Read it here first: The Cost of Sarbanes-Oxley

It is a rather annoying tendency of politicians — and their empty-headed acolytes — to use and abuse of data and charts. One of the more egregious recent offenders  was the laughable assertion put forth by an accounting professor Ivy Zhang that Sarbanes-Oxley cost more than $1.4 trillion dollars.

Zhang proves that understanding how to do mathematics does not mean one actually understands what the numerals being added together actually represent. Her incompetent analysis calculated the drop
in stock market capitilization during July 2002 — the period just before the
legislation was passed, and concluded that was the cost of the legislation.

The only explanation for that kind of reasoniong is blunt head trauma. Its is beyond flawed. If we were to use that same method of reckoning, then we would be forced to conclude that Sar-box has created several trillion dollars worth of wealth. Why?  As the chart we showed last Summer "proves," since  the Sar-box was passed, the stock market has gone up significantly.

Market’s Performance Since Sarbanes Oxley (7/02-6/05)

Click for larger chart
Source: The Big Picture

One would hope a professor of accounting would have a little more insight into market capitalization and what actually dirves markets than was exhibted by Ms. Zhang.

Our takedown of her foibles was echoed in a column this week by the NYT’s terrific columnist Floyd Norris, in Trusting Bosses Not to Cheat (it even uses a similar post Sar-box SPX chart).

Mind you, I’m not suggesting plagiarism; rather, I am bragging that we are about 1 year ahead of the Grey Lady in our insight and analysis.

Here’s an excerpt from the column:

"Mr. Feeney, a Florida Republican, is the chief House sponsor of a bill to exempt the vast majority of companies from having their internal controls reviewed by auditors. A witness at the hearing, Mallory Factor, would like to go much further. The Free Enterprise Fund, which he heads, has filed a suit seeking to have the Public Company Accounting Oversight Board, which was created as a result of Sarbanes-Oxley, declared unconstitutional.

"Sarbanes-Oxley had a trillion-dollar negative impact on the U.S. economy," he told the hearing, citing research by Ivy Zhang, an assistant professor of accounting at the University of Minnesota.

Ms. Zhang did estimate that consideration of the law cost shareholders almost that much. But now she has backed down. The latest version of her paper, she told me, indicates a far smaller effect, although she declined to put a number on it . . .

How does she deal with the fact that the market bottomed in the fall of 2002, about the time efforts to enforce Sarbanes-Oxley got under way, and has had a sustained rise since? That is probably irrelevant, she told me, since the market would have already discounted the effects of the law, and whatever happened later was caused by something else.

Explaining market moves is not so easy, and her paper would be unworthy of much attention but for its use by opponents of regulation."

I am unfamiliar with Congressman Tom Feeney, but one can only conclude that he is innumerate (mathematically illiterate), and has very little comprehension of how the stock market actually functions. Is it too much to ask from the men and women we send to Congress for intelligent debate and analysis? Basic understanding about the areas that regulate? Street smarts?

The biggest complaint about SOX is the heavyt burden it exacts on small firms. There is a very simple solution to the more onerous costs of SOX:  Exempt the smallest companies from compliance. Example: Any firm whose market cap is under 250 million for 2 consecutive Qs could have the option to opt out. Their symbol will reflect this decision with an "S" suffix designating non-Sarbox compliance.   For example, ABCD co. becomes "ABCDS."

Of course, investors will recognize this, and some may choose to invest accordingly. But if we really believe in the free market, we will allow the marketplace to work. Hell, if some people are correct in their views, investors may reward the clever cost cutting by management with their investing dollars.

I trust the investing public to use their judgement on this.  Does Washington?


Trusting Bosses Not to Cheat
NYTimes,  June 23, 2006

How Much Does Sarbanes-Oxley Cost?
The Big Picture
Saturday, June 18, 2005

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What's been said:

Discussions found on the web:
  1. Paul commented on Jun 25

    I love this argument: “honesty is HARD, so we don’t WANT to…” That’s the state of the apologists for corporate America regarding Sarbanes Oxley. Unreal.

    Corporations are just swimming in money now. Profits have been at record levels for many quarters.

    Somebody want to convince me that the attempt to keep them honest through SarbOx has caused deep hardship? Ridiculous.

    Paying my taxes is an onerous process for me, but one that I’ll gladly do to have my private property and free speech protected. I wonder if I cheat the IRS if I can pull a Skilling, “Gee, I have absolutely NO idea what happened in my household in the last 5 years. How can you possibly hold ME accountable? I’m just the boss of everything!”

    If you and I can do it, corporations can do it too. Give me a break.

  2. royce commented on Jun 25

    Rather than putting it to a lack of skills, I assume Zhang’s analysis is based around coming up with a conclusion that pleases corporate America, increasing her fees from consulting work and improving her flow of research money.

  3. BDG123 commented on Jun 25

    I developed a bad case of gas on the starting date of that chart so I’m wondering if that had something to do with it as well.

