Sarbanes-Oxley: Benefits vs. Costs
Sarbanes-Oxley: Benefits vs. Costs
The American Competitiveness and Corporate Accountability Act of 2002, commonly referred to as the Sarbanes-Oxley Act (SOX) was enacted in response to corporate financial scandals involving companies such as Enron, WorldCom, and Tyco International. While SOX was written specifically for public companies; a few provisions, including whistleblower protection and document retention apply to all companies and nonprofit organizations (Levy, 2009). The stated purpose of the SOX legislation is “to protect investors by improving the accuracy and reliability of corporate disclosures” (Martin & Combs, 2010). SOX ...view middle of the document...
Finally, Section 404 requires the inclusion of an internal control report in a company’s annual report; increasing transparency and further strengthening investor confidence.
Benefits of SOX
SOX’s requirements are considered best practices that can result in better corporate governance (Levy, 2010). The most apparent benefits of SOX are increased accountability and transparency and improved internal controls. According to a survey referenced in Strategic Finance (as cited in Levy, 2010), complying with SOX strengthens internal controls, ensures accountability of those involved in financial reporting, decreases risk of fraud, reduces errors in financial operations, and improves accuracy of financial reporting.
Requiring CEOs and CFOs to certify the accuracy of the financial statements and disclosures included in periodic reports increases accountability. The Enron and WorldCom scandals highlight what can happen when CEOs and CFOs are not required to take responsibility for a company’s financial statements: claiming ignorance and deflecting blame. If SOX had been implemented, those CEOs and CFOs would have been required to attest to the accuracy of their financial statements; making them more inclined to ensure the financial statements were thorough and complete. Accurate financial reports provide stockholders and potential investors with a clear picture of a company’s health and future prospects.
Requiring the lead audit partner and reviewing partner to rotate off the audit every five years reduces the potential for audit fraud. Additionally, rotating principal audit personnel regularly helps to reduce the risk of error. If the same individuals are intimately involved with successive annual audits, they may become complacent and overlook errors. Audit errors lead to inaccurate financial reporting which will detrimentally influence investor confidence; thus affecting a company and its stockholders monetarily. Reliable auditing of a company’s financial reports is necessary to reduce the risk of future financial scandals like the fall of Enron and its accounting and audit firm, Arthur Andersen.
SOX also promotes board independence by mandating outside directors on the board. Greater board independence leads to improved managerial oversight, increased transparency, and reduced risk of fraud. Outside directors help ensure the board is making the best decisions for shareholders rather than making decisions based on the potential to collect outrageous executive bonuses.
Impact of SOX on Business
The biggest impact of SOX on business relates to internal controls. Effective internal controls are vital to any company. Upon implementation of SOX, smaller companies were given an extension to comply with the Section 404 requirement for an internal control report. This was driven by the difficulty and cost of documenting and assessing internal controls by management as well as the unavailability of auditors to attest to...