Wednesday, January 03, 2007

The law of unintended consequences writ large

William Niskanen hopes that SOX gets put away in a drawer somewhere.

WHEN the new Congress begins its session tomorrow, two familiar faces will not be present: Senator Paul S. Sarbanes and Representative Michael G. Oxley, who are both retiring. Mr. Sarbanes, a Maryland Democrat, has served for 30 years; Mr. Oxley, an Ohio Republican, for 26 — and their main legacy will be their joint attack on corporate corruption, the Sarbanes-Oxley Act of 2002.

The act, which was passed hastily in the wake of the Enron scandal, was surely well intentioned. But it has proven counterproductive in the extreme, and Congress would best honor the departing lawmakers by repealing it.

Sarbanes-Oxley has seriously harmed American corporations and financial markets without increasing investor confidence. The section of the law requiring companies to perform internal audits has turned out to be far more costly than proponents projected, especially for smaller firms. These costs have led some small companies to go private, hardly a victory for public oversight, and some foreign firms to withdraw their stocks from American exchanges.

In addition, the average “listing premium” — the benefit that companies receive by listing their stocks on American exchanges — has declined by 19 percentage points since 2002. This explains why the percentage of worldwide initial public offerings on our exchanges dropped to 5 percent last year, from 50 percent in 2000.

Other costs associated with the act may turn out to be more important. For example, more stringent financial regulations and increased penalties for accounting errors may make senior managers too risk-averse. Most chief executives are not accountants, so the requirement that they personally affirm tax reports — at the risk of jail time should anything be amiss — may make them reluctant to partake in perfectly legitimate activities.

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