Suppose you've got a growing business. You've just opened your 100th restaurant, and your company is making just over a million dollars in annual profits. You want to expand further -- spend a million dollars to rent a new building and hire more cooks and waiters. An accounting firm offers you new services that will cost nearly half that, money you might otherwise spend continuing to expand the business.
Do you hire more cooks, or do you hire more accountants?
Under the Sarbanes-Oxley Act, you hire the accountants. The restaurant chain in question is Max & Erma's; its CFO told researchers at the Competitive Enterprise Institute the company will have to pay $500,000 to $600,000 every year to meet the demands of the new anti-fraud law, Congress' attempt to avoid more Enron-like fiascos by making businesses pay accounting firms to keep them in check.
If spending half a million dollars on accounting instead of growth isn't depressing enough, what do you say to $100 million a year? That's what oil giant BP, a British company whose U.S. business generates less than half its income, is paying, according to its CEO. And that figure is just "external costs"; it doesn't include the time the company's own employees spend complying with the new law.
Or how about 96 percent? That, a study by the law firm of Foley & Lardner found, was the increase last year in the average audit fees of smaller public companies -- from $532,000 in 2003 to $1 million in 2004.
The law's defenders claim its good consequences outweigh its costs. But if that's so, why not let investors figure it out? If certain accounting practices make companies better investments, investors will put their money in companies that use those methods. If having your accountant grill you for not having a written policy on hiring and firing will make your business sounder, you don't need the federal government to force you to do it.
Even the regulators may be realizing this law has gone too far: Last week, the Securities and Exchange Commission (SEC) proposed a rule that would spare some foreign companies the full burden of Sarbanes-Oxley, and an SEC advisory committee suggested protecting small American corporations.
We don't need the government to force businesses to spend half their profits on accountants, because free markets police themselves. Those that serve customers well are rewarded with more customers; those that do well for investors attract them. Bad guys who cheat get a reputation for cheating. They lose customers, lose investors and go out of business. Think of how eBay works. The selling price of each item is determined by auction, so buyers and sellers both get the best possible deal. Sellers are rated by their customers, so the "community" quickly identifies cheaters.
The competition of the market protects us better than the ever-mounting pile of rules legislators pass. And it keeps the costs reasonable, because the private sector has to bear its own burdens, while government forces its costs on others.
The market doesn't catch everything -- there will always be fraud on eBay, and, on a larger scale, scams like Enron. But Sarbanes-Oxley won't catch all the fraud either.
Competition will catch more of it. The more I've watched the markets work, the more impressed I've become with how competition solves problems with speed and flexibility rarely seen in government-imposed solutions.
Enron and the other recent business disasters are evidence of the market working. Government regulators didn't discover the deceit. Enron's lies were revealed when private security analysts raised questions and private investors started dumping the stock.
The cheaters have been caught, and the cheating stopped. The bad guys can't do it anymore. No one is laughing all the way to the bank.
No one, that is, except the accountants the government is forcing businesses to hire.