Two years ago, a Republican Congress and a Republican president enacted the most far-reaching new regulatory controls on Americans businesses since the 1930s. They were reacting to Enron and other corporate scandals. But rather than study the issue carefully first, instead both rushed to do "something" by enacting the Sarbanes-Oxley Act (named for Senator Paul Sarbanes, Democrat of Maryland, and Representative Michael Oxley, Republican of Ohio) in record time.
Republicans are normally skeptical about government regulation of business--with good reason. Regulation is always ham-handed, forcing everyone--guilty and innocent alike--into the same cookie-cutter mold. All must pay the price for the sins of a few, even if exiting laws and regulations, properly enforced, are more than sufficient for the purpose. But fearing bad press, Republicans suspended their normal disbelief in the virtues of regulation and joined to pass a Democratic bill that has severely crippled business expansion.
No one denies that there was a corporate governance problem that came to a head with the Enron scandal. But in their zeal to pass new legislation, no one in Congress ever stepped back to ask what was the magnitude of the problem. Some 12,000 companies are required to file public financial statements with the Securities and Exchange Commission. According to George Benston, professor of accounting at Emory University, no more than a few dozen per year was ever implicated in dishonest bookkeeping. But rather than simply step up enforcement by the SEC, all companies were treated as guilty until proven innocent and forced to comply with onerous new regulatory requirements.
The most onerous provision of the Sarbanes-Oxley legislation is section 404, which requires establishment of extensive new internal controls for financial reporting. A recent study by Financial Executives International, an industry group, found that the average compliance cost for large companies was $4.6 million, involving 35,000 hours of internal manpower, $1.3 million on external consulting and software, and additional audit fees of $1.5 million.
These numbers are probably very low. FEI admits that the compliance cost jumped sharply between its 2003 and 2004 surveys, as companies became more aware of what they had to do. On May 19, Maurice Greenberg, chairman of AIG, the world's largest insurance company, told shareholders that Sarbanes-Oxley was costing them $300 million per year. General Electric recently said that it was paying $30 million per year in compliance costs.
According to a new study by Foley & Lardner, a law firm, the average cost for being a public company with sales of less than $1 billion increased by $1.6 million last year due to Sarbanes-Oxley. There was also an unquantifiable loss of productivity because senior executives must spend so much time dealing with its requirements. Scott McNealy, CEO of Sun Microsystems, calls Sarbanes-Oxley "buckets of sand in the gears of the market economy."
The Foley study found that 20 percent of companies surveyed were considering going private, eliminating public shareholders, in order to avoid Sarbanes-Oxley costs. Ed Nusbaum, CEO of Grant Thornton, an accounting firm, explains, "By going private, companies can greatly reduce their level of risk associated with shareholder litigation, while cutting costs and regaining a sense of control and confidentiality."
The only problem is that going private is not a cure-all. A study last year by Robert Half International, a staffing company, found numerous cases where even a private firm could be forced to comply with Sarbanes-Oxley. For example, companies doing business with governments may be forced to comply. Also, those with public debt or those required to report to government agencies may still find themselves in the Sarbanes-Oxley net even if they are private companies.
Europeans have been especially outspoken in their criticism of Sarbanes-Oxley because many European companies are listed on American stock exchanges, and thus forced to comply as well. New listings are down sharply as a consequence.
It's hard to say what the effect of Sarbanes-Oxley has had on the economy, but some economists suggest that it may be behind the slow growth in investment and hiring. As Washington Post columnist David Ignatius put it on March 9, Sarbanes-Oxley has "added to the wariness of CEOs" and "reduced the job-creating dynamism of the economy."
Stephen Bainbridge, professor of corporate law at UCLA, thinks Sarbanes-Oxley was completely unnecessary. He says all economic booms inevitably breed their financial scandals. Those at Enron et al. would likely have occurred even if Sarbanes-Oxley had already been in effect. The scandals simply gave statists a new excuse to regulate business. "Corporate scandals are always good news for big government types," Bainbridge notes.
To be sure, there are some benefits from Sarbanes-Oxley as well as additional costs. But it would have been nice if Congress had at least considered the costs before rushing the legislation through.