Wednesday, November 17, 2004

Wharton study: Does Sarbanes-Oxley Hurt Shareholders and Hide Poor Management?

In April 2004, minutes after posting healthy increases in sales and earnings, the publicly traded Niagara Corp. announced it was "going dark," delisting its common stock. The company, a steel manufacturer with sales last year of nearly $300 million, was hardly alone: During 2003 for example, 198 firms went dark, up from only 67 in the previous year. While most companies say they are deregistering from major exchanges to escape the steep costs associated with regulatory filings, some investors and