Analysis of the Sarbanes-Oxley Act Essay Example
Analysis of the Sarbanes-Oxley Act Essay Example

Analysis of the Sarbanes-Oxley Act Essay Example

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Summary of the Sarbanes-Oxley Act

The Sarbanes-Oxley Act (SOX) was enacted on July 30, 2002 to protect shareholders and the public from fraudulent business practices and accounting errors. It focuses on maintaining independence in auditing by requiring CEOs and CFOs to certify financial reports. The act enhances transparency in financial reporting and encourages accountability by involving independent audit firms.

This discussion examines the impact of the SOX Act on CEOs, CFOs, and outside independent audit firms. It also analyzes the advantages and disadvantages of this act and identifies necessary modifications. CEOs and CFOs are crucial figures in public companies, with the CEO possessing ultimate decision-making authority and the CFO overseeing financial activities.

Rehbein (2010) states that CEOs and CFOs are required to prioritize the welfare of public company owners and stakeholders. The Sarbanes-Oxley Act (SOX) was implement

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ed in 2002 to improve corporate governance and establish better internal and external oversight. Orin (2008) views this act as a substantial effort to enforce ethical conduct and restore confidence in financial markets.

Studies have shown that the SOX regulations have resulted in increased disclosure and information which is advantageous for market participants. These regulations have also contributed to lowering the cost of capital and providing more accurate information on the performance of executives like the chief executive officer and chief financial officer (Rehbein, 2010). The implementation of effective business ethics became crucial with the introduction of SOX, and the law made it necessary for corporate codes of ethics to be published. However, it did not specify their content (Orin, 2008).

The act was designed to prevent unethical business practices. CEOs and CFOs are encouraged to be cautious when faced with increased uncertainty an

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legal liability, and to refrain from overstating earnings. Section 406 instructs companies to disclose whether they have implemented a code of ethics for their senior financial officers. It also requires companies to provide reasons for not adopting a code of ethics, and any revisions or waivers made to the code.

The Code of Ethics requirement serves as a framework for internal corporate governance by establishing guidelines for acceptable behavior for all individuals within a corporation, including officers, directors, employees, and internal accountants (Orin, 2008). Livingstone suggests that the moral foundation of society is built on human collaboration, and it is in our collective interest to adhere to conventional moral principles. As social beings, community is valuable as it enables us to prosper and succeed.

Upholding just rules is beneficial for maintaining this community. To evaluate a decision, it is important to consider if it promotes a harmonious and respectful atmosphere by taking into account the needs of others (2009).

The Sarbanes-Oxley Act (SOX) regulations have several provisions that aim to enhance the credibility of financial statements. Notable requirements include the certification of financial statements by the CEO and CFO, as well as the evaluation of internal controls by management and an auditor's opinion on them.

In 2010, Lobi and Jian stated that the Sarbanes-Oxley Act of 2002 (SOX) increases the potential legal liability for CEO/CFOs. According to SOX Section 302, titled "Corporate Responsibility for Financial Reports," CEOs and CFOs are required to create a statement certifying the accuracy and appropriateness of financial statements and disclosures in periodic reports. This certification should also confirm that the issuer's operations and financial condition are accurately represented. Violating this section requires intentional

intention to incur liability.

A recent study conducted by Xue Wang at Emory University examines how SOX affects CFO compensation and turnover rates. The study focuses on the important role of CFOs in developing firms' financial reporting, making voluntary disclosure decisions, and taking ultimate responsibility for the quality of internal control systems. It provides valuable insights into SOX's impact on the executive labor market.

The study demonstrates that increased information disclosure regarding a company's internal controls has advantages for corporate governance. Specifically, it facilitates board oversight of CFO activities. Furthermore, it reveals that firms with strong internal controls experienced a rise in salary, bonus, and total compensation after SOX. Conversely, CFOs of companies reporting internal control issues faced a notable decrease in their compensation packages.

According to Wang, the turnover rates for CFOs generally increased from the time before the implementation of the Sarbanes-Oxley Act (SOX) to after its implementation. The outside independent audit firms state that SOX was passed in July 30, 2002, by Congress to safeguard shareholders and the public from fraudulent corporate practices and accounting errors while ensuring auditor independence. After the enactment of SOX, audit firms now claim to be more cautious in terms of client retention and acceptance decisions due to the significantly increased risks associated with auditing (Ryu, Uliss, and Roh, 2006).

According to Section 404 of SOX, firms and auditors must assess internal control systems annually for company operations and financial reports. However, post-SOX, auditors face increased risks and negative media attention. As a result, they are now expected to employ more rigorous processes and cautious measures when determining whether to issue going-concern or other qualified opinions, as compared to their previous

practices (Ryu, et al, 2006).

The concerning aspect is Section 404 of the Sarbanes-Oxley Act (SOX), which deals with "management assessment of internal controls" (Bisoux, 2005). According to Bisoux (2005), the true issue behind Sarbanes-Oxley is an ethical one. Ethics should be integrated into every business case to make students aware that they will come across ethical dilemmas in different scenarios and understand that there may be instances where they are asked to engage in unethical behavior. In such situations, they will need to contemplate the type of individuals they aspire to be and consider the consequences.

