Tuesday, June 19, 2007

Sarbane-Oxley Good For Who?

Stephen Bainbridge: Sarbanes-Oxley bleeds profits, cuts risk taking ... (HT Glen Reynolds)

Professor Bainbridge reports, via examiner.com, that Sarbanes-Oxley may not be the solution to all corporate ills that it was touted to be. Even tho the final results are still unknown and will only be known by the benefit of 20-20 hindsight where we can see the companies that DID NOT go public, DID NOT float their shares in the United States and chose to forego the greatest financial markets in world history... Sarbanes-Oxley never spoke to the exposed ills of corporate greed, corruption, fraud and theft that were making the headlines. Our political leaders found it easier to solve a problem that did not exist than to write new laws for crimes that were already illegal.

Sarbanes-Oxley is praised for restoring confidence in the markets. There was no loss of confidence except in the newsrooms of broadcast television and the backrooms of the halls of Congress. It was just more smoke-and-mirrors by the political class to show that they were busy ding "something", anything. The crimes were not committed by a lack of legislation. They were the result of pure human greedy, weakness, and corruption. They were caught. Arthur Andersen was sacrificed on the altar of "doing something important"... over 20,000 people at Anderson lost their jobs as a result solely of the hue-and-cry by our press to "do-something-now"...

...don’t know whether SOX in fact benefits the economy, we do know that it has imposed a much higher regulatory burden on U.S. public corporations than the law’s sponsors ever imagined. According to The Wall Street Journal, for example, publicly traded U.S. corporations routinely report that their audit costs have gone up as much as 30 percent, or even more, due to the tougher audit and accounting standards imposed by SOX.

The chief regulatory culprit is SOX section 404, which requires both management and the company’s outside auditors to annually assess the firm’s internal controls over financial disclosures. The Securities and Exchange Commission initially estimated that section 404 compliance would require only 383 staff hours per company per year.

According to a Financial Executives International survey of 321 companies, however, firms with greater than $5 billion in revenues spend an average of $4.7 million per year to comply with section 404.

A poorly written passage of the law that confuses EVERYONE, even the brilliant minds in Congress. Nobody knows what constitutes a violation but since the penalties are extremely severe everyone errs on the side of extreme caution.

... other ongoing expenses imposed by SOX include legal fees, premium increases in directors and officers insurance policies, and higher director fees to attract qualified independent directors to serve on boards of directors.

These costs are disproportionately borne by smaller public firms. A study by three University of Georgia economists, for example, found that post-SOX director compensation increases have been much higher at small firms. For small firms operating on thin margins, these and related SOX compliance costs can actually make the difference between profitability and losing money.

As a result, SOX has substantially distorted corporate financing decisions. On the one hand, SOX has discouraged privately held corporations from going public. As law professor Larry Ribstein observed on his blog, ideoblog.com, startup “companies are opting for financing from private-equity firms,” rather than using an initial public offering to raise money from the capital markets.

In the long run, or perhaps the not-so-long run, this barrier to the public capital markets may have a very negative effect on the economy, according to Ribstein: “Since going public is an important venture capital exit strategy, partially closing the exit could impede startup financing and therefore make it harder to get ideas off the ground.” Conversely, Ribstein notes, this is also a good deal of evidence that SOX is causing firms to go private.

.... recent study by former SEC Chief Economist Ken Lehn identified a new and very troubling consequence of SOX. Lehn’s study tested the proposition that SOX has a chilling effect on risk taking by managers.

Using a large sample of U.S. and U.K. companies, Lehn and his co-authors found that relative to U.K. firms, U.S. public corporations have significantly reduced their research and development and capital expenditures, while significantly increasing their cash holdings, since SOX. As a result, the equity of U.S. companies has become significantly less risky vis-à-vis U.K. companies since SOX.

Having been involved in start-up and turn-around companies most of my career I can support the chilling affect that Sarbanes-Oxley has had on the projects that I see working. Many are avoiding the venture capitalists when seeking start-up or growth funding. Many are working with Private Equity and Asset-Based-Lenders.These companies are paying a heavy price in our growth timing . They have lost opportunities because they lack the ready access to capital. There are very few exit strategies that mention an Initial Public Offering. Most look to re-cap and sell to management or sell to a larger fund or competitor. The result is less return for success and reward for risk taking. There are fewer investment opportunities for the mutual funds, pension funds, insurance companies and individuals. The United States has periodically gone through an almost-Puritan revulsion at the excesses of prosperity and growth of wealth. hope that someone comes to their senses and adjusts the law. Too many years of seeking to raise capital in Europe (UK) or Asia will ingrain the habit and shift the prosperity out of sight and out of mind...

No comments: