SOX Section 404: Good or Bad?

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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