Table of Contents
In the year 2000 to 2002, the US public companies were characterized by scandals, as huge amount of money was lost without a trace. This made many investors to loose confidence, as safety of their money was not guaranteed. Thus, the government established Sarbanes Oxley Act in 2002 to restore confidence of investors and seal loopholes that led to lose of money (Jahmani 59). Since its enactment, it has shaped corporate governance in the US because it demands public companies to strengthen their audit committees and perform internal control tests as well as make these companies disclose their financial dealings or status (Jahmani 59). Moreover, Sarbanes Oxley Act introduced penalties to organizations or audit firms that were involved in frauds as it aims at restoring the investors’ confidence by checking the organizations involved. On the other hand, Sarbanes Oxley Act is a burden to many organizations because its implementation is costly as will be outlined in the subsequent paragraphs.
Benefits of the Act
The Act led to reliability of financial information given by the public companies (Jahmani 59). Sarbanes Oxley Act aimed at restoring public confidence in the financial transaction that public organization gives to the investors. Thus, it required these companies to have internal control that produces reliable financial information to the investors (Jain 40). Today, these organizations have a vibrant internal control that gives accurate information regarding the company’s financial performance. Thus, Sarbanes Oxley Act brought back the public and investors’ confidence.
Secondly, Sarbanes Oxley Act strengthens corporate governance because it requires companies to be ethical and act according to the provisions of the law (Jahmani 59). Today, the public firms are governed by ethical values and business culture that translates to better bottom line performances that is comprised of the employees. Sarbanes Oxley Act requires company bosses to lead by examples and this leads to their increased performances. The law has emphasizes on financial reporting and control (Prentice and David 1843). This makes the organization to focus on the regulatory compliances at all level thereby promoting corporate governance in the public companies.
Thirdly, Sarbanes Oxley Act has led to reduction of financial statement fraud compared to the period before its enactment (Jahmani 59). Before the enactment of this law, public firms witnessed high level of financial statement fraud that almost wrecked the entire industry. The most noted financial fraud was in the case of Enron and WorldCom where billions of dollars was lost without trace (Zhang 117). This action lowered the confidence of financial market investors, as they feared losing their money and investments. Since Sarbanes Oxley Act was enacted in 2002, the nation has not witnessed or realized a major financial scandal. This is an indication that the law is working and the fraudsters fear it because of the heavy penalty that it gives to the offenders. The enactment of the law has led to many companies reporting less fraudulent activities and all these can be attributed to the positive outcomes (Jain 40).
Fourthly, the Act has created a model for private and non-profit organization to implement (Jahmani 63). Although Sarbanes Oxley Act was enacted to restore public confidence on public organization, the model has attracted other private organization because they feel it is good for them. For instance, a study conducted by PriceWaterhouseCoopers revealed that 30% of the US best performing private organizations plans to implement Sarbanes Oxley Act (Prentice and David 1843). The private organizations see it as best in improving documentation and testing, strengthening governance and ethical conducts as well as adopting best governance practices (Zhang 117). Therefore, Sarbanes Oxley Act is beneficial to not only the public firms but also the private and non-governmental institutions that believes it has value through operational and controlling efficiencies. The organizations that implement the act can prevent many bad things that occur as a result of administrative errors.
Lastly, Sarbanes Oxley Act helped in the improvement of market liquidity (Jahmani 63). For instance, it requires a mandatory disclosure of financial transactions to the investors and this has largely contributed to improving liquidity of the market since it reduces information asymmetry. The high confidence among investors because of the regulatory compliance by the organizations makes them to pump in more money thereby improving market liquidity. The same scenario has not been witnessed before because the investors were keeping their money for fear of losing to the fraudsters in the market.
Disadvantages of Sarbanes Oxley Act
The disadvantages of the Act are realized because of the implementation costs. It is costly for the organization to implement all the provisions of the Act because some things have to be introduced for the first time in efforts to comply. The costs can either be direct or indirect as discussed in the subsequent paragraphs.
The Sarbanes Oxley Act requires companies to have additional manpower towards its implementation in the organization. This is a direct cost because the firms require five hundred additional man-hours which has a value of about $91,000 (Jahmani 62). Similarly, some have faulted section 404 of Sarbanes Oxley Act, which comes with a huge cost, as it requires an annual control test. According to some findings, compliance fee for this section for a company with a capitalization of $750 million is about $4.3 million (Jahmani 62). Thirdly, the audit fee has increased since the law came into force. This means that organization have to put more money as auditing fee, a move that will increase the operational cost and re-curing expenditures. The big four audit firms have experienced increased demand that has made them to adjust their fees upwards as the expense of the public firms (Prentice and David 1843).
On the other, the indirect costs associated with the act is immense. For instance, many studies have revealed that many private companies have increased since the passage or enactment of the law (Zhang 117). It is because many public companies are converting to private companies because of their inability to comply. Secondly, the law has led to lost investor opportunities because of the companies that have withdrawn from being listed in the US Exchange (Jain 40). The main reason for the delisting is the compliance fee, which is very huge, thus, other companies prefer listing on the London Stock Exchange. The third cost is opportunity cost suffered by many companies since much time was devoted to compliance at the expense of other activities that brings value to the firms (Prentice and David 1843). Time and resources required for compliance are many and make these organizations to lose important things that bring value. Lastly, the law has burdened finance departments because of the large volume of work. For instance, they have additional work of running the daily duties of the department, documentation and reporting to the concerned parties. This comes with anxieties and stress whose effects cannot be quantified.
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- Jain, Kanze. The Sarbanes-Oxley Act of 2002 and security market behavior: Early evidence. Contemporary Accounting Research, 23.3(2006)
- Jahmani, Yousef. The impact of Sarbanes-Oxley Act. Journal of Business & Economics Research. 6.10(2008), 57-65
- Prentice, Robert and David Spence. Sarbanes-Oxley as Quack Corporate Governance: How Wise is the Received Wisdom? Georgetown Law Journal, 95(2007), 1843-1944.
- Zhang, Ivy Xiying. Economic consequences of the Sarbanes-Oxley Act of 2002, Working Paper, University of Minnesota, (2007)