Sarbanes-Oxley Has Let Fresh Air Into Boardrooms

July 29, 2005
Thomas Healey and Robert Steel

Financial Times
It almost seems poetic justice that in the lead-up to the third anniversary of the US Sarbanes-Oxley Act, the individual responsible in a large way for its passage - Bernie Ebbers, former chairman of WorldCom - should be sentenced to 25 years in prison for orchestrating a fraud that not only toppled the telecommunications company he founded but triggered shareholder losses of Dollars 180bn (since the share price's peak in 1999).
Designed to repair damaged investor confidence following an outbreak of corporate boardroom scandals, Sarbanes-Oxley set important new baselines for financial reporting and disclosure by companies. It also imposed tight new regulations on auditors and virtually single-handedly changed the face of corporate governance.
Critics of the groundbreaking act, however, see it in a very different light. They charge that it swung the pendulum too far, imposing enormous compliance costs on companies (and indirectly on their shareholders) that outweigh the potential benefits of reduced fraud. So what has Sarbanes-Oxley really accomplished?
On balance, a great deal. Consider: a study of 2,500 international companies by GovernanceMetrics International found that the reforms have led to a 10 per cent improvement in the corporate governance performance of large US companies compared with their foreign counterparts. The reaction of the equity markets underscores the progress we have made in improving corporate governance. The US stock market has rebounded 40 per cent since the act was signed by President George W. Bush on July 30, 2002, compared with the nearly 20 per cent it tumbled during the first seven months of that year in the wake of the Enron and WorldCom scandals. Today, the markets are once again performing efficiently and there are more initial public offerings.
The demise of Arthur Andersen, the accounting firm, has opened up more work at large companies for auditors. Additionally, the finance and audit committees of corporate boards are taking their roles much more seriously and imposing greater accountability on their members. Gone are the days when Enron's directors could approve a stock split, place shares in a compensation plan, purchase a corporate jet, launch an investment in a Middle East power plant and grant Andrew Fastow, chief financial officer, exemption from the energy trader's code of conduct - all in a single, one-hour teleconference.
However, Sarbanes-Oxley has drawn criticism from businesses that the cost of complying with the act is way out of line with potential benefits to shareholders. There may be some truth in this. A survey of 115 companies by Foley Lardner, a law firm that has tracked the financial implications of the act, found the cost of being "public" for small and mid-cap organisations has increased, on average, 130 per cent, prompting one-fifth of US public companies to consider pulling back from the capital markets and going private. AMR Research estimates the one-off cost of complying with Sarbanes-Oxley is Dollars 5.5bn (Pounds 3.1bn) (although that is still a bargain compared with the Dollars 180bn beating WorldCom investors took).
To judge Sarbanes-Oxley fairly, it is necessary to look beyond costs. In passing the act, Congress sent an unequivocal message to US capital markets at a time when they desperately needed it. The legislation might not have been perfect but it accomplished its paramount goal: to boost investor confidence and bring the markets back to life.
It is now time to take the next step. The business community, instead of carping about the shortcomings of the act, should be offering constructive criticism about how it can be improved. The US Securities and Exchange Commission and the Accounting Oversight Board should use those suggestions to fine-tune and strengthen Sarbanes-Oxley, particularly the controversial section 404, which requires outside accounting firms to vouch for the reliability of a company's internal control systems, a procedure that has proved surprisingly costly and time-consuming. Even in its current form, there is no denying the monumental import of this act. It has brought a blast of fresh air to business-as-usual boardrooms and to once-dispirited investors - no small achievement following a wrenching period of corporate excess.

Thomas Healey, a former partner of Goldman Sachs, was assistant secretary of the Treasury under President Ronald Reagan; Robert Steel is a retired vice-chairman of Goldman Sachs; both are senior fellows at Harvard University's Kennedy School of Government

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