Pro-Business Lobby Misinformation, Part 2—Sarbanes-Oxley as the Root of All Evil

By Lee Russ

Thursday, August 14, 2008 at 09:02 PM

Since the passage of the Sarbanes-Oxley Act following the Enron debacle, the business community has ascribed every form of evil to that law. Hannah Clark of Forbes once described how the business world feels about the Sarbanes-Oxley (SOX) Act this way:

According to critics, the Sarbanes-Oxley Act has caused a litany of ills: Executives are retiring early, public companies are going private, foreign firms are listing abroad and U.S. firms are losing their competitive edge. The sweeping law, written in the wake of the Enron scandal, has served as a scapegoat for all the evils facing corporate America since it was passed in 2002.

The legislation has been demonized by "libertarians" large (the Cato Institute) and small (John Stossel). But guess what...

A study published by Ohio State's Fisher College of Businessjust debunked one of the most consistent criticisms, that SOX is driving corporations to list their stock outside of the US. The study's abstract notes:

On March 21, 2007, the Securities and Exchange Commission (SEC) adopted Exchange Act Rule 12h-6 which makes it easier for foreign private issuers to deregister and terminate the reporting obligations associated with a listing on a major U.S. exchange. We examine the characteristics of 59 firms that immediately announced they would deregister under the new rules, their potential motivations for doing so, as well as the economic consequences of their decisions. We find that these firms experienced significantly slower growth and lower stock returns than other U.S. exchange-listed foreign firms in the years preceding the decision. There is weak evidence that firms experience negative stock returns when they announce deregistration and stronger evidence that the stock-price reaction is worse for firms with higher growth. When we examine stock-price reactions around events associated with the passage of the Sarbanes-Oxley Act (SOX), we find negative average stock-price reactions with some specifications but not others. Further, there is no evidence that deregistering firms were affected more negatively by SOX than foreign-listed firms that did not deregister. Our evidence supports the hypothesis that foreign firms list shares in the U.S. in order to raise capital at the lowest possible cost to finance growth opportunities and that, when those opportunities disappear, a listing becomes less valuable to corporate insiders so that firms are more likely to deregister and go home.

The study essentially operated on the premise that, if SOX was the, or even a, predominant reason for delisting, that could be ascertained by examining the companies that actually took the step of delisting from the American capital markets. The authors looked at 59 firms that deregistered in the six months after adoption of SEC Rule 12h-6, easing the restrictions on delisting. Their conclusion, not really surprisingly, is quite different than what the business lobby propagandists have tried to portray:

Admittedly, the power of some our tests is limited by the fact that our sample of deregistering firms includes only 59 firms. Nevertheless, we find evidence that deregistering firms have poorer growth opportunities than other foreign firms with exchange listings and that these deregistering firms performed poorly prior to their deregistration announcements. We do not find any reliable evidence that foreign listed firms suffered from SOX or that SOX had a more adverse impact on deregistering firms. Finally, deregistering firms did not benefit from (and actually, in some tests, may have been hurt by) their deregistration announcements, and the shareholders of deregistering firms with better growth opportunities were affected more adversely by deregistration. None of these results are directly supportive of the loss of competitiveness theory. Some of these results are directly supportive of the bonding theory and others do not contradict it.

So all the Wall Streeters who have cried wolf about the loss of prestige and power of US capital markets, who have screamed mightily that foreign firms are being "driven from our shores," appear, quite simply, to be full of it. Really, really full of it. There is little evidence of any exodus of firms already listed in the US and this study finds no evidence that the firms who have delisted did not do so because of SOX. The only remaining question is whether SOX has kept new foreign firms from ever registering in the US at all. I've seen no evidence of that, and I think it unlikely. Any discouragement from listing in the US is more likely the result of the incredibly shabby shape of the US economy and, in particular, of the money markets.

An interesting finding in the Ohio State study is that those deregistering firms which were in good shape and expected to grow actually lost market value when they deregistered. Hardly what you would expect if the US regulatory environment was anywhere near as burdensome as the wolf-criers claim. Sarbanes-Oxley was a sane response to the insane lack of oversight that produced Enron and a fistful of similar disasters. Yes, it costs money, but that money buys a necessary disincentive for CEOs and other upper level execs to pull the crap that Enron pulled. and no, there really isn't much, if any, evidence that SOX is "killing business."

In any event, there would be no SOX if the corporate honchos had been able to restrain themselves the way they now claim to be able to. And the suggestion that SOX is unnecessary because shareholder suits against the corporation is a better and more efficient device to produce corporate honesty....please. Shareholder suits are ridiculously expensive, and the laws are ridiculously stacked against the shareholders. Both these factors provide far too little incentive to sue. Not to mention that by the time there's a viable suit, the economic damage has likely been done already.

But I guess you can't blame the propagandists for trying. SOX does increase corporate cost, and the subject gets very complex very quickly, so it probably seemed like a good bet that they could convince the public that the temporal relationship between SOX and the loss of foreign esteem for American markets bore a cause and effect relationship.

What I expect we will ultimately discover is that the adverse effects these propagandists ascribe to SOX were, in fact, caused by the same kind of corporate misbehavior and lack of oversight that gave rise to SOX in the first place. And the wheel goes round....