The Cost of Compliance
Alums in corporate finance discuss the real-world effects of recent securities regulation.
ANN ARBOR, Mich.—The high cost of complying with the Sarbanes-Oxley Act, the most significant securities regulations enacted since the 1930s, may adversely affect the U.S. economy, according to four Ross School alums who work in corporate finance.
While these regulations do provide benefits to companies and shareholders, the act should be refined, they told a group of Ross School students at a Dean's Seminar on November 30.
The panel of alumni, moderated by Joel Slemrod, the Paul W. McCracken Collegiate Professor of Business Economics and Public Policy, discussed the Sarbanes Oxley (SOX) Act of 2002 and FIN 48, the Financial Accounting Standards Board (FASB)'s new regulations about accounting for income taxes.
SOX was enacted in the wake of corporate scandals involving Enron and WorldCom and requires higher standards for corporate financial reporting, including the certification of financial reports by CEOs, CFOs and independent auditors. It also established the Public Company Accounting Oversight Board.
FIN 48 attempts to standardize reporting of uncertain income taxes and determines when and how corporate tax reserves can be released. FIN 48 takes effect for fiscal years beginning after December 15, 2006.
The four panelists were:
- Dean Bergy, BBA '81, vice president and chief financial officer of Stryker Corp., a leading provider of orthopedic implants, equipment and other medical products.
- Dan Susik, MBA '83, senior vice president of Ryder System Inc., a worldwide transportation and logistics solution provider.
- Robert Totte, BBA '74, MBA '76, vice president of Jarden Corp., a recently formed company of brand name home goods, including Sunbeam and Mr. Coffee.
- Joel Wittenberg, MBA '92, vice president and treasurer of Kellogg Co., the world's leading producer of cereal and maker of other convenience foods under numerous name brands.
The panelists summarized how SOX has affected their companies and their jobs and expressed mixed feelings about the regulations. They concluded that while compliance has brought some benefits to companies, there is a high cost of compliance that is particularly onerous for small companies.
Costs of complying with SOX reporting requirements include hiring more internal and external auditors and updating or implementing new information systems. Private and foreign-owned companies operating in the United States but not listed on the U.S. stock exchange are exempt from SOX.
Bergy emphasized the effectiveness of internal corporate responsibility over the effects of SOX. The chairman of Stryker said that morality cannot be legislated. "To some extent, SOX tries to do that," Bergy said. "The message from the top of the company is more important."
Wittenberg agreed that SOX did not essentially change the way Kellogg operates. He pointed out the benefits of greater documentation and more disclosure regarding off-balance sheet operations, but the costs for complying with SOX have been high, he said.
Susik said compliance is important for corporate governance ratings, which make the company more credible to investors and analysts.
According to Totte, increased corporate tax regulation enacted after the downfall of the accounting firm Arthur Anderson has affected all corporate tax functions, creating significant time and labor in addition to complying with SOX. Broader disclosure of tax reserves would provide "a road map for taxing authorities," causing companies to be more conservative with investing in regards to their tax reserves, he said. He and the other panelists agreed that it would dampen companies' appetites for agressive tax shelters.
The panel discussion fell on the same day that the Committee on Capital Market regulation released an interim report on the effects increased securities regulation has had on U.S. capital markets. The report recommends that SOX be refined so the U.S. Securities and Exchange Commission can adopt principles-based rules and guidance instead of detailed rules, and that the benefits of regulation are created at a lower cost. All the panelists agreed with the call for change.
When Slemrod asked the panelists to compare the costs and benefits of complying, he noted that "it is harder to quantify the benefits than the costs," because the costs are tangible while the benefits of better outsider access to company information would be reflected in a lower cost of raising funds. While the cost of implementing these controls has been substantial($4.36 million on average), the cost is highest during the first year and is expected to decrease in subsequent years, he said.
The panelists also agreed with the report's finding that the cost of compliance may have caused a decrease in U.S. companies' ability to raise capital and increased competition with foreign companies that are not required to comply with SOX.
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