In July of 2002, Congress swiftly passed the Public Company Accounting Reform and Investors Protection Act at the time when corporations like Arthur Anderson, Enron and WorldCom fell due to fraudulent accounting practices and bad internal control. This bill, sponsored by Mike Oxley (R-OH) and Paul Sarbanes (D-MD), became known as Sarbanes-Oxley Act (SOX).It sought to restore public confidence in publicly traded companies and their accounting practices, though the companies listed above were prosecuted on laws that were already in place before SOX. Many studies have examined the effects of SOX on corporations in the past eleven years. The benefits are hard to quantify and the cost are rather hard to estimate including the effect on market efficiency.
Critics argue that SOX was passed too quickly without sufficient data to support its effectiveness in curbing the moral hazard behaviors that led to the downfall of these big corporations, causing investors to lose their savings and confidence in the market. This paper will try to answer whether the benefits outweigh the costs of implementing this law. It also analyze whether it has been effective in curbing moral hazard behaviors and improving the efficiency of capital markets while protecting shareholder rights. Finally, it will suggest of improvements can be applied or has it been effective in its role in curbing fraudulent activities while promoting a more efficient market.
SOX: An Overview
SOX at its core was meant to increase the disclosure requirements of publicly traded firms. In addition, SOX increased the role of independent directors in corporate governance, expanded the liability of officers and directors, required companies to assess and disclose the adequacy of their internal controls, prompted major securities exchanges to adopt new rules and regulation standards when it came to corporate governance, and, most importantly, created the Public Company Accounting Oversight Board (PCAOB).
In terms of increasing independent directors in corporate governance, SOX directed the Securities and Exchange Commission (SEC) to adopt rules that prohibit listings of companies that did not have an audit committee. The audit committee must consist of independent directors, and if the committee is in place but did not have enough independent directors, it must add more independent directors to the board. In addition, at least one of the directors must be a financial expert as defined by the SEC.
As for the liability of officers and directors, SOX expanded the scope of their legal obligation by increasing penalties for violating securities law and creating new crimes for certain acts which included securities fraud, obstruction of justice, and false certification of financial statements. This part of the SOX act actually modified the current laws that had been in place by increasing the penalties associated with civil and criminal violation of securities law. It also requires that all...