One reason, accountants say, is that SOX audits now require much more work, and auditing firms must devote more resources to their larger clients. But regardless of SOX, audit firms are at risk when they deal with struggling companies, Skie says: “Suppose Enron had simply failed, even with no fraud involved. As the audit firm, you’re still associated with a failed business, and investors might look at you to recover damages.”
The kicker in all this, sources agree, is that SOX’s cost/benefit ratio to investors is more questionable in smaller companies than in giant corporations. True, if any public company succumbs to fraud, its shareholders are injured. But a small-company failure does not wreak the widespread havoc of an Enron or WorldCom.
Go Private?
Is Sarbanes so burdensome that a lot of small public
companies will
go private just to avoid it? No Twin Cities accountant
interviewed for
this story cited such a case. But all
pointed
to a related
phenomenon.
“I think
the main
effect will not be
that public companies go
private
but rather that private
companies
are dissuaded from going
public,” says
Public-to-private conversions are occurring in the Midwest, however. Brian Blaha, a senior manager in the Green Bay, Wisconsin, office of regional accounting firm Wipfli, LLP, says that four of his midsize public clients have gone private in the past year. Three of them were banks, an example being First Manitowoc Bancorp of Manitowoc, Wisconsin.
“Banks have an advantage in going private, in that they are more likely to have the capital [required] or access to it,” Blaha says. But since Sarbanes went into effect, he says, a new query has been added to Wipfli’s list of questions to ask clients in other industries, as well: “What benefit are you getting from being a public company?”
| The ROI on SOX
One way or another, investors pay for the costs public companies incur to comply with Sarbanes-Oxley regulations. Do the benefits to shareholders outweigh the costs? A study released in May by Lord & Benoit, LLC, a Worcester, Massachusetts, research firm, suggests that the answer may be yes—or at least that investors really do reward companies that pass muster under Section 404 of the SOX legislation. The study looked at 2,481 public companies that have submitted at least two Section 404 assertions (in connection with annual reports filed in 2004 and 2005, for example) since SOX took effect for “accelerated” companies in 2004. Lord & Benoit says those businesses represent about half of the entire market capitalization of all publicly traded companies in the United States. The companies were divided into three categories based on whether auditors deemed their 404 assertions “clean” (controls were effective) or “adverse” (controls were ineffective in some significant way). • Companies that had clean assessments in both years saw their share prices increase by an average that rounds out to 28 percent. • Companies filing an adverse 404 assessment in the first year but a clean one in the second year had average stock-price gains of 26 percent. • Companies with adverse filings in both years saw their average stock prices decrease by 6 percent. Over the same period, as a point of comparison, the Russell 3000 Index rose 18 percent. Lord & Benoit admits that the study is far from definitive. But the firm says its research “impl[ies] that companies that historically operated organizations with no material weaknesses in their internal controls, or were able to identify and correct material weaknesses in a timely manner, experienced much greater increases in share prices than companies that did not.” |
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