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Advantages and Disadvantages of SOX
In the early 2000s, a veritable parade of major corporations entered bankruptcy, engulfed
in wide-scale financial fraud and accounting misrepresentations. Enron and WorldCom were
high-flying, then-leading firms in their respective industries, whose common stock prices at one
point signaled enormous clout in the world. Many lost faith in the securities market and in ways
of valuing firms via these financial instruments. This created a bit of a bind as firms had
previously tried to regulate their own behavior to prevent accounting misrepresentations, to
foster investors’ faith in market valuations.
Tax Advantages of Sarbanes-Oxley Act
In 2002, after years of endemic accounting errors and outright fraud, Congress passed the
Sarbanes-Oxley Act (Sox) to protect shareholders and the public. Its founding principle was
relatively clear-cut: to improve the accountability of corporate managers to their shareholders
and to restore much-damaged confidence in American capitalism, which under the shadow of the
accounting fiascos at Enron, WorldCom and the like had begun to seem a little fragile, to say the
least (Economist, 2005). More specifically, the intent was to achieve this aim by holding
companies more closely to account through a legislative framework of greater regulatory
standards and oversight. Its opponents claim that it represents added and sometimes excessive
regulatory burden and compliance costs, while proponents see it as fundamental to the ongoing
health and resilience of corporate governance. Sarbanes-Oxley remains at the heart of legislation
and regulation in the corporate sphere.
Intended to provide investors with assurance that they can trust the financial information
of public companies, SOX has 11 sections. One is the ‘Corporate Responsibility’ section which
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requires that the CEO and chief financial officer attest that financial statements are presented
fairly in accordance with generally accepted accounting principles and have been evaluated by
those who have responsibility for establishing and maintaining internal controls. At the extreme
end, as there is more executive responsibility, there is also more transparency and control over
financial reporting. A survey of more than 400 executives revealed that more than half of them
believed that SOX improved their understanding of internal control (Bentley, 2010). And this
increased understanding can help SOX achieve its broader goals, including the ‘Enhanced
Financial Disclosures’ sections, which in turn bolster the spirit of disclosure and robust financial
management, leading to increased investor confidence.
Internal controls are the most important lines of defense against erroneous financial
reporting, and internal control testing ensures that every transaction that potentially impacts a
company’s bottom line is executed in a proper manner. SOX required companies to test their
internal controls every quarter and report on their status. This continuous monitoring assists
company leaders in maintaining a high-quality environment of internal controls. That type of
environment was sorely lacking at Enron, which had inadequate controls to the point that leaders
circumvented proper internal controls. Since SOX requires the executive leadership of a
company to certify that they have both accurate financial statements as well as adequate controls
to ensure their integrity, it also requires the auditors, who are considered independent of
management, to verify the actions of management. After this has occurred, auditors are free to
make further inquiries from management to assist them to confirm the validity of the controls
that are in place. Since the passage of SOX, it has caused auditors to perform more rigorous and
independent traditional audits. Also, to enhance the audit function, another provision of the Act
required every public company to have a separate committee of the board of directors that is
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charged with looking after the relationship between the company and its auditors. The result is
that auditors are more involved; they can ask key questions about controls; and, therefore, that
such auditors are more ‘independent’ of management, or at least can question the validity of
controls. A recent study suggests that auditors are finding around three-fourths of unpremeditated
internal control deficiencies (Bedard and Graham, 2011). This extra scrutiny and involvement by
auditors strengthen the integrity of financial reporting and ensures that investors have confidence
in the information reported.
Tax Disadvantage of SOX
There are examples of when the SOX Act was implemented, and the results have been
subject to debate. One argument is that being small and publicly owned doesn’t provide enough
quantitative qualifier to absolve small public companies from the same standards and scrutiny
that their larger multinational brethren are required to adhere to. Though not an impossibility,
they may not encounter challenges with the standards themselves, the expense incurred in the
compliance of Sarbanes-Oxley is beyond what any small company can bear. The cost associated
with the Sarbanes-Oxley Act is huge. One CEO from a small healthcare company stated: ‘When
an organization has to spend $1 million to comply with all the Sarbanes-Oxley requirements, the
smaller the company, the more onerous that cost is going to be’ (Cziborr, 2005). Second, the
financial burden, including the cost of hiring extra compliance staff and auditors to complete
extra accounting checks, is no small challenge for small companies. Often, smaller companies
suffer from limited access to resources, especially the workforce. One way to meet the SOX
violation of segregation of duties requirements is to hire more accounting staff; outsourcing from
the current employees of the company from other divisions outside of accounting is not exactly
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an option, for it could compromise the integrity of internal controls (Vitez, 2009). As such, while
the SOX Act aims to ensure greater corporate governance and financial transparency, which
many authorities claim a positive impact on securities markets including stock prices in the
United States and in other countries with similar rules and enforcement, the implementation of
SOX can also cause a major headache for small- and medium-cap firms.
Opinion
Over time, SOX can be refined to better maintain the integrity of financial disclosures,
which is essential for investors to continue funding organizations. While smaller companies have
struggled with the costs of compliance, this issue is not merely subjective. Congress has
instructed the SEC to reassess and quantify the specific financial burdens that companies face in
adhering to SOX (Jahmani & Dowling, 2008). The Act was not enacted without reason; it was a
necessary response to the fraudulent activities of several major corporations. The various
sections of SOX are carefully designed to establish a robust control environment in publicly
traded companies. Focusing on the control environment ensures that internal controls serve as
secondary and tertiary defenses rather than the primary line of defense (Dittmar & Wagner,
2006). This structure helps investors trust financial disclosures without needing to scrutinize
them for potential fraud, thus fulfilling the mission of SOX. As the Act evolves, it aims to
balance the integrity of financial reporting with the operational realities of companies of all sizes,
ensuring investor confidence and market stability.
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References
Bentley, L. (2010, June 25). Survey: Sarbox Compliance Does Pay Off Over Time. Retrieved
from http://www.itbusinessedge.com/cm/blogs/bentley/survey-sarbox-compliance-does-
pay-offover-time/?cs=41941
Cziborr, C. (2005, August 8). Critics say accounting reform has gone too far: costly new rules in
Sarbanes-Oxley Act of 2002 create woes for public companies. San Diego Business Journal,
26(32), 17+. Retrieved from http://go.galegroup.com.ezproxy.emich.edu/ps/i.do?
p=ITOF&sw=w&u=lom_emichu&v=2.1&it=r&id=GALE
%7CA135467221&sid=summon&asid=998057a3ff96d77fe007a9cb5250f4d9
Economist. A price worth paying? (2005, May 21). Retrieved from
http://www.economist.com/node/3984019
Jahmani, Y., & Dowling, W. (2008). The Impact Of Sarbanes-Oxley Act. Journal of Business &
Economics Research,6, 10th ser. Retrieved from
https://cluteinstitute.com/ojs/index.php/JBER/article/viewFile/2479/2525.
Jean C. Bedard and Lynford Graham (2011) Detection and Severity Classifications of
SarbanesOxley Section 404 Internal Control Deficiencies. The Accounting Review: May
2011, Vol. 86, No. 3, pp. 825-855
Wagner, S., & Ditmar, L. (2014, July 31). The Unexpected Benefits of Sarbanes-Oxley.
Retrieved from https://hbr.org/2006/04/the-unexpected-benefits-of-sarbanes-oxley