    That said, Sarbox was a great idea but IMO a bad implementation. It appears in retrospect the first “body” Sarbox should have been applied to was the US CONGRESS! The greatest corporate criminal activity of our time beyond the handful of cases of CEO greed are the chucking of pensions onto the PBGC or trashing defined benefit programs altogether for people who have worked under a clear contract of such for ten or twenty years. Especially companies which are healthy or making record profits like IBM, Verizon and Motorola. This criminal activity is only allowed because our palm greased politicians allow it.

    Personally, it is more important to me that we clean up Washington first. The hold lobbyists, foreign and domestic, have on Washington, is the most criminal activity going on in America today. While the founding fathers were surely not perfect men and likely to fall under the trance Washington is currently under if they were in the same situation, I am quite confident they would hurl at the time of the “Great Unpleasantness” as this will surely be called.

    Sarbox, in its current implementation, is just absolutely killing smaller companies and it is killing smaller tech companies who no longer want to list on American exchanges. Or, as the head of a promising biotech company said in a recent article, *paraphrasing* We are a development stage company. I could either hire ten more scientists which increase our chances of success, or I could hire ten more accountants to meet Sarbox requirements. If you think corporations are swimming in profits so the costs are hooey, look at the price of goods sold. They aren’t going to eat it, YOU are. Or, consider going public as a small company and tell me you want to spend $1 million annually as a small company on Sarbox. Ahh, a million here, a million there. No big deal. I’m sure that the regulations required to list in the US have nothing to do with why Britain is getting all of the new international listings.

    I am hoping a reform or reforms in other area of corporate governance alleviate the need for much of Sarbox. I do like the signoff requirements by the CEO and CFO because they are now requiring their direct reports to sign off and on and on. The matrix of signatures is a great “check” to foolishness by a selected few. At least some type of Sarbox-lite or exception for smaller companies would be a move in the right direction.

  4. ken commented on Jun 25

    Any ‘promising’ biotech company that makes excuses like that is really not that ‘promising’ at all.

    At a time when investors were throwing money at small cap stocks, to hear someone complain that they had to make the tough choice between compliance and research demonstrates clearly that this is a company as berift of good ideas as it is of good management.

  5. OldVet commented on Jun 25

    There’s a great positive benefit to transparency in financial reporting and vigorous oversight of the quality of that reporting. It’s that little investors can have some confidence in the capital markets, and that they can invest in them knowing somebody is helping them to make good decisions based on truthful reporting by companies.

    S.O. generates costs to some, income and benefits to others, and the net effect has been to help rather than hurt investors. You want my money, I want you to tell me the truth. It’s a fair trade.

  6. cm commented on Jun 25

    Barry: You may hope that an accountant can see further, but as I understand it, the subject of accounting is precisely doing arithmetic on numbers without regard to what they mean.

  7. Lord commented on Jun 25

    I like the idea of attributing all change to one event. Just think of all the assertions we can make! Bush bad, terrorism good, X has cost us x dollars, Y has created y dollars, Z would have created z dollars if X did not cost us x dollars. It is all so wonderfully meaningless.

  8. Barry Ritholtz commented on Jun 25

    CM — at the very least an accountant has to understand the significance of events relative to the numbers they use — especially the numbers they select to analyze (She wasn’t exactly doing taxes)

    Remember, Zhang’s thesis was “How can I determine the cost of Sarbox?” It was her decision to use the decrease in total market capitalization as the deciding measure.

    Whether that is accounting or not dont matter much to me; It was her choice. The fact that she chose that reflects her lack of understanding of markets, and general naivete. She chose the subject matter, as well as the qualitative evaluation of the quantitative data.

    I cannot blithely ignore this; She made her own erronous analytical bed, and now her damaged reputation must sleep in it.

  9. cm commented on Jun 26

    Barry: Fair enough. I did not mean to disagree with your criticism of the person, just express my surprise about the aspect that her being prof of accounting was supposed to be of any significance.

    On a not unrelated note, it seems to me that a lot of corporate decisions are made, probably not by accountants, but certainly with their help and based on similar simplistic accounting principles, with substantial disregard of the intangible complexities of subject matters and on the fundamental assumption that all information needed to “manage” the business is “in the numbers”.

    For example, that the problem of offshoring part of your workforce to places 8-12 timezones away is fully described by nominal salaries of matching job grades, and facility operating costs, in the respective locations. I’m exaggerating a lot of course, but I think otherwise that’s pretty much the idea.

  10. bk commented on Jun 26

    I am really sick of hearing how ‘burdensome’ Sarbox is on smaller companies. Going public is a priviledge and if it is too ‘expensive’ or ‘burdensome’, then they can just stay private or sell themselves in a private transaction.

  11. Hugh Taylor commented on Jul 5

    Does anyone know the outcome of the June 29th Federal Court hearing regarding the Free Enterprise Fund’s case against the PCAOB?

  12. RP commented on Mar 30

    It’s FUNNY to see a group of people with no knowledge of business research criticizing the research design of a paper. Guys, you really don’t know what you are talking about.

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