This is something that Sarbanes-Oxley does not address. According to a survey of 1,001 investors and their opinions of the SOX, 79% stated that the requirement to establish independent audit committees has been effective and 76% believed that external auditors reporting to independent board-based audit committees has had a positive impact. ("Auditing", 2007) CEOs and CFOs are concerned about Sarbanes-Oxley potentially impeding their companies' growth and their willingness to take risks (Bisoux, 2005).

According to Bisoux (2005), the effectiveness of Sarbanes-Oxley in giving shareholders a better understanding of a company's financial health is uncertain. This law guarantees the accuracy of financial statements by public companies and has generated considerable interest from CEOs and CFOs as they will now be accountable for their company's financial state and encounter higher independent audit fees. Section 404 of SOX focuses on the problem of using inadequate management as a justification for financial inaccuracies.

Due to Sarbanes-Oxley, the audit fees have significantly increased for some companies, tripling for some and quadrupling for others. The implementation costs of these regulations can result in a decrease in the stock

value of a company (Bisoux, 2005). According to Livingstone, Immanuel Kant defines his principle as a "categorical imperative," which is an order that allows no deviation. It is a direct command that mandates doing the right thing every single time, without exceptions or convenient circumstances.

External independent audit firms play a crucial role in deterring companies from violating the regulations established by the SOX (2009). If these firms are diligent and accurate in their duties, they can effectively prevent companies from trying to bypass the SOX. According to Ryu, et al (2006), auditors have the responsibility of assessing uncertainties regarding a company's viability for approximately one year. Therefore, auditors may face legal consequences if their clients go bankrupt without any prior warning from audit reports issued within a year before the bankruptcy occurs. Consequently, there has been a noticeable increase in external auditing as a response to these factors.

According to Ryu, et al (2006), the implementation of SOX may have a substantial effect on the stock value of different companies. The authors propose that if auditors declare a going-concern opinion while the client is still financially stable, it may damage the auditor-client relationship and raise the chances of losing the client. Auditors might opt not to provide a going-concern opinion due to concerns about losing clients, even if they acknowledge that those clients are experiencing financial distress. This consequence could significantly impact investor confidence in the company.

The Sarbanes-Oxley Act (SOX), implemented in July 2002 as a reaction to corporate and accounting scandals involving notable US companies such as Enron, Tyco, and WorldCom (Kamar, Karaca-Mandic & Talley, 2007), has both advantages and disadvantages. One advantage is that

it enhances investor confidence by improving the transparency and accuracy of financial reports (Snee, 2007).

In a report conducted by the University of Iowa’s college of business, it was found that the market had experienced an eleven percent jump by August of 2002 (Snee, 2007). Another benefit of the act is Section 906, which mandates that chief executive officers and chief financial officers of public companies must personally endorse their company’s financial reports. This requirement effectively fosters a heightened sense of accountability among corporate executives. Lastly, the Act safeguards whistleblowers from employer discrimination and enhances penalties for SEC violations.

Although the enactment of SOX has increased stockholders' confidence, it has raised concerns in many companies, especially smaller enterprises. Firstly, Kamar et al (2007) argue that there is ample evidence showing that SOX has increased accounting and audit costs for public firms. The authors assert that before SOX, audit fees already constituted a higher portion of revenues for smaller firms. They add that this disparity between small and large firms increased after SOX, particularly for small firms that complied with Section 404, which is the most costly aspect of the legislation. Secondly, SOX has also had a significant impact on small businesses' decision to go public (Kamar, Karaca-Mandic ; Talley, 2007). Minnesota Senator Norm Coleman (2007) claims that this act forces small businesses to choose between hiring new workers or auditors, a decision that would not be necessary if they decided to stay private (as cited in Kamar, Karaca-Mandic ; Talley, 2007).

The implementation of Sarbanes-Oxley in 2002 has put smaller businesses at a disadvantage compared to larger public companies. This is because small businesses have to bear the

increased costs of compliance while larger companies can better manage these expenses with economies of scale. As a result, smaller businesses are forced to stay private and cannot grow within their domestic capital market. Since Sarbanes-Oxley was enacted, there has been a decline in the number of businesses choosing to go public. Additionally, SOX affects international markets beyond national borders.

A report by Robert Kennedy College in Switzerland (n.d.) states that the negative impact on the U.S. economy has been felt as foreign companies reconsider listing their stocks on American stock exchanges. Companies like Porsche, Daimler Chrysler, and Bayer are unhappy with the requirement of the Sarbanes-Oxley Act for upper officers to sign off on reports and be held fully responsible. Wendelin Weideking, CEO of Porsche, argues that this requirement makes no sense because many employees are involved in finalizing the accounts and under German law, the management board collectively assumes responsibility (as cited in Kamar, Karaca-Mandic & Talley, 2007). Additionally, executive officers of other companies believe they spend too much time avoiding liability instead of focusing on increasing shareholders' value (Kamar, Karaca-Mandic & Talley, 2007). Many investors question whether changes should be made to the Sarbanes-Oxley Act, implemented on July 30, 2002, as they are left with less confusion regarding business financial reports and the changes in federally regulated financial reporting laws. The act was put in place to reassure investors about businesses' ethical and sound financial reporting obligations due to previous instances where corporations presented misleading financial information (n.d.).I aim to analyze if the Sarbanes-Oxley act requires further modifications to achieve its intended goals.

