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Sarbanes-Oxley = a downturn in corporate risk-taking

Posted by: Diane Brady on September 26, 2007

For all its noble intentions, the five-year-old Sarbanes-Oxley Act prompts many complaints from the corporate community. It has been blamed (wrongly, in most cases) for prompting companies to shun public listings in New York. Executives complained about the cost of compliance, and the potential for liability. Then they turned around and decided it wasn’t so bad after all.

Now, two academic studies commissioned by the American Enterprise Institute conclude that SOX, as it’s fondly known, has reduced the corporate risk-taking that produces economic growth. One study led by Professor Kenneth Lehn at the University of Pittsburgh compared 4000 US companies with close to 1000 similar companies in the UK , concluding that the U.S. players were more risk-averse.

The second paper, by Professor Katherine Litvak of the University of Texas Law School, will be presented at the AEI on September 28. Litvak compares about 1000 pairs of companies, each including a foreign company with U.S.-listed shares (thus bound by U.S. law). It also concludes those subject to SOX are more risk-averse than similar companies.

Why is this alleged to be the case? The AEI’s main message seems to be that empowered, independent boards have reduced the discretionary authority of executives. It’s much easier to have your way when your pals or business partners have a seat in the boardroom. (A) They’re less likely to stop you. (B)They’re less likely to kick you out if things go wrong.

What intrigues me is whether the apparent reduction in risk taking will translate into reduced profits for shareholders over the long term. That conclusion would certainly fit with the mission of the AEI, a conservative think tank that pushes for, among other things, limited government. But corporate executives also talk about the benefits they have seen from better financial controls and governance. Big risks can translate into big profits but they can also create big blow-ups. It’s interesting to see how the prognosis on SOX’s impact continues to evolve.

Reader Comments


September 26, 2007 2:50 AM

May turn out to be very informative for CEO's who are still fighting to add bottoms to their margins.


Dan Curtis

September 27, 2007 9:02 AM

I didn't agree with the Federal governments implementation of SOX in 1992. Done in haste to placate those suffering from corporate greed and unethical business practices in order to look good politically, SOX's effects are more negative than positive.

We have laws on the books that ought to be enforced more harshly to punish CEOs, CFOs, and others with their hands in the cookie jar is a better answer.

Risk taking is what made our country great, produced some of the most competitive (still the case) companies in the world, and is what will continue to keep us out front. Hindering that trait is not good. SOX needs modifying, and the sooner the better.


September 27, 2007 10:47 AM

By the way SarbOx was implemented in 2002.

I don't think it hurts to have a board actually think about the risks the firm is taking rather than blindly following a leader in a "yes man" fashion. I think an independent board will accept risks, no matter how steep, if they think it will bring the highest shareholder value.

A "buddy board" is more succeptable to putting the entire entity at risk by not scrutinizing ideas or asking tough, thourough questions to management.

Is this a good thing? So far studies have indicated that independent boards produce higher shareholder returns than their counterparts.

I have included a link to one study.

I don't think our country is taking less risk. The larger risks are being taken by entrprenuers, venture capitalists and private equity instead of the general public via publicly traded shares.

As a more savvy investor I would like to have those opportunities available to me, but I don't think SarbOX is whats keeping them from me. I think those with the most capital see an opportunity and don't want to share the rewards, so they don't share the risks.



September 27, 2007 11:39 AM

This is an interesting addition to the discussion:

UNIVERSITY PARK, PA (September 27, 2007) – Media coverage of the ineffectiveness of corporate boards of directors forces those boards to take corrective actions and increases shareholder profits in the months after the negative publicity, according to new research co-authored by a professor at Penn State's Smeal College of Business.

In a new paper forthcoming in the Journal of Financial and Quantitative Analysis, Henock Louis, associate professor of accounting at Smeal, and his co-authors look at the impact of the media on managers' and investors' behavior by examining how media exposure of board ineffectiveness affects corporate governance, investor trading behavior, and security prices.

Their study is based on BusinessWeek's past publications of the worst boards of directors.

The authors find that, among the 50 unique firms that appeared on the magazine's worst board lists in 1996, 1997, and 2000, 34 (or 68 percent) took observable steps to improve their governance structures.

Of those 34, 82 percent replaced their chief executive officer, president, or board members, 18 percent increased the number of outside board members, and 12 percent instituted some broad corporate governance changes. Firms that appeared on the worst board lists significantly increased the number of outside directors and were significantly more likely to abandon their staggered board structures after the negative public exposure.

Managers are not the only ones to react to the media publicity, however. Shareholders also take some action, ultimately causing the stock price to rise in the wake of the negative media coverage.

The authors find that individual investors tended to overreact and sell, or at least stop buying, shares of the companies whose boards were called out by BusinessWeek. This activity puts downward price pressure on the stocks, which is quickly countered by trading activity by institutional investors.

These savvier investors, who perhaps already know about the ineffectiveness of various boards prior to the publicity generated by the magazine, buy up the worst-board firms, leading to a price reversal and a profit for shareholders in the months following the list's publication.

"The worst-board firms experience very strong stock performance in the week after and over the four months subsequent to the BusinessWeek publication," Louis and his co-authors write. They suspect that this is because these savvier investors may anticipate that the negative publicity will spur the worst-board firms to take some corrective actions.

Ultimately, they conclude "that media releases of (noisy) information affect the behavior of market participants and that exposing board ineffectiveness forces targeted firms to take corrective actions and enhances shareholder wealth."

"Managers' and Investors' Responses to Media Exposure of Board Ineffectiveness" is co-authored by Louis, Jennifer Joe of Georgia State University, and Dahlia Robinson of Arizona State University.

A draft of the paper can be found online at papers. ?abstract_id=714501.


December 9, 2008 9:43 AM

yes interesting discussion It will help to CEO Which is actualy thinking to increase their margins and profits.


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