A Misguided Defense of Sarbanes-Oxley
Alan Murray of the Wall Street Journal defends the Sarbanes Oxley Act, arguing that its costs do not explain why more companies are going private. In contrast, the CEO of Georgia Pacific explained that his company sold out to private Koch Industries in order to avoid mounting Sarbox costs. Murray claims that estimated annual auditing costs of $14 million (on average) are small compared to CEO compensation and stock options. This comparison is inappropriate. Management compensation is determined by supply and demand, while auditing costs are forced on companies by regulation. The costs of management services are set by markets, and can be consciously increased or decreased depending on whether they achieve a sufficient return on investment. Absent regulation, most companies clearly would not have spent 45% more in 2005 on wasteful, duplicative, and over-cautious audit checking activities that have no discernible benefit to shareholders. Secondly, auditing cost estimates tally up fees, insurance premiums, and other direct costs. They do not factor in related costs such as management distraction, diversion of employee man hours into time-wasting activities, and Sarbox' general discouragement of corporate risk taking. Finally, Murray seems to misunderstand that auditing fees appear small in relation to the total revenues of a giant corporation like General Electric, but are actually a shockingly large percentage of the revenues of small businesses and start-ups seeking to go public.
Murray repeats the mantra that Sarbox has forced some companies to make needed improvements to internal controls. No doubt, a company that had poor controls may have improved them in order to comply with Sarbox. This does not mean that U.S. businesses in aggregate benefited from Sarbox. A law mandating a 45% increase in marketing spending might help some companies too, but it would cripple most others. Even companies with superior internal controls were forced by this perverse law to spend more money on internal controls. Moreover, Murray ignores opportunity costs. Perhaps a company would generate higher shareholder value by increasing its marketing spending rather than by improving auditing controls. Sarbox does not allow companies to decide for themselves how to allocate scarce resources, and hence causes inefficiency in the aggregate.