The Sarbanes-Oxley Act was passed, in part, to fight the evils of unethical behavior. Has it been worth the cost? The verdict on the efficacy of S-Ox is still an open question, though initial indications have been that §404 has been successful in improving the transparency of financial reports along with the reliability of financial reports. These benefits have not come without costs, however, including an increase in privatization, smaller profit margins, and an increase in redundancy costs. This analysis seeks to balance some of those costs against their benefits.
A trend towards increased privatization of formerly public companies was apparent even before S-Ox was signed (Megginson & Netter, 2001), though there has been some speculation that privatization has increased even more because of S-Ox (Dodwell, 2008). There have been some benefits, Dodwell asserts: transparency and reliability of financial reports has increased, motivation to improve transaction controls out of fear of failing an audit, emphasis on the control environment and mindset, and even the use of S-Ox documentation as a training tool for new employees and a backup and communication device (2008, p. 40).
One of the largest private companies in America, Hospital Corporation of America (HCA), owns, manages, or operates 169 hospitals, along with many surgery, imaging, radiation, and rehabilitation centers, was public from 1990 to 2006, when it was taken private. Like Henry Ford taking Ford Motor Car private in 1916 after being ordered by a court to pay out retained earnings to shareholders (Dodge v. Ford Motor Co., 204 Mich. 459 (1919)), HCA did not want to live by the Sarbanes-Oxley rules.
The number of companies having to change their business practices has been large; Hermanson, Ivancevich, and Ivancevich have noted that 55% of public companies have changed revenue recognition policies, and 8% have had to file earnings restatements (2008). They do note, though, that internal control weakness reports have been declining among larger companies, and that this is a demonstration of the effectiveness of S-Ox, particularly § 404 (Hermanson, et al., 2008).
However, the benefits have not come without a cost. Dodwell notes the costs as including smaller profit margins due to increased compliance costs, opportunity costs of deciding not to pursue some otherwise economically valuable opportunities, redundancy costs, increased costs to hire auditors (whose hourly rates have increased due to greater demand), and an increase in the number of companies deciding not to be listed on the U.S. stock exchanges but instead seeking foreign listing (2008).
In the long run, will the benefits of the Sarbanes-Oxley Act prove to be worth the costs? The initial reports suggest that the answer may be a qualified yes.