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Read it here first: The Cost of Sarbanes-Oxley

Posted By Barry Ritholtz On June 24, 2006 @ 2:29 pm In Corporate Management,Data Analysis,Financial Press,Markets,Politics | Comments Disabled

It is a rather annoying tendency of politicians — and their empty-headed acolytes — to use and abuse of data and charts. One of the more egregious recent offenders  was the laughable assertion put forth by an accounting professor Ivy Zhang that Sarbanes-Oxley [1] cost more than $1.4 trillion dollars.

Zhang proves that understanding how to do mathematics does not mean one actually understands what the numerals being added together actually represent. Her incompetent analysis calculated the drop
in stock market capitilization during July 2002 — the period just before the
legislation was passed, and concluded that was the cost of the legislation.

The only explanation for that kind of reasoniong is blunt head trauma. Its is beyond flawed. If we were to use that same method of reckoning, then we would be forced to conclude that Sar-box has created several trillion dollars worth of wealth. Why?  As the chart we showed last Summer [2] "proves," since  the Sar-box was passed, the stock market has gone up significantly.

Market’s Performance Since Sarbanes Oxley (7/02-6/05)

Click for larger chart
Post_sox_nasdaq_chart [3]
Source: The Big Picture [2]

One would hope a professor of accounting would have a little more insight into market capitalization and what actually dirves markets than was exhibted by Ms. Zhang.

Our takedown of her foibles was echoed in a column this week by the NYT’s terrific columnist Floyd Norris, in Trusting Bosses Not to Cheat [4] (it even uses a similar post Sar-box SPX chart).

Mind you, I’m not suggesting plagiarism; rather, I am bragging that we are about 1 year ahead of the Grey Lady in our insight and analysis.

Here’s an excerpt from the column:

"Mr. Feeney, a Florida Republican, is the chief House sponsor of a bill to exempt the vast majority of companies from having their internal controls reviewed by auditors. A witness at the hearing, Mallory Factor, would like to go much further. The Free Enterprise Fund, which he heads, has filed a suit seeking to have the Public Company Accounting Oversight Board, which was created as a result of Sarbanes-Oxley, declared unconstitutional.

"Sarbanes-Oxley had a trillion-dollar negative impact on the U.S. economy," he told the hearing, citing research by Ivy Zhang, an assistant professor of accounting at the University of Minnesota.

Ms. Zhang did estimate that consideration of the law cost shareholders almost that much. But now she has backed down. The latest version of her paper, she told me, indicates a far smaller effect, although she declined to put a number on it . . .

How does she deal with the fact that the market bottomed in the fall of 2002, about the time efforts to enforce Sarbanes-Oxley got under way, and has had a sustained rise since? That is probably irrelevant, she told me, since the market would have already discounted the effects of the law, and whatever happened later was caused by something else.

Explaining market moves is not so easy, and her paper would be unworthy of much attention but for its use by opponents of regulation."

I am unfamiliar with Congressman Tom Feeney, but one can only conclude that he is innumerate (mathematically illiterate), and has very little comprehension of how the stock market actually functions. Is it too much to ask from the men and women we send to Congress for intelligent debate and analysis? Basic understanding about the areas that regulate? Street smarts?

The biggest complaint about SOX is the heavyt burden it exacts on small firms. There is a very simple solution to the more onerous costs of SOX:  Exempt the smallest companies from compliance. Example: Any firm whose market cap is under 250 million for 2 consecutive Qs could have the option to opt out. Their symbol will reflect this decision with an "S" suffix designating non-Sarbox compliance.   For example, ABCD co. becomes "ABCDS."

Of course, investors will recognize this, and some may choose to invest accordingly. But if we really believe in the free market, we will allow the marketplace to work. Hell, if some people are correct in their views, investors may reward the clever cost cutting by management with their investing dollars.

I trust the investing public to use their judgement on this.  Does Washington?


Trusting Bosses Not to Cheat [4]
NYTimes,  June 23, 2006

How Much Does Sarbanes-Oxley Cost? [2]
The Big Picture
Saturday, June 18, 2005

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2006/06/read-it-here-first-the-cost-of-sarbanes-oxley/

URLs in this post:

[1] Sarbanes-Oxley: http://www.sarbanes-oxley.com/

[2] last Summer: http://bigpicture.typepad.com/comments/2005/06/how_much_does_s.html

[3] Image: http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/post_sox_nasdaq_chart.gif

[4] Trusting Bosses Not to Cheat: http://select.nytimes.com/2006/06/23/business/23norris.html

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