Corporate America and Sarbanes-Oxley Act: The Costs vs

Benefits
Abstract: In response to the wave of scandals that damaged the reputation of corporate
America, in 2002, the Securities Exchange Commission (SEC) formulated the Sarbanes-Oxley
Act. The Sarbanes-Oxley Act intended to improve transparency, management accountability
and bring in accuracy in corporate disclosures and help restore investors' confidence. Analysts
believed that the benefits of the law would be realised in the long run and would help
corporate America improve its tarnished image. However, companies had to bear huge
compliance-related costs of the act. To bypass the act and avoid these huge costs they began to
de-list from the New York Stock Exchange (NYSE) and other US stock exchanges. The case
details the accounting irregularities and frauds that have gradually come to light since 2001

Pedagogical Objectives:
To understand the conflict of interest between accounting and consulting professions,
considered to be one of the reasons for such failures in corporate governance
To discuss the ability of Sarbanes-Oxley Act in checking frauds and preventing the top
executives from siphoning off huge amounts at the cost of shareholders and employees'
interest.

Keywords :Corporate Governance Case Study, Sarbanes-Oxley act, Accounting scandals, Enron
debacle, Corporate governance problems, Image of corporate America, Corporate disclosures,
Compliance-related costs, Delisting from stock exchanges, Chief Executive Officer pay, Retaining
investor confidence, Benefits to shareholders

Contents :
» Corporate America and the Auditing Industry
» Sarbanes-Oxley Act
» Costs vs. Benefits
» Public Company Accounting Oversight Board

Introduction: In 2002, SEC formulated the Sarbanes-Oxley Act in response to the wave of
scandals thatmarred the reputation of corporateAmerica, costing nearly $40 billion on GDP of
the country, in terms of its effect on stock prices.Accounting and governance related frauds of
Enron, Tyco,Aldelphia andWorldComled to loss of shareholders and employees’ trust in top
management.TheSarbanes-OxleyAct intended to improve transparency,management
accountability and bring in accuracy in corporate disclosures and help restore investors’
confidence.

The federal legislationmandated disclosure of company’s state-of-affairs by all public

companies to its shareholders. In addition, the CEOwas to certify the details revealed to the
shareholders, by signing and certifying the financial statements. TheAct required due diligence
in the disclosure of the required information to the investorswhile holding the topmanagement
liable for irregularities. Also, public companies were to regularly change their auditors. All these
stipulations and their compliance raised the cost of auditing for the companies, in terms of the
auditing fees and the cost of personnel involved. Further,more costs came to light for the
country’s economy as public companieswere delisting fromNYSE and other stock exchanges of
the country to escape theUS corporate governance regulation.On the other hand, analysts
believed that the benefits the law aimed atwould be realized only in the long-term.Meanwhile,
the scandals continued to erupt even after the Act came into effect, as some believed
fraudsters would always find unscrupulous ways to escape.

Corporate America and the Auditing Industry Traditionally, auditing industry inAmerica has
been solely responsible for auditing of company accounts to be perused by shareholders for
assessing the financial state of their investments. Till the late 1930s, auditing was
voluntary.After the SecuritiesAct of 1934, auditingwasmademandatory, as companies were
required to disclose information to the public. The jobwas entrusted to third parties,who were
appointed to audit the accounts of public companies. In the late 1980s, the laws that restricted
advertising and competitive bidding for accounts by the auditorswere lifted. Subsequently,
consolidations in the industry left fewdominant players in the industry (Exhibit I). Since then,
auditing industry in US has been dominated by the big five firms namelyAndersen, Deloitte
Touche, PriceWaterhouse Coopers, Ernst & Young and KPMG...

Sarbanes-Oxley Act On July 30th 2002,GeorgeW.Bush signedSarbanes-OxleyAct of 2002,

reinforcing the need for accountability and due diligence in corporate disclosures. Bush
announced, “Nomore easymoney for corporate criminals, just hard time. The era of
lowstandards and false profits is over”13 , and added, that the long-standing corporate scandals
that have resulted in loss of trust on US business systemwould be addressed.14 The law
intended to bring in checks and balances in the financial disclosures and corporate governance.

Costs vs. Benefits The corporate scandals at Enron andWorldCom, had above all, questioned
the premise of corporate governance, which defines the roles of the executives working
towards enrichment of shareholder’s wealth. The wave of scandals depicted the incidents of
betrayal by the top executives who pocketed huge amounts while leaving the shareholders at
losses. American capitalism built on the shareholders’ capital, was losing the trust of the
investors. This would in future determine the access to investments in the country, wheremore
than half of allAmericans own stock.

Public Company Accounting Oversight Board Public Company Accounting Oversight

Board.Moving to a different private sector regulatory structure, a new Public Company
Accounting Oversight Board (the Board) will be appointed and overseen by the SEC. The
Board,made up of fivefull-timemembers,will oversee and investigate the audits and auditorsof
public companies, andsanctionboth firms and individuals for violations of laws, regulations and
rules...