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What's Your COS (Cost of SOX)?

June 10

We recently came across what we consider the first rigorously quantitative study of the out-of-pocket costs of complying with federal Sarbanes-Oxley regulation (SOX). It's a just-published survey of 762 public companies by Financial Executives International (FEI).

The survey doesn’t track the heightened legal liabilities for corporate managers and boards that SOX has delivered unto the eager hands of class-action lawyers.

The FEI data are disturbing. For companies generating less than $75 million in annual revenue, the first year of SOX cost them about $1 million apiece. That’s a fixed cost that directly reduces pre-tax profit. Said another say, for a company producing 5% pre-tax profit, the cost is equivalent to a $20 million reduction in sales.

The news is even worse for the smallest public companies, those with sales of less than $25 million. For them, SOX cost averaged about $865 thousand. Using the same profit assumptions as the above example, for a $25 million company this expense equates to a 30% reduction in sales.

Not that the surveyed companies don’t feel at least some benefit was derived from SOX compliance: about a third of respondents felt that their financial reports were more accurate; 40% estimated that their financial reports were more reliable; 25% thought SOX would help them prevent or detect fraud; and 55% guessed that investors would have more confidence in their reports.

But -- here’s the bottom line -- 94% of the total sample stated that the costs of SOX compliance exceeded its benefits. All of the 100 respondents generating sales under $100 million felt this way.

The managers surveyed had a lot of ideas on how to make SOX more bearable. Leading the list were “allow for a more risk-based audit approach” (in other words, focus on areas in proportion to their potential for problems) and “reduce degree of documentation” (no surprise here). Overall the list of suggestions looks like a pathetic cry for relief from overbearing and substantially irrelevant red tape.

Long ago, in a world far-far away, those who told people what to do understood how regulation is delicate surgery: they didn’t open patient’s chests to cure heartburn. As SOX is written now, it’s a powerful argument for staying private or going private, and for the unnecessary handicapping of American companies in the face of rising global competition. Particularly ironic, SOX is the child of politicians who profess concern about job retention and growth.

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