As eye-popping numbers tallying the costs of Sarbanes-Oxley continue to mount, the last refuge of the law’s defenders is the claim that the law was worth it since it restored investor confidence in the wake of the corporate scandals. This rationale is incorrect. Investor confidence was unfazed by the original corporate scandals, Enron et. al., which investors rightly understood as isolated events. Indeed, empirical evidence now suggests that the net effect of “Sarbox” has been to decrease investor confidence, dismantling the rationale for maintaining the law in its present form.
The staggering costs of Sarbox bear repeating. An analysis by Ivy Xiying Zhang of the University of Rochester measured the total stock market impact of the law, and found that it has cost over $1 trillion, with a “T.” About a third of that cost can be attributed to direct compliance costs, while the remainder is the result of the economic inefficiencies created by the law. Nobel Laureate Milton Friedman recently told the New York Sun that Sarbanes-Oxley is the biggest problem facing the U.S. economy today, noting that it tells entrepreneurs, “Don’t take chances because down will come the hatchet. We’re going to knock your head off.”
The Securities and Exchange Commission estimated that compliance with Sarbox would cost just $91,000 per company. That was bad guesswork, even for federal bureaucrats: A recent estimate from Financial Executives International puts that cost at $4.36 million per company, about 50 times the SEC estimate.
Still, the bill’s chief architect, Sen. Paul Sarbanes of Maryland, opposes any major reform, even rejecting calls for reform from fellow Democrats, including Rep. Nancy Pelosi and New York attorney general Elliott Spitzer. Sarbanes also disagrees with his fellow lead sponsor, Rep. Mike Oxley, who called the law “excessive” and said that it was rushed through in a “hothouse environment.”
Despite the hundreds of billions, or even trillions, of dollars Sarbox has cost the U.S. economy, Sarbanes remains firmly convinced that it was all worth it. He remarked last week that the law “is working as intended.” Why? “Investors have regained confidence in our capital markets.”
The investor-confidence rationale is slippery, because it posits that whatever the costs of Sarbox have been, the costs of inaction would have been still greater. Indeed, if the markets went into freefall as a result of the corporate scandals, then such a case could be made. But markets shrugged off the scandals without any major sell-offs.
An analysis by Peter Wallison of the American Enterprise Institute found that the stock market continued to rise in the wake of the Enron scandal, and while the Dow ticked down 6 points the day the Worldcom outrage was revealed, it jumped 150 points the following day and held that gain over the next six trading days. Only when news of an aggressive legislative response broke did stocks begin their decline, the Dow dropping 462 points in two days once President Bush called for reform.
Professor Zhang exhaustively examined the market response to all of the significant events leading to the passage of Sarbanes-Oxley, and concluded that the market lost about $1 trillion. Still, devotees of Sarbox believe investor confidence remains unshaken. They rationalize that the stock market behavior observed by both Wallison and Zhang is merely a coincidence, and wave off all of the cost estimates on the basis that there have been no major scandals since the law was passed.
A novel study by professor Kate Litvak of the University of Texas School of Law offers even more evidence to the contrary. Litvak compared foreign companies who are subject to Sarbox (because they are listed on U.S. exchanges) with analogous foreign companies not subject to the law. She found that investors expected Sarbox to have a net negative affect on companies forced to comply. That is to say, the benefits, whatever they may be, were determined to be clearly less than the costs as far as investors are concerned. No wonder companies have so often cited Sarbox as a reason for fleeing U.S. stock markets, either going private or shifting their listings to London or Hong Kong.
These facts turn the investor-confidence rationale on its head. If we really care about restoring investor confidence, we need to recognize that Sarbanes-Oxley was counterproductive regulatory overkill and set about the task of undoing it.
– Phil Kerpen is policy director for, and Mallory Factor is chairman of, the Free Enterprise Fund.