Dissertation on "Effects of Sarbanes Oxley SOX"

Dissertation 25 pages (8538 words) Sources: 25

[EXCERPT] . . . .

Compliance of the Sarbanes-Oxley Act

Impacts and Compliance of the SOX

The study investigates the impact of the Sarbanes-Oxley Act 2002. The literatures are reviewed to reveal the motive behind the passage of SOX Act. The Act is to protect the investors and improve the accuracy of the accounting practice. With the costs of compliance, many smaller firms migrate to private to escape the costs burden. However, larger firms enjoy abnormal returns at post-SOX. Both primary and secondary data are used to test the hypotheses and satisfy the research objectives. The analysis of data is implemented for the validity and reliability of data.

Research findings reveal that smaller firms leave public and go private because of the costs burden. However, some sophisticated investors initiated LBO going private transactions by buying the entire shares of some firms. Some public firms merge with private firms. While SOX has negative effects on smaller firms, larger firms enjoy abnormal profits after the passage of SOX. Typically, SOX has improved the business efficiency of the public firms and restore the public confidence in the accounting practice.

CHAPTER 1: INTRODUCTION

Accounting and corporate scandals that swept the business circle in the late 2001 seriously eroded the confidence of the capital markets. Many investors suffered the financial losses because of the so-called accounting errors. (Zhang, 2007). One of the examples of the high profile scandals was the misappropriation of accounting records by the Worldcom management. The internal audit revealed that $3.3 billions were improperly recorded in the company financial statements. (Tran, 2002). Similarly, Euron, which was the seventh largest corporation in the United States also publicly admitted of the financial misappropriation of $3 billions. Many investors lost confidence in the U.S. corporate governance, and some international investors were thinking of diverting their investments to other countries. To restore the confidence and integrity in the accounting and financial practices, the senate passed the Sarbanes-Oxley Act (SOX) Act and the law came into force in July 2002. (Gantt, 2007). Main objective SOX Act is to restore the integrity of the financial reporting of the publicly traded companies. Section 302 of the Act requires CEO and CFO of the public companies to certify the company financial statements. To certify the financial statement, the executives must verify the accuracy of the financial data before they are made public. The essence of the certification is to promote sound business process that affects the financial data. (Byrum, 2003).

One of major requirement of SOX is Section 404 that requires the corporate organizations to assess the internal controls while section 409 requires the publicly traded companies to publicly disclose their financial statements. Section 906 requires the corporate organizations to certify their financial data before they are published. (Evans, 2005). Non-compliance with the SOX provisions includes jail term and/or personal fines for the CFO or CEO. To comply with the SOX Act, many small and large companies set aside several millions of dollars. The costs of compliance include the accounting fees, the internal control costs, higher director's fees, and other necessary costs. (Lowengrub, 2005). Survey conducted by the Financial Executives International reveals, "the total cost of compliance with Sarbanes-Oxley Section 404 is now estimated at $3.14 million for the average company." (Hanish, 2004 P. 9).

"The business community has expressed substantial concerns about its costs. Whereas the out-of- pocket compliance costs are generally considered significant they are likely swamped by the opportunity costs SOX imposed on business. Executives complain that complying with the rules diverts their attention from doing Business. Furthermore, the Act exposes managers and directors to greater litigation risks and stiffer penalties. CEOs allegedly will take less risky actions, consequently changing their business strategies and potentially reducing firm value" (Zhang, 2007 P. 75).

With the effects of SOX on publicly traded companies, some large firms and many smaller public companies have converted to privately owned companies to escape the costs of compliance. The impacts of costs of compliance of the Sarbanes-Oxley Act have generated the research problems that the dissertation attempts to address.

1.1: Statement of Problem

The study intends to investigate whether the impact of the Sarbanes-Oxley has influenced the private-owned company to remain private. The study also investigates whether the impact of the SOX has made the publicly traded companies to convert to private-owned company. Evidence has revealed that the cost burden has made many smaller public companies to consider going private. The study conducted by Grant Thornton LLP reveals that 16 months after the enactment of SOX, over 30% of smaller public companies went private. For example, the Bestway, Inc. states that its decision go private is the costs and burden associated with SOX. While many smaller companies go private because of the costs, rather than going private, some smaller firms prefer to be acquired by larger public firm or merge with other larger private firms. (Bova, Minutti-Meza, Richardson et al. 2010).

The study explores the decision of the publicly traded companies to convert to private companies. The quantitative technique is used to investigate the reasons public traded firms go private, and the impacts of SOX on firms. The study formulates the research objectives for the greater understanding on the impact of SOX and the reasons firms go private.

1.2: Research Objectives

To show the impact of the Sarbanes-Oxley Act on the net increase of the private smaller businesses.

To show that the impact of the Sarbanes-Oxley Act leads larger publicly traded corporations to migrate to private company due to the adherence of Section 404.

1.3: Rationale of the Study

Since the enactment of SOX, there are hot debates in the academic and business communities whether firms has benefited from the enactment of SOX. Evidence has shown that fewer firms have gone into the capital markets since the enactment of SOX. There is general believe that the rising costs of the SOX compliance has made large number of smaller firms to go private. The rational behind this study is to investigate whether the impact of SOX has made the smaller and larger publicly traded companies to go private due to the associated costs of compliance. The research employs the quantitative technique for the research design. The financial valuation of the impact of the SOX Act on the smaller and larger companies is established. To enhance the greater understanding on the difference between smaller and larger companies, the definitions of smaller and larger corporations are established. Organizations are ranked as larger corporation if they are included in the 1000 Fortune lists. (Fortune Datastore 2011). However, smaller companies are defined as those having values of $15M in their current fiscal years. The dissertation only focuses on the smaller and larger companies having headquarters in the Unite States. To quantify the effects of SOX on smaller and larger companies, their market values at both pre-SOX and post-SOX are evaluated. The rational is to examine whether there are statistical significant in the difference in the market values before and after the SOX enactment.

1.4: Research Questions

1. What are the factors leading publicly traded companies to go private?

2. What are the impacts of the Sarbanes-Oxley Act on publicly traded companies?

3. What are the effects of converting from a publicly traded company to a private owned company?

4. What are the consequences of staying private ?

5. What are the long-term economic effects of migration from publicly traded companies to private owned companies ?

By answering the research questions, the study provides several significance.

1.5: Significance of the Study

The significant of the study is as follows:

First, the study will make the U.S. regulators to be mindful of the impact of costs of compliance on smaller companies.

Moreover, the study will be relevant to the foreign regulators outside the United States who are attempting to improve on their corporate governance to fully understand the costs of compliance and its effects on smaller and larger firms.

The study will also enhance the greater understanding of the privately owned companies attempting to go public the significant effects of costs of compliance especially costs associated with Section 404.

Finally, the study will be relevant to the foreign companies attempting to enter into the U.S. capital markets to have fully understanding of the SOX Act and the costs associated with its compliance before ventures into the U.S. capital markets.

1.6: Inductive and Deductive Approach.

Business and social science researchers employ generally deductive approaches to test the hypothesis. The deductive approach move from the general to specific. Sometimes, deductive reasoning is called the top-down approach. For example, a researcher might choose a theory and narrow the theory down to test the hypothesis. Typically, deductive approach collects specific data to test the hypothesis. Pattern of deductive reasoning are as follows: Theory ?Hypothesis ?Observation ?Confirmation.

On the other hand, inductive approach distances itself from deductive approach by moving from the specific to the general observation. The inductive approach, which also called bottom-up approach begins with the observation and measurement, then formulates the hypotheses and finally draws general… READ MORE

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