December 28, 2005

Passage of the Day: John Stossel on the Cost of Sarbanes Oxley

Filed under: Economy,Taxes & Government — Tom @ 11:31 am

I missed this piece from before the holidays, the ABC consumer reporter and recently-converted free market advocate lays out just some of the costs, and skewers the flawed assumptions behind the law:

Sarbanes-Overkill
Dec 21, 2005

Suppose you’ve got a growing business. You’ve just opened your 100th restaurant, and your company is making just over a million dollars in annual profits. You want to expand further — spend a million dollars to rent a new building and hire more cooks and waiters. An accounting firm offers you new services that will cost nearly half that, money you might otherwise spend continuing to expand the business.

Do you hire more cooks, or do you hire more accountants?

Under the Sarbanes-Oxley Act, you hire the accountants. The restaurant chain in question is Max & Erma’s; its CFO told researchers at the Competitive Enterprise Institute the company will have to pay $500,000 to $600,000 every year to meet the demands of the new anti-fraud law, Congress’ attempt to avoid more Enron-like fiascos by making businesses pay accounting firms to keep them in check.

If spending half a million dollars on accounting instead of growth isn’t depressing enough, what do you say to $100 million a year? That’s what oil giant BP, a British company whose U.S. business generates less than half its income, is paying, according to its CEO. And that figure is just “external costs”; it doesn’t include the time the company’s own employees spend complying with the new law.

Or how about 96 percent? That, a study by the law firm of Foley & Lardner found, was the increase last year in the average audit fees of smaller public companies — from $532,000 in 2003 to $1 million in 2004.

The law’s defenders claim its good consequences outweigh its costs. But if that’s so, why not let investors figure it out? If certain accounting practices make companies better investments, investors will put their money in companies that use those methods. If having your accountant grill you for not having a written policy on hiring and firing will make your business sounder, you don’t need the federal government to force you to do it.

Even the regulators may be realizing this law has gone too far …..

We don’t need the government to force businesses to spend half their profits on accountants, because free markets police themselves. Those that serve customers well are rewarded with more customers; those that do well for investors attract them. Bad guys who cheat get a reputation for cheating. They lose customers, lose investors and go out of business. Think of how eBay works. The selling price of each item is determined by auction, so buyers and sellers both get the best possible deal. Sellers are rated by their customers, so the “community” quickly identifies cheaters.

The competition of the market protects us better than the ever-mounting pile of rules legislators pass. And it keeps the costs reasonable, because the private sector has to bear its own burdens, while government forces its costs on others.

The market doesn’t catch everything — there will always be fraud on eBay, and, on a larger scale, scams like Enron. But Sarbanes-Oxley won’t catch all the fraud either.

Competition will catch more of it. The more I’ve watched the markets work, the more impressed I’ve become with how competition solves problems with speed and flexibility rarely seen in government-imposed solutions.

There are two reasons I have been advocating that noncorporate and especially government entities to be brought under Sarbanes Oxley. First, THEY are the ones that are out of control (see previous posts below), not for the most part (and despite the headlines) the corporate world they criticize. Second, if these government and other entities have to experience what businesses have had to endure with Sarbox, they will be first in line calling for repeal or a major rethink of the entire law.
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2 Comments

  1. There is a standard developing (XBRL: stands for Extensible Business Reporting Language) which I hope will greatly reduce costs (and increase accountability) associated with public accounting at all levels.

    Think of it as the equivalent of HTML hyperlinking for Business Reporting…but with all the associated commentary, supporting documentation (text,audio, video,etc.) …’metadata’ that financial data have. This will allow for more third party review of publicly reported finances.

    There will be some fixed upfront costs moving towards this standard but the downstream beneifts could be tremendous.

    The SEC is moving in this direction with a volunatry program. See: http://www.sec.gov/rules/proposed/33-8496.htm

    Comment by Porkopolis — December 28, 2005 @ 12:10 pm

  2. #1, Thanks for the info, Mario. This idea has been kicked around for at least 5 years now; I hope they can figure out a way to bring it to fruition, because I agree that it should lower costs, force comparability in reporting and improve transparency. The SEC comment deadline at the link you provided is over a year old–hope that’s not an indication that inertia has set in.

    Now let’s make Uncle Sam do it too…..

    Comment by TBlumer — December 28, 2005 @ 12:30 pm

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