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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