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The Effectiveness of the Sarbanes-Oxley Act

The Effectiveness of the Sarbanes-Oxley Act

The corporate accounting scandals affecting big companies such as Tyco International, WorldCom, and Enron revealed the limitations of the financial and reporting standards. As a result, the Congress passed the Sarbanes-Oxley Act to regulate the public accounting in the US. For example, in section 404, the Act outlines the requirements to ensure efficient internal control over the financial processes. It provides the Public Company Accounting Board with a significant role in the corporate governance. However, some companies argue that the cost of implementing the regulation outweighs its benefits. As a result, some companies went private instead of establishing an internal control. However, the companies with a strong internal control can effectively adjust to the regulations. Though initial implementation of the Sarbanes-Oxley Act may be costly, the law proves to be efficient in the long-rung since it reduces the chances of the corporate fraud by establishing the internal controls and disclosure of the financial information; therefore, it enhances investors’ confidence.

The Sarbanes-Oxley Act enhances the corporate governance. The core element of the corporate governance is to balance the management discretion and that of the stakeholders. Consequently, the issues such as collective-action and principle-agent relationship appear. For example, in the collective-action problem, the shareholders may lack the ability to exercise their ownership due to various reasons since they do not regulate the business process. As a result, the management may use an opportunity to protect own interest at the inventor’s expense. However, even though the shareholders make decisions that allow the business to maximize its profits, others may hold insignificant stocks to seeking the need. Secondly, the principle-agent problem focuses on entrusting the agent, who is the management, with the investments to maximize the shareholders’ value. However, the agents have conflicting interests of whether to maximize own or shareholders’ value. To eliminate the conflict, the Sarbanes-Oxley Act prohibits the accounting companies from performing certain audit and consulting services for a similar company (Landsman, Nelson, & Rountree 2009). Additionally, it requires the audit companis to report to the independent audit committee. The committee, in its turn, evaluates the effectiveness of the auditors to improve the corporate governance (Gordon, 2002).

The Sarbanes-Oxley Act enhanced the disclosure of financial and other information. The disclosure requires appropriate representations of the financial position, performance, and cash flow of an entity for various periods. The fair representations require faithful disclosure of transactions, as well as other events and conditions, in accordance with the recognitions of assets liabilities and expenses in the financial reporting framework (Luo, & Salterio, 2009). Additionally, the structure requires consistency in the items classification in the financial statements. In the Enron scandal, for example, the company altered its financial statements to avoid being declared a bankrupt. The company established the off-balance-sheet accounts to hide the immense losses. As a result, the company increased the net income providing inaccurate information to the shareholders. To curb the menace, the Sarbanes-Oxley Act requires the CEOs and CFOs of the company to certify all financial statements liable for any fraudulent. Nonetheless, the company’s independent auditors must certify the correctness of the assessments by the management (Prawitt, Smith, & Wood 2009).

The Sarbanes-Oxley Act enhanced the internal independence of the directors and management. For example, it requires separation of the chairperson from the CEO of the company. The committees of public companies oversee the management making decisions relating to the finance, corporate strategy, and profitability (Luo & Salterio, 2014). As a result, the boards must identify the issues and change management for consideration. Additionally, it may replace the management who fails to develop the effective solutions. However, in most corporate frauds, it is not a manager who perpetrates the offense. On the other hand, the CFO, CEO, and the chairperson of the board may be a part of the fraud. By ensuring independence of the two bodies, the Act enables the company’s committee or regulators to establish perpetrators (Gordon, 2002).

The critics of the Sarbanes-Oxley Act, however, argue that the cost of thee law implementations outweighs the benefits. For sure, the sum required is significant especially for the small and medium-sized businesses. Moreover, the critics attribute the loss to slow economic growth. First, they state that the cost deviate the company from the core business. For example, the Act requires employees to meet auditors on a quarterly basis and assess the internal controls. As a result, it is a time-consuming procedure; therefore, it affects the business hours. Second, some small and medium businesses decide to go private or exit the U.S. stock market (Amir, Guan & Livne, 2010). Finally, the foreign companies may not settle in the US while local companies may become less competitive in the global markets (Gong & Liu, 2012). However, the critics do not realize the benefits of the Act. For example, the assessment of internal controls by the auditors is to prevent fraudulent or incorrect transactions, which may be costly in the long run. Secondly, even if the companies go private, there are instances that necessitate the audit. For example, when a bank issues credit to a private company, it always requires an audit report. Thirdly, the foreign companies may not be afraid of the U.S. capital market because of the stringent policies. However, the procedures do restore the investors’ confidence (Gordon, 2002, & Leuz, 2007).

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In conclusion, the Sarbanes-Oxley Act covers a range of regulations for the public companies. During the first ten years of implementation, the Act has successfully controlled and standardized the public accounting and financial reporting. However, it faced some challenges from the public. The most significant and often controversial section is “Section 404: Assessment of internal control.” Broad topic includes the auditors’ independence, corporate governance, and disclosure. Critics argue that even though the Act provides numerous guidelines and standards, the cost of its implementation outweighs the benefits. However, the true benefits can be realized in the long run only. For example, a transparent public accounts increase the investor confidence. Moreover, the companies adhering to the corporate governance are competitive in the global market since they can sustain operations and avoid additional expenses such as the lawsuits.

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