Thursday, July 12, 2012

Sarbanes-Oxley: An Agency Problem Remedy with Global Effects (July 04, 2012)

Sarbanes-Oxley: An Agency Problem Remedy with Global Effects
Michael D. Lavespere
July 04, 2012

Abstract

The purpose of this analysis is to investigate the impact of The Sarbanes-Oxley Act (2002), not only to investors and U.S. Corporations, but to the market landscape globally since its enactment nearly a decade ago.  The research includes understanding the intended goals of The Sarbanes-Oxley Act, the agency problem in publicly traded corporations, and the change of corporate perception over the years.  In addition, the spill-over benefits and resulting legislation in foreign companies are discussed.  Has legislation intended to remedy a U.S agency problem help address the problem globally?  
Keywords:  The Sarbanes-Oxley Act, SOX, Sarbox, Enron, Investors

Introduction
This July will mark the 10 year anniversary of The Sarbanes-Oxley Act (2002), commonly known as “SOX” or “Sarbox”.  Sarbanes-Oxley was Congresses’ response to the epidemic of agency problems of corrupt executives in companies like Enron, WorldCom, Arthur Anderson, Hollinger International, and Tyco.  The primary goal of Sarbanes-Oxley was to thwart the accounting and financial scandals dominating the news headlines.   Executives were seemingly using publically funded companies as their own personal ATM machine and unethically reporting inaccurate financials to investors.  Although very few would disagree that something must be done, many argued that the legislation was over reaching the boundaries of the federal government by mandating the way a corporation should structure its board of directors, forcing internal process on corporations, and the cost of such mandates. Volumes of articles, books, periodically, and journals have been written over the last decade concerning the impact and concerns of such a large sweeping act.  The interesting findings are legislation that was intended to protect American investor has had benefits globally. We now have a decade of information to reflect over these effects of the largest government mandates on corporate America since the New Deal.  In this reflection, one must ask if Sarbanes-Oxley has brought more benefits than costs.
Methods Results and Conclusions
Addressing the Agency Problem
Sarbanes-Oxley requirements are primarily restricted to publicly traded companies, and for good reason.  When an organization seeks public funding from investors, a shift of ownership and responsibilities occur.  As investors purchase ownership of a corporation, they are trusting that the financial managers of the said company will ethically increase owners’ equity in the short-term and the long-term.  This innately develops a potential conflict of interest in that the company’s management team—CEO, Financial Managers—must make decision to increase owners’ equity while disregarding one’s personal agenda.
The trust between ownership and management is called the agency relationship.  In essence, the stockholders (principals) have employed the managers (agents) to act on their behalf.  When agents fail to do so, an agency problem exists and reveals itself in either a direct agency cost or an indirect agency cost to the principals.  Publicly traded companies are problematic in that the stock owners are not active participants in the day-to-day functions of the corporation and are subject to only the information that they are given by management.  The most famous example of an agency problem is Enron. Enron’s management team continuously reported false assets and profits; in addition to, hid liabilities from stock holders to keep stock prices falsely elevated. The widespread abuse of such examples in publicly traded companies birthed The Sarbanes-Oxley Act to protect investors in 2002.   
Domestic and Global Concerns
In Kurt Stanberry’s (2010) article in the Global Review of Accounting and Finance publication, he addresses the impact of Sarbanes-Oxley on the Global Market.  He concludes that Sarbanes-Oxley has overall benefited the global market place “assuming one ignores cost-related issues” (Stanberry, p. 187).  Outside of cost, the initial primary concern of Sarbanes-Oxley was that only U.S companies would have to comply, giving foreign entities an undeserving competitive advantage.  However, in 2006, the Securities and Exchange Commission made an amendment that required foreign entities listed on the U.S. exchanges to also comply with Sarbanes-Oxley (p. 3).  Foreign entities argued that this amendment was the attempt of the U.S. to impose its domestic laws and play “Big Brother” to the world.   
Benefits
There is no dispute that such a large scale government reform will bring costs; nevertheless, the benefits of Sarbanes-Oxley have far outweighed these costs for both investors and corporations over the long term.  According to a recent study from Protiviti (2012), “nearly 70% of organizations say their internal control over financial reporting structures have improved since SOX became a requirement” (p. 1).  The report continues to note that although compliance cost and efforts were initially high, many organizations believe the benefits outweigh the costs (p. 3).  This is a dramatic change in corporate perception of Sarbanes-Oxley from 10 years ago.  In addition, investors have also benefited as designed.  With more effective corporate governance and accountability under The Sarbanes-Oxley Act (2002), investors trust in financial reporting has increased, notwithstanding a bad economy.  Since Sarbanes-Oxley, financial restatements have dramatically increased for the succeeding 4 years after the passing of Sarbanes-Oxley (Audit Analytics, 2010, p.3).  Many argue that it is due to the complexity of the new requirements; regardless of the reason, it indicates that companies are attempting to provide accurate reporting to its investors—even if it requires restating. The need for stronger oversight of company financials was globally contagious.  A year after Sarbanes-Oxley, Gartner Research reported that “Germany and the Netherlands are following the United States and the United Kingdom in drafting legislation to oversee company financial audits” (Logan & Caldwell, 2003).  Soon after, Japan and later the European Union also joined the ranks behind the U.S. to address corporate scandal with the European Union's 8th Company Law Directive Act (2006) and Japan's Financial Instruments and Exchange Law (2006).
Conclusion
The controversial Sarbanes-Oxley Act (2002) has facilitated, not only protecting U.S investors from corporate scandal, but it has influenced the economies and governments of several other countries to do the same. What was intended to address the agency problem, accounting and financial scandals, and corporate greed in the U.S. has paved the way for an ethical global market place where investors can participate with confidence.  In recent years with the Stanford Financial and Lehman Brothers scandals, it is apparent that much work is still needed to ensure the survivability of a free-enterprise marketplace that is fair for investors. The Sarbanes-Oxley Act (2002) has made this goal reachable.
 