According to Burks (2011), there is no evidence of a statistically

negative drift specifically in the post-SOX period. This means that the drifts observed after SOX are actually less negative compared to pre-SOX investing. In fact, price efficiency seems to improve after the implementation of SOX (Burks, 2011, p. 509). Additionally, Burks found no evidence that post-SOX restatements result in higher trading volume after accounting for contemporaneous returns (p. 511). These results suggest that there is no increased disagreement among investors regarding the restatements following the implementation of SOX.

Burks suggests that investors are not confused by post-SOX restatements and that the overall transparency in business reporting has improved due to SOX. However, opponents of Sarbanes-Oxley argue that the act reduces competition with foreign rivals, as reported by Martin and Gay (2010). These opponents also believe that including businesses from other markets like the UK was an unintended consequence of SOX. Despite this unintentional effect, most businesses still trade through the SEC, which has a relatively minor impact on the United States' global market position.

After careful consideration of both sides of the analysis, I have concluded that the Sarbanes-Oxley Act (SOX) requires changes to be implemented in future legislation. The federal government is currently addressing these changes in the Dodd Frank Act. The changes include addressing high implementation costs of SOX, passing legislation to penalize retaliation against whistleblowers by the SEC, and promoting competition in the global market.

The Dodd Frank Act will also serve as an overseeing agency for federal components and ensure ethical financial reporting standards for American businesses in the future. These necessary changes will improve the effectiveness of SOX and reduce instances of unregulated unclear business practices.

If one argues that legislation can guarantee accuracy

in public company financial statements, they must explain why previous laws have failed. We maintain that SOX successfully achieves its goal of ensuring transparency and accuracy in public company financial statements.

The main goals of the act are to enhance corporate responsibility and improve financial disclosures while combating corporate and accounting fraud. Evidence shows that this law has successfully restored investors' confidence and promoted a culture of increased responsibility among corporate executives since its enactment in 2002 (Snee, 2007). Additionally, the act increases penalties for SEC violations and provides protection for whistleblowers, effectively deterring fraud and deceit.

The Securities Act of 1933 and the Securities Exchange Act of 1934 are two important securities laws that came before the Sarbanes-Oxley Act (SOX). According to Bumgardner (2008), the scope of the 1933 act was limited because compromises were made during its creation, and Roosevelt initially decided not to pursue broader regulatory authority. Hence, this law only regulated the issuance of new securities and did not include existing securities or stock exchanges.

The Securities Exchange Act of 1934 is an important law that regulates securities to prevent false statements or omission of vital information during the buying or selling process. However, it does not adequately tackle the issue of misrepresentation caused by illegal concealment or falsification of records related to a company's debts, earnings, acquisitions, mergers, or other financially significant transactions (Bumgardner, 2008).

References:

Auditing. (2007). Journal of Accountancy, 204(4), 21. Retrieved from EBSCOhost.

Bisoux, T. (2005). The Sarbanes-Oxley.Retrieved from here.

Bumgardner, L. (2008, August 19). How does the Sarbanes-Oxley Act impact American business?Retrieved from here.

Burks J.(2011).

According to Kamar, Karaca-Mandic, and Talley (2007), restatements after the implementation of the Sarbanes-Oxley Act could potentially

cause confusion among investors. Additionally, these researchers have conducted studies to analyze how Sarbanes-Oxley affects small businesses and gather supporting evidence.

Furthermore, Livingstone (2009) and Lobo and Jian (2010) have also explored the subject of ethical decision making in their respective discussions.

The article by Martin, B. H. D., & Gay, B. K. (2010) in the Journal of Investment Compliance investigates the impact of the Sarbanes-Oxley Act on discretionary financial reporting behavior and highlights changes in securities regulations that provide greater protection for investors. Additionally, a separate article by Orin, R. M. (Winter 2008) in the Journal of Accounting, Auditing & Finance examines ethical guidance and constraints imposed by the Sarbanes-Oxley Act.

Rehbein, K. (2010). Sarbanes-Oxley: Does It Help to Distinguish Good CFOs From Bad Ones? Academy of Management Perspectives, 24(4), 90-92.

Ryu, T. G., Uliss, B., & Roh, C. (2006). The Effect of the Sarbanes-Oxley Act on Auditors’ Audit Performance, Proceedings of the 2006 Academy of Business Administration Conference.

Snee, T. (2007, February 20). UI researchers find positive market reaction to Sarbanes-Oxley Act. The University of Iowa News Series. Retrieved from http://news-releases.uiowa.edu/2007/february/022007sox-reaction.html

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