As a largely symbolic measure meant to reassure the investing public that the Congress was “solving” the problem of corporate corruption, the use of SOX is akin to wielding a sledgehammer to solve a very specific problem. Without the highly publicized (overhyped?) corporate scandals in 2000 and 2001, Congress likely never would have implemented SOX "reforms." Congress again, in its efforts to "solve" a problem, may have created a solution that has unintended consequences. Small public firms are burdened to the point where they are no longer able to compete with large, entrenched firms in the raising of investment funds from the public markets. Even private firms face SOX costs.
Most assume that SOX has led to many smaller firms going private, the larger question is “why.” One oft-mentioned major reason as to why he believes that small firms go private when faced with SOX requirements, e.g., increased auditing cost and the resulting minor benefits of remaining public. However, I think this is the area in which needs to be addressed. Without this analysis, the Congress may (1) assume that SOX is working well, (2) believe that minor “tweaks” could fix the reasons that small firms are exiting the public markets, or (3) repeal SOX completely. While a complete repeal is extremely unlikely to occur, the more dangerous scenario would be that Congress does not understand either why small firms are exiting because of SOX or what the implications of that exiting will occur, with a result that no SOX fixes are ever implemented.
Most focus as to “why” small firms go private is the enormous cost associated with meeting the increased auditing burdens. For large firms, this cost is proportionally much smaller than that for the small firm – which can be as high as 3% of the firms’ budget. In highlighting the costs of auditor attestation fees, small firms lacked the accounting staff necessary to deal with increased auditing requirements and certification of internal controls.
I am not so sure, though, that this would be as significant of a cost to SOX reporting. When SOX appeared, both small and large firms, as well as the supporting legal and accounting firms, lacked any experience on exactly what SOX required. Everyone had to learn, and learn quickly. As with the launch of anything new, initial operating costs are high due to the steep learning curve involved. Over time, costs decrease as experience grows, standardized procedures are developed and best practices implemented, and comfort levels increase. I am sure public firms experienced similar “pains” when the SA and the SEA were implemented in ’33 and ’34.
Thus, in order to effect change in SOX to remove its burdens upon entrepreneurship, I feel that those who study SOX should focus on not the costs at implementation, but the costs that one may reasonably expect to occur going forward. Only by exploring the continuing costs of SOX can the market, pundits, and the Congress decide if the benefits, if any, outweigh the costs to American competitiveness. It may very well be true that the implementation of SOX caused a large amount of small firms to go private. Eric Talley, in his most recent scholarship, concludes that the implementation of SOX:
“[I]nduced small firms to exit the public capital market…represent[ing] a burden on entrepreneurship that transcends the immediate effects we have estimated. Creating an environment in which entrepreneurship can flourish is seen by many as a fundamental virtue of the American economy.”
However, as I stated above, the continuing costs of SOX should be measured. If costs decrease over time to an acceptable level, though, small firms may find that the public markets remain a viable means to raise capital. If costs remain high, then it becomes more imperative for Congress to repeal or at least amend SOX to reduce or eliminate the regulatory burden imposed on entrepreneurship. Without the rise of small firms and their ability to raise expansion capital, large firms become entrenched and unthreatened by competition from small firms. Of course, by the time that Congress decides that it needs to “fix” its previous “fix”, many business may have lost the ability to expand and the consuming public will have lost the resulting innovation that small firms provide to the marketplace.
It appears that these arguments have been heard by the SEC. The SEC's Advisory Committee on Smaller Public Companies will issue in April a final report on possible exemptions from 404 requirements for companies of under $125 million in market capitalization and under $125 million in annual revenue.
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