internally on the costs of Sarbanes-Oxley and other compliance programs (Sri Forum Limited, 2003).

The act is an attempt to restore public confidence that corporations have squandered away. A responsibility of public research is to inform the public to the diverse issues that surface. The advantages and disadvantages need to be discussed at length. A significant impact of the Sarbanes-Oxley Act is to make the board of directors more inquisitive of various items that are presented to them for approval. (Joseph J. Riotto, 2007)Historically, items presented to board of directors might have been a simple “rubber stamp.” Now, board of directors need to be aware of the ramifications of their approval. Recently, the percentage of chief executive officers who were forced out by their boards rose significantly. In fact, on average, directors are now spending 50% more time each month than before on their responsibilities (Prentice, 2005). In short, it raises the visibility of procedures for corporate accountability. There is mounting speculation that the act has decelerated corporate mergers and acquisitions. One rationale is that the due diligence process for acquisitions could conceivably be lengthened because of the directors taking their responsibility more seriously. In addition, an effective compliance program can mitigate the amount of a criminal fine imposed under the act's guidelines; improve processes to eliminate criminal opportunities; establish requirement for corporate adherence to the act; and promote good corporate citizenship.

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As far as the state and local government sector is concerned, it might be in their best interests to further investigate and be proactive. Balancing the needs and expectations in this area is ideally done before it becomes a strict requirement. Compliance to the act is costing firms significant amounts of time, professional fees, and other resources (Beasley and Hermanson, 2004). Congress determined that the public interest is best protected by, not less regulation, but more regulation of corporate policy and governance. From the government's viewpoint, success is not measured solely by the bottom line, but by the optimization of public interest. A centralized corporate governance approach has been emphasized. The act has endorsed the Commission to promulgate such rules and regulations, as may be necessary or suitable in the public interest or for the safety of investors, and in furtherance of this act. The passage of time might be the true test of the effectiveness of the act. Corporate fraud is essentially the product of the morality and ethics of management. (Joseph J. Riotto, 2007)

To Conclude, One of the criticisms of SOX is that it overly burdens small-cap firms. The net benefits of SOX in the form of increased accountability of managers to act in shareholders’ interest outweigh the costs of increased disclosure and compliance. On the whole, the SOX support the substitutability of governance mechanisms for small-cap firms. Some sub-optimal deployment of the endogenous governance mechanisms is observed. Firm leverage is inversely related to performance. Laws are implemented so that they are followed; however, there will always be those that look to circumvent the law. In short, the act is recognized as a dynamic document in the sense that additional rules can be implemented for the betterment of the public interest.


  • Beasley and Dana R. Hermanson, Effective Compliance Programs in the Aftermath of Corporate Megascandals. Insights: the Corporate and Securities Laws Advisor, Englewood Cliffs NY 18 (5) (2004), pp. 12–18.
  • Coffee, 2006 J. Coffee, Gatekeepers: the professions and corporate governance, Oxford University Press, New York (2006).
  • Joseph J. Riotto, Understanding the Sarbanes-Oxley Act next term—A valued added approach for public interest, Critical Perspectives on Accounting, September 2007
  • Lorne N. Switze, Corporate governance, Sarbanes-Oxley, and small-cap firm performance, The Quarterly Review of Economics and Finance, Volume 47, Issue 5, December 2007, Pages 651-666
  • Prentice, 2005 R. Prentice, Student guide to the Sarbanes-Oxley Act, Thomson Publishing (2005).
  • SriForum Limited, 2003 Sri Forum Limited. “Sarbanes-Oxley almost integrated into corporate governance strategy” NY. July 2003.
  • Strempel, 2004 D. Strempel, Companies pay price for Sarbanes-Oxley, Fairfield County Bus J 43 (June 24) (2004), p. 11.