The Impact of the Sarbanes-Oxley Act on Publicly Held Companies

Introduction

The Sarbanes-Oxley Act of 2002 (SOX) was passed as a result of the Enron, Tyco and WorldCom scandals (Slaughter). Its main purposes were to prevent companies from engaging in accounting fraud, improve the reliability of financial reporting, and restoring investor confidence (Wagner & Dittmar, 2006).

The Act dictates how all publicly held companies are required to report their financial information (Magloff). While SOX increased the accuracy and validity of the financial information available to outside stakeholders, it created many challenges for businesses that have to comply with SOX guidelines. In 2005 Section 404 of the Act took effect and increased "unproductive auditing expenses" (Swartz, 2005). In 2010 President Barack Obama passed the Dodd-Frank Wall Street Reform and Consumer Protection Act to further improve the accountability and transparency of the financial system (Brief Summary of the Didd-Frank Wall Street Reform and Consumer Protection Act).

Statement of the Problem

Regulations are created for a reason and they produce benefits. These are meant to protect us and discourage fraudulent actions by others. However, they come with a cost. The requirements of the Act can place a burden on businesses of all sizes, and penalties for noncompliance are very serious. Companies must spend to ensure compliance and the costs are estimated from hundreds to millions of dollars based on company size and the specific reforms required (Martin & Combs, 2010). Because the Act requires a high level of financial reporting and internal auditing, it can place a disproportionate burden on smaller companies to make sure they are in compliance. The management teams of all companies have a legal duty and are held personally responsible for the reliability of the financial statements. While large companies may have teams of auditors and accountants to do this, smaller companies may struggle significantly (Magloff).

The goal of this paper is to determine the cost-benefit of the Sarbanes-Oxley by using archival research and secondary sources.

In his blog, Marc Morgenstern (2009), who has been on the SEC's Executive Committee for Small Business Capital Formation for more than 25 years and serves as the Senior Advisor and/or Board member to public and private companies stated:

Sarbanes-Oxley taught us that laws passed in an emotional cauldron, while well-intentioned, frequently have significantly adverse consequences. In the securities world, these consequences are disproportionately borne by smaller enterprises, public and private, and ultimately by all investors. We can't afford that. (Morgenstern, 2009)

Purpose of the Study

Many authors agree that the Sarbanes-Oxley Act was a necessary and useful piece of legislation. In her article titled "Executives Praise SOX but Seek Changes", Nikki Swartz (2005) wrote: "while no one disputes the benefits, business leaders have been complaining loudly that the costs associated with Section 404 compliance are higher than expected and an undue burden" (Swartz, 2005).

In 2004, the initial burdens of implementing SOX were so great that it created uproar among publicly held companies that weren't prepared for the costs of new accounting software and the additional audits that were required. As SOX went into effect, many were surprised by the weaknesses and gaps that compliance reviews and assessments had exposed. In the following years, a number of companies have begun to standardize and consolidate key financial processes to eliminate redundant information systems and eliminate unnecessary controls. It turns out that SOX-inspired procedures serve as a template for compliance with other statutory regimes (Wagner & Dittmar, 2006).

The initial purpose of this research was to learn more about the Sarbanes Oxley Act of 2002. In the process of conducting this research I discovered a number contradicting statements and the intent is to determine the cost-benefit of the Sarbanes-Oxley by using archival research and secondary sources.

Rationale

This topic was chosen based on personal interest and in order to understand the cost-benefit of the Sarbanes-Oxley Act of 2002. An archival method was used to compile empirical data on direct and indirect costs among companies that have implemented SOX as well as studies on restatements before and after SOX implementation. The intention is to consider a number of pertinent companies and empirical research such as reporting credibility in the context of earnings restatements and audit costs.

Research Questions

There are several questions that will be pursued in the course of this research. Among them are:

1. Can either costs or benefits be measured or quantified?

2. What are the benefits of SOX and/or Dodd-Frank Acts?

3. What are the costs of SOX and/or Dodd-Frank Acts?

4. Who is most affected by SOX and/or Dodd-Frank Acts?

Significance of the Study

It has been ten years since SOX was implemented and the jury is still out on the desired outcomes. Seeking employment within any publicly traded company requires knowledge and experience with SOX. Investors of all sizes should be aware of the protections provided to them by this legislature.

As the research unfolds, it becomes clear that there are a number of different opinions about SOX and its consequences on businesses, investors, auditors and accountants. Some people are great fans of the legislature, others are not very happy about the costs and requirements of SOX. It became necessary to determine if they can be identified, or if the benefits and burdens can even be measured, quantified or compared.

Methodology

This research is to be developed by using the deductive approach, which is identified by going from the general objectives to specific definitions and assumptions. It is sometimes informally called a "top-down" approach (Trochim, 2006). The main objective of this research is to determine the cost benefit of the Sarbanes-Oxley Act of 2002 and its impact on financial reporting. The original theory was that the SOX act of 2002 was a financial burden on publicly traded companies and that the costs, both direct and indirect outweigh the benefits. More specifically it was a burden on smaller sized companies that didn't have the right resources