What Is Wrong with Sarbanes-Oxley? - Corporate Governance and Business Ethics

We can now return to SOX to re-examine the costs of this particular piece of legislation.

  • Complexity of content: First of all, SOX is by any standards a complex piece of legislation. It covers many different aspects of company behavior from auditing to analysis to internal bookkeeping to insider trading rules to board structure. It is unquestionable that bundling so many initiatives in one law made it a very complex piece of legislation. Arguably, learning makes it possible to adjust efficiently to partial legal changes, but implementing a set of changes enacted as the same time will be much more costly.
  • Complexity of enforcement: The creation of a new enforcement agency the PCAOB with a strange semi-private status and an unclear division of labor with the Securities and Exchange Commission increased the ambiguity. The PACOB is entitled to pursue any functions which it deems necessary to promote high professional standards.
  • External Control: SOX was enacted top down contrary to the US common law tradition and despite protests from business leaders. It was enacted under perceived time pressure (stock prices were falling). A series of laws with time for discussion would no doubt have given business more time to adjust and met with less resistance. It is interesting to compare this with UK corporate governance, which has to a large extent relied on marginal changes in the best practice corporate governance codes, which are written by businessmen and adopted on a more voluntary comply-or-explain basis. After the Maxwell or the BCCI scandal which prompted UK corporate governance codes, there have been remarkably few financial scandals in British business.
  • Unclear legitimacy: The rationale was unclear and disputed from day 1. More than anything else falling stock prices were the aftermath of the internet bubble. Symbolically the law was very much directed at Enron and Arthur, which had already been severely punished by bankruptcy. Despite a relatively simple easily communicable storyline in the Enron Anderson story, the law went well beyond prohibiting Enron-type practices by introducing sections 302 and 404, which address problems related to the internal consistency of accounting which has very little to do with the top-level fraud in Enron. The easiest solution to avoiding collusion between companies and their auditors requiring companies to change their auditing firm at regular intervals was avoided, perhaps due to lobbying from the auditing profession.
  • Non-experts: SOX involved many different people so that implementation could not be left to complexity-loving experts. For example section 302 had branch managers all the way down testify that their accounting was correct accordingly to certain vaguely defined and imperfectly understood standards. US managers responded to section 302 by requiring their lower level managers to sign off all the way down the organization, and this may have been as an unintended response to the law.
  • High penalties: The penalties for non-compliance were severe up to 10 years in prison, which is more severe than sentences for manslaughter. Moreover, the law was religiously enforced. Understandably, this combination of ambiguity and severity created widespread anxiety.

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