Academic journal article Multinational Business Review

SOX as Safeguard and Signal: The Impact of the Sarbanes-Oxley Act of 2002 on US Corporations' Choice to List Abroad

Academic journal article Multinational Business Review

SOX as Safeguard and Signal: The Impact of the Sarbanes-Oxley Act of 2002 on US Corporations' Choice to List Abroad

Article excerpt

Abstract:

Corporate scandals at Enron, Tyco, and MCI highlight the issue of opportunistic management behavior. The US Congress responded to these scandals by passing the Sarbanes-Oxley Act of 2002 (SOX). SOX imposes additional management responsibilities and corporate operating costs on companies trading under SEC regulations. This paper examines three options for US corporations responding to SOX: compliance with SOX, taking a company private, or moving to a non-SEC-regulated exchange, such as an international exchange. The paper then examines potential corporate governance options using Transaction Cost Economics (TCE; Williamson 1985) to develop propositions regarding which options firms may select.

INTRODUCTION

"Many of today's corporate leaders and their financial advisors seem to be lacking fundamental integrity" (Waddock 2005:146). The signs of managers lacking fundamental integrity and acting opportunistically are evident in headlines about corporate scandals at Enron, Tyco, and MCI. The US Congress responded to these scandals by passing the Sarbanes-Oxley Act of 2002 (SOX). SOX imposes additional management responsibilities and corporate operating costs on companies trading under SEC regulations. However, complying with SOX has been costly. Some firms have cited the cost of complying with SOX as a rationale for de-listing from SEC-regulated exchanges. This rationale may be justified for some firms while other firms may use the rationale to avoid compliance with tougher control standards. This paper uses Transaction Cost Economics (TCE) to explore which firms theoretically will choose to stay Usted or be de-Usted. The paper also uses TCE to explore which of the de-listed firms are doing so because the added costs are not justified and which ones are doing so to avoid complying with increased control requirements. This paper contributes to current literature by developing a theoretical framework through the above explorations for examining the de-listing decision-making process using TCE.

THEORETICAL DEVELOPMENT

SOX

SOX and the costs of SOX compliance arises from the potential for moral hazard. Accounting and economic theorists have recognized that moral hazard may stem from management acquiring information asymmetrically from shareholders (i.e., Baek, Min, and Ryu 2006; Hendriksen and Van Breda 1992). One form of moral hazard is the principal-agent problem, where the interests of stockholders (principals) diverge from the interest of management (agents), and management behaves opportunisticaUy against stockholder interest (Jensen and Meckling 1976). Independent audits of financial statements provide a deterrent to opportunistic management behavior. However, several corporate scandals emerged because auditors may not have remained fully independent (Chambers and Crowley 2003). The 107th US Congress responded by passing the Sarbanes-Oxley Act of 2002 (SOX) as a means to better ensure the independency of external audits (HR Rep. No. 107-610, 2002).

SOX implements new corporate controls, including stronger auditor independence rules and a new regulating agency to oversee the accounting profession, the Public Company Accounting Oversight Board (PCAOB). SOX also requires companies to have codes of ethics for senior financial officers, prohibits companies from extending credit to company directors or officers, prohibits company officers from selling stock when the pubUc and other employees are "blacked out" from doing so, and requires that companies must report stock sales within two business days of the transaction. SOX also requires that management must implement, maintain, and evaluate a comprehensive internal control system, disclose to the auditor any material weakness, fraud, or material change in the controls, and require the Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) to personaUy attest to the accuracy and completeness of financial statements with a penalty of bonus and personal profit forfeiture if an accounting restatement is made. …

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