Sarbanes-Oxley: Good Idea or Bad Idea?

Few acts of legislation have rocked the financial and accounting world like Sarbanes-Oxley did in 2002.  When it was passed into law it was considered by many to be one of the most far reaching bills for businesses ever.  It was made as a result of scandals like Enron and WorldCom. It has cost companies millions of dollars to implement the changes needed to comply with Sarbanes-Oxley and has discouraged companies from even becoming public companies.  The initial public offerings of companies have declined from 900 in 1999 to 20 in 2003 (Stephens and Schwartz).  Expert’s reaction on the bill have come down on either side.  Economist Alan Greenspan called Sarbanes-Oxley a nightmare and said it should be scraped as soon as possible.  The only part of the act that he liked was that executives have to take responsibility for their financial statements (Arnold).  Others who take a more favorable view of Sarbanes-Oxley say that although there was a huge initial investment made by companies to implement the act, those companies are reaping numerous benefits of efficiency and effectiveness (Hirth).  Regardless of people’s views the main section people tend to focus on is section 404.  Section 404 has to do with the documentation and implementation of companies’ internal controls.  This paper will seek to evaluate the different views of Sarbanes-Oxley and the reason behind those views.

The main complaint that people have with Sarbanes-Oxley is that it is extremely expensive to implement, and they are not sure that it even accomplishes its goals of protecting a company from fraud.  A law firm named Foley & Lardner conducted studies in 2003 and 2004 about the expenses of implementing Sox. The survey found that the average annual cost of being a public company had doubled.  For companies with revenues under a billion dollars, costs increased from $1.3 million a year to $2.9 million. These costs did not even include the initial setup for Sox (Stephens and Schwartz).  Of the 115 companies that Foley & Lardner interviewed, 21% said that they were seriously considering going private because of the high cost of being a publically traded company (Stephens and Schwartz).  Smaller public companies are unable to sustain the extra expense of Sox.  Sox deters smaller companies from going public even though they would greatly benefit from having access to the public capital markets.

One solution to this problem that has been suggested is that Section 404 should become optional to public companies under a certain dollar amount of revenue.  Then if a company cannot bear the cost of complying with Sox, it can opt out and the stock market will punish those companies as it sees fit.  The company would have to say that it will not follow Sox, and investors would know that the company was potentially more risky, but the company could still raise capital with investors that think they have enough potential profit to buy their stock.  Managers of companies complying with Sox also complain that with all the added documentation they are unable to actually do their job since they constantly need to be signing documents and meeting notes verifying that they were there.  To verify that managers have received documents, they need to also reply back to employees acknowledging the receipt.  Companies also need to store all this new documentation and archived emails, which costs money.  Managers now have to set aside more time for documenting than before.  For smaller companies, separation of duties can also be a real challenge.

People on the other side say that while the initial implementation of Sarbanes-Oxley was extremely expensive, the costs go done substantially.  In a survey conducted by Protiviti on the effects of Sox, it was found that companies complying with Sox had reduced their costs by 50 percent compared to year one of implementing costs of Sox (Hirth).  This is a substantial reduction in price, and experts believe that as time goes on companies will find new and better was to reduce spending.  People in favor of Sox also point out that when Sox was initially implemented, it was unclear exactly what the government expected from public companies.  This led to companies implementing an excessive amount of controls, but as companies move forward, they are more strategic in how they design controls.  Companies now have a better idea of what the government expects as well, so companies are starting to remove unnecessary and redundant controls.  As companies and the government get more and more comfortable with Sox, it becomes more and more efficient and less expensive.

Another advantage that has come through the implementation of Sox is that companies have discovered ways to become more efficient than they would have been without Sox.  When leaders of America’s top companies were asked if the benefits of Sox outweighed the costs accrued in their first year of implementing it, 60% responded no. After about four years when re-surveyed, however, only 30% said that the cost outweighed the benefits.  Furthermore, about 65% of these companies said that they use Sox to drive improvements in their company (Hirth).  The search for strong internal controls has led companies to realize that technology can be a fantastic way to implement controls.  Companies have implemented ERP systems or accounting software, because they have built-in controls like separation of duties, versioning, documentation, and archiving.  For example, in Oracle an individual must first sign in before entering, and then the person who prepares a journal entry can never post it, thus creating separation of duties and access control.  Tyco’s SEC department uses a program called Swift to create all its complicated footnotes for its 10Q and 10K.  The program automatically creates a log every time a document is opened and records who opened it.  Furthermore, it saves the version of the file before it was edited.  Swift creates a paper trail for audit teams to follow.  These programs make controls easier to manage and implement and increase efficiency.  Swift has allowed Tyco’s SEC department to finish its 10Q and 10K days faster than it used to.  This is just one example of how implementing Sox has increased efficiency.  Implementing Sox is expensive, but it adds the potential for higher efficiency, because executives have more confidence in their companies and have more data to analyze due to all the documentation.  This allows executives to make more accurate decisions about the future of their companies.

There are many people on both sides of the fence on the issue of whether Sarbanes-Oxley was a good or bad decision.  It is definitely expensive to implement and has the potential to weigh management down with the constant signing of documents and making of binders for the auditors to find.  Some have even questioned the effectiveness of Sox accomplishing its goal to make the investor feel more secure with recent scandals like Lehman brothers (Benner).  One of the many problems with Sox is that it is the government’s attempt to codify morals, which will never be completely successful.  However, since implementing Sox nothing as substantial as Enron or WorldCom has happened.  Some would argue that Lehman Brothers could have been even worse had not Sox been implemented.  The costs of maintaining Sox have been dropping, and leaders in companies feel that it has increased efficiency, so the solution seems to be somewhere in the middle, which seems to be the way of life.  Sox definitely could have been made and implemented better, but it has helped America’s economy.  One thing is certain: Sox is never going away so America might as well get used to it.

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Works Cited

Arnold, Paul P. “Solving Sarbanes-Oxley Section 404.” Berkeley Eletronic Press. Berkeley, 2007. Web. 20 Aug. 2010.

Benner, Katie. “Is Sarbanes-Oxley a Failure – Mar. 24, 2010.” CNNMoney.com. 24 Mar. 2010. Web. 02 Sept. 2010.

Hirth, Robert B. “2010 Sarbanes-Oxley Complience Survay.” Risk Business Consulting. June 2010. Web. 20 Aug. 2010.

Stephens, Lynn, and Robert G. Schwartz. “The Chilling Effect of SARBANES-OXLEY: Myth or Reality?” New York State Society of CPAs. New York CPAS, June 2006. Web. 02 Sept. 2010. <>.