The main objective of the Sarbanes–Oxley Act is to avoid frauds. Section 404 of the Act requires management of public companies and the external auditors to report on the company internal control over financial reporting. In order to comply with this requirement, companies need to pay a lot of money. According to information I could find online, the accounting and auditing costs could increase by 30% to some companies, mainly the smaller ones.
I believe that these extra costs are high enough to discourage companies from issuing in the US stock market, and I do have some doubts regarding the effectiveness of this section in the Act. When I read a little bit about this Act I could think of a person putting his hand on the bible to be sworn to tell the truth before testifying in court. Indeed, this Act gives and explicit responsibility to mangers regarding financial reports of their companies. However, without being too familiar with the details of the Act, I believe that managers who are determined to commit a fraud will do it regardless of this Act, same as a person who testifies in court can avoid telling the truth even after swearing with a hand on a bible. The act sounds more symbolic than effective to me. And even if this Act is effective, the question what is the trade off? How many frauds would be avoided compare the money lost from companies that avoid issuing in the US? We have to remember the opportunity cost. I believe, and again maybe I underestimate the effectiveness of this act, that at the end of the day, the American public loses more than it benefits from this Act. I think that the American public would better off had the legislators could think of severe punishments to managers who commit frauds.
Even though Section 404 will not prevent management from acting in a dishonest manner it still seems like this rule is necessary, as it gives at least some assurance that a company’s transactions are being properly reported and that its transactions are properly authorized. To follow the analogy of being sworn in in court, if someone is found to have lied under oath he can be convicted of perjury and fined or jailed (that’s what sent Martha Stewart to jail). Presumably, the threat of penalty would therefore make people less likely to lie under oath. Likewise, I would assume that by swearing that the company has established the proper internal controls and by requiring an auditor to attest that the assertions made by management are true should reduce the likelihood that there will be false information. I think that many of the instances of accounting fraud in recent years, such as Enron, are also proof that even though instituting new accounting rules can raise the cost of doing business (or of going public) that the cost of not following the rules or of not having proper safeguards in place can be far more costly in the long run.