George W. Bush called the SOX Act “the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt”.
It has been a decade since the Sarbanes-Oxley Act became in effect. Obviously, the SOX Act which aimed at increasing the confidence in the US capital market really has had a profound influence on public companies and public accounting firms. However, after Enron scandal which triggered the issue of SOX Act, public company lawsuits due to fraud still emerged one after another. As such, the efficacy of the 11-year-old Act has continually been questioned by professionals and public. In addition, the controversy about the cost and benefit of ...view middle of the document...
” This opportunity cost increased as managers diverted their attention to “designing, documenting and ensuring compliance with new internal controls” ( Ahmed, 2010). The following paragraphs explore how costly the overall SOX Act is for all the public companies to comply with it, since 2004; the key components of the direct SOX compliance costs; indirect costs associated with SOX Act; and SOX related costs specifically for small business and businesses with weak internal controls.
Significant Compliance Costs in 2004
The SOX Act has always been described as “an endless list of compliance requirements” with no productive benefit (Hunter, 2007). Most of the costly compliance requirements are included in section 404 of SOX Act. “It’s turned out to be a gorilla,” said Charles Elson , “Its costs are phenomenal” (Quoted by Philadelphia Business Journal). Despite the unapparent recovery of investors’ confidence, complaints about the greatly increased costs have been heard everywhere. Obviously, the complaints came from the affected companies. To comply with the requirements of section 404 of SOX which is related to internal control, audit firms need to spend much more on the testing of a company’s internal control, the cost of which would certainly be passed on to their clients. In addition to increasing audit fees paid to auditors, more costs have been incurred, such as staff training, system and documentation updating, and hiring additional consultants and lawyers (D’Aquila, 2004). The SOX compliance costs were initially estimated at about 0.9 million for each impacted firm. However, referring to FEI survey in 2004, the average compliance cost of $4.36 million was up 62% more than estimated (Park, 2004). The significant increase in the compliance costs was mainly contributed by the rise of internal costs, external costs and fees paid to external auditors. These costs are substantial. Management of the affected companies also found that costs of internal control were up to .92% of company’s total revenue. Therefore, even if it was indicated by several surveys that section 404 did add to investors’ confidence in public companies’ financial statements since SOX act came into effect, it is difficult to precisely measure investors’ confidence in the markets while the affected companies have to bear the inflicted soaring costs.
Why SOX costs were high in the beginning
The audit fees during the initial post SOX period are the highest for several reasons. First, with the dismissal of Big Four firm Arthur Anderson following the collapse of Enron, all of Arthur Anderson’s clients were seeking a replacement, allowing accounting firms to raise their price. Second, public accountants are pressed for time, since the newly issued PCAOB guidance needed to be implemented before the 2005 deadline. Therefore, it is reasonable for accountants to charge a higher price. The third reason for the high audit fees at the beginning period after SOX is the lack of practical...