Reevaluating Sarbanes-Oxley

Jonathan Ortmans, President, Public Forum Institute

At a time when we need risk-takers to start companies and create jobs, we need to do everything we can to remove unnecessarily burdensome regulations that dampen entrepreneurship. A high-impact, low-cost reform would be to make some of the more onerous requirements of the Sarbanes-Oxley Act of 2002 optional. This would permit companies whose shareholders don’t feel that the benefits of “SOX” requirements outweigh compliance costs to access public capital more quickly and less expensively. This kind of access to capital is critical for the survival of young firms, which have accounted for all net job growth in the United States in the past two decades.

The logic behind this recommendation, laid out cogently in the Kauffman Foundation’s State of Entrepreneurship Address, is that SOX was enacted in the aftermath of corporate financial reporting scandals, after all, to protect shareholders. So why not allow shareholders to vote on whether their companies will fulfill certain SOX requirements?

Among other strict requirements related to financial reporting and corporate governance, SOX imposed stiffer auditing requirements on public companies, required CEOs to certify the accuracy of their companies’ financial statements, subjected auditors to oversight by the new Public Company Accounting Oversight Board and prohibited them from engaging in consulting business for clients they audited. The New York Stock Exchange and the NASDAQ subsequently changed their listing requirements, requiring a majority of corporate boards to have “independent” directors. Substantial man-hours and other resources have since been devoted to SOX compliance.

Are the complex and expensive SOX regulations good for the growth of young firms, and ultimately for the economy as a whole? Several studies have documented that SOX reforms may be discouraging successful entrepreneurial firms from raising capital by going public. Put simply, SOX increased the cost of being a public company. Instead, growing firms may choose to sell to larger companies when trying to “exit.” The problem with this incentive is that selling risks killing the entrepreneurial energy when the successful startup becomes a part of a larger, typically more bureaucratic company.

The tighter controls imposed by Sarbanes-Oxley to protect shareholders appear to have come at the expense of new jobs and innovation. In an already credit-constrained economy, opening capital markets for entrepreneurial financing, including stock exchanges, is important.  Policymakers should re-evaluate the effect of SOX on entrepreneurial firms and consider turning its most onerous requirements optional.

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