The Declining Costs of SOX

The efforts to devise excuses for the harm caused by SOX get harder and harder. As I have written, those complaining about the costs of SOX (mostly Section 404) have invariably overstated the costs associated with the provision. It’s true that audit fees went up but this was inevitable in the aftermath of Enron and Worldcom, with or without Section 404. Moreover, according to my co-contributor, Kevin O’Brien, accounting firms in the pre-SOX days under bid the costs of auditing and made up for it on the consulting side. Once auditing and consulting was separated, auditing fees would naturally go up, which they did.

Mostly, though, opponents of SOX ignored that much of the initial outlay was either onetime charges as company’s got their internal controls in order or reflected the uncertainties associated with compliance with any new system. These factors suggested that costs would eventually start to fall. And, in fact, the latest data from Financial Executives International shows exactly that.

Their survey shows that auditor fees are largely unchanged while costs of compliance with Section 404 has fallen. The press release is here. As the press release notes a 23% drop in total costs from the year before.

• “Total average cost for Section 404 compliance was $2.9 million during fiscal year 2006, which represents a 23 percent decrease from 2005 totals. The data also shows reductions in internal and external costs of compliance, with internal staff time decreasing by 10 percent. The lower costs can be attributed to companies’ increased efficiencies in complying with Section 404.”

What else did those surveyed think of the impact of Section 404? Most still thought that the costs exceeded the benefits. Nonetheless, they had these views:

• 60 percent of accelerated filer companies agreed that compliance with Section 404 has resulted in more investor confidence in their financial reports.
• 46 percent agreed that financial reports are more accurate.
• 48 percent agreed that financial reports are more reliable.
• 34 percent agreed that compliance with Section 404 has helped prevent or detect fraud.

Not exactly a resounding condemnation of SOX from those most directly impacted.  And it is likely that the costs of compliance will continue to drop (although the auditing fees will not until there is greater competition among public accounting firms).  

The real question is the impact of these additional costs on smaller companies. Most of the companies in the FEI survey were accelerated filers that can easily afford the additional costs. Smaller companies, however, are likely to have weaker controls, sometimes a consequence of rapid growth and sometimes a consequence of not having sufficiently updated systems after becoming public. While these companies probably benefit the most from Section 404 (in terms of increased investor confidence in the financial statements), they also cannot as easily afford the costs.  It is in this area that the cost benefit analysis is the most difficult. 

Comments

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