Monthly Archives: December 2010

SOX Section 404: Good or Bad??

Posted on December 1, 2010 by danny.park

This post is a response to the article written by Jeffrey Marshall titled, “Are Foreign Issuers Shunning the U.S.?”  It can be found on blackboard on the Accounting page in the readings folder.

The Sarbanes-Oxley Section 404 is the section of the Sarbanes-Oxley Act that requires management and the auditor to analyze and report on the accuracy and effectiveness of a company’s internal control methods and procedures.  Because of the fact that this law is the most expensive provision for companies to carry out I can understand why rumors would fly that the costs associated with Section 404 are driving foreign companies from listing in the U.S. 

However, after some research I agree with Mr. Marshall, the author of the article, that “the situation is not that simple” and that globalization of the capital markets is more the driving force for foreign companies to migrate away from the U.S. listings.

According to the annual Finance Executives International survey (FEI), which provides Section 404 costs for reporting companies, reports that Section 404 costs have continued to decline relative to  revenues since 2004 (Mr. Marshall’s article was published in 2006).  In 2007, 168 companies with average revenues of $4.7 billion spent on average $1.7 million on compliance costs (a mere 0.036% of revenue).  When compared to 2006 survey data, which has 200 companies with average revenues of $6.8 billion reporting $2.9 million (0.043%) in compliance costs does show a steady yearly decline.  Also, FEI reported that the implementation of Section 404 has had a positive effect on investor confidence, reliability of financial statements, and fraud prevention.  Therefore, it can be argued that since the debacle of Enron, Tyco, WorldCom, and other corporate accounting scandals, the Sarbanes-Oxley Act (most specifically Section 404) has enabled many companies to increase revenues and retained earnings by spurring and motivating investors to trust the financial system. 

Indeed, according to the Lord and Benoit Report (2006), a study that examined if the benefits of Section 404 exceeded the cost, studied a population of 2,500 companies.  There results indicated that those companies that had no material weaknesses in their internal controls, or companies that corrected them in a timely manner, experienced greater (by 10%) increases in share prices than companies that did not.

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Sarbanes-Oxley: A Price Worth Paying?

Posted on December 1, 2010 by Judah Ferst

When do the benefits that come with regulation become an undue burden? The Economist’s article, A Price Worth Paying, examines this question about the Sarbanes-Oxley statute. In the wake of scandals in the early 2000’s, like those at Enron and WorldCom, congress needed to act to calm the public’s fears and the economy. But in doing so, many worry that they went to far and imposed burdensome regulations on publicly traded firms.

The main point of contention is regarding section 404 of the statute, which states that managers are responsible for maintaining an: “adequate internal control structure and procedures for financial reporting” and that their accountants must certify these controls and disclose any “material weaknesses.” Failure to do so could result in criminal penalties.

This section has cost publicly traded companies billions in compliance fees, most of which were paid to their accountants and auditors who, ironically, were the ones responsible for the problems in the first place. As the article highlights that while there may be benefits in having these controls in place, they will probably never reach the anticipated $1.4 trillion. In addition, the Big Four accounting firms are loosing clients because with the increased annual costs to their audits, many firms are looking into smaller accounting practices to handle their books. While many will delight if the accounting field is leveled, one of the Big Four failing would hurt the economy tremendously. We are already seeing negative economic impacts due to Sarbanes-Oxley as many companies are deciding not to go public and foreign companies are choosing not to be listed on American exchanges.

Sarbanes-Oxley, as many laws, was a response to a troubling trend in American businesses. However, at the end of the day, will it actually prevent firms from failing? And if it does, will the economic hardships borne by companies in the meantime be worth it? Unfortunately we are a long way away from even beginning to answer these questions and only time will tell if the price is worth paying.

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