 References
Stanberry, K. (2010). U.S. Sarbanes Oxley Act: Has It Positively Impacted Corporate Accountability On A Global Level. Global Review of Accounting and Finance, Vol 1, (1) September 2010, 179 - 188.
107th Congress Public Law 204 (2002). Public Law 107 - 204 - Sarbanes-Oxley Act of 2002 Washington, DC: U.S. Government Printing Office. Retrieved from http://www.gpo.gov/fdsys/pkg/PLAW-107publ204/pdf/PLAW-107publ204.pdf
Securities And Exchange Commission (2006). Concept Release Concerning Management’s Reports On Internal Control Over Financial Reporting. (RIN 3235-AJ58,Release No. 34-54122; File No. S7-11 -06) Retrieved from http://www.sec.gov/rules/concept/2006/34-54122.pdf
Protiviti. (2012). 2012 Sarbanes-Oxley Compliance Survey: Where U.S. Listed Companies Stand: Reviewing Cost, Time, Effort and Processess  Retreived from http://web.ebscohost.com.proxy.amberton.edu/ehost/detail?sid=b7804631-ab05-449f-91ef-d6e1d5ecf8ee%40sessionmgr11&vid=1&hid=13&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=bwh&AN=201206041300PR.NEWS.USPR.SF17777
Audit Analytics. (2009) 2009 Financial Restatements: A Nine Year Comparison, Retrieved from http://www.complianceweek.com/s/documents/AARestatements2010.pdf
Logan, L., & Caldwell, F (2003). Tougher Financial Accounting Requirements Spread in Europe.  Gartner Research.  Retrieved from  http://www.gartner.com/id=418599 
Official Journal of the European Union. (2006)  Directive 2006/43/EC Of The European Parliament And Of The Council Retrieved from http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2006:157:0087:0087:EN:PDF
Financial Services Agency. (2006). Financial Instruments and Exchange Act (Act No. 25 of 1948) English Translation.  Retrieved from http://www.fsa.go.jp/common/law/fie01.pdf


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