Saturday, December 26

How costly is the Sarbanes Oxley Act? Evidence on the effects of the act on corporate profitability

There is a tidal wave of regulation that is coming down the pipes from the various assorted regulators. There are 3 costs to this regulation to financial firms. The cost of implementing the change, the cost of of running the change and the opportunity cost related to the sum of the previous two costs. And believe you me, after having had about 15 years of experience of looking at regulatory change, they can mount up to a pretty penny. Seriously big pennies and I frequently doubt if this is actually making our lives better and safer. Stick to gold (just half kidding). What I also find very interesting is that these regulations are rarely followed by good costed business cases on the cost/benefits to be achieved. Its almost like an article of faith that more regulation is good. Period. No questions asked. Well, I am again not sure.

With that said, what about SOX? well, here’s a good interesting paper on it. Abstract:

The Sarbanes-Oxley Act (SOX) was intended to protect investors by improving the accuracy and reliability of corporate disclosures. However, critics have argued that the costs of SOX far outweigh its intended benefits. Prior studies based on stock-price reactions to SOX-related events document mixed evidence on the expected impact of SOX. In contrast, we provide evidence on the net realized costs of SOX by examining its impact on operating profitability. We find that average cash flows decline by 1.3 percent of total assets after SOX. These costs are more significant for smaller firms, for more complex firms, and for firms with lower growth opportunities. Annually, these costs range from $6 million for smaller firms to $39 million for larger firms. Further, we document that net SOX-related costs are not limited to one-time expenses associated with internal-control design and implementation. In aggregate, for the 1,428 firms in our sample, these costs amount to about $19 billion per year. Profitability is lower for up to four years post-SOX. To our knowledge, ours are the first estimates of the realized net costs imposed by SOX.

$19 billion per year with profits being impacted for 4 years. And no calculation of the compound nature of regulations which come from hundreds of regulators, in hundreds of markets. It is a heavy burden that society is placing on the financial institutions and I am yet to be convinced on a macro level that this is really thought through.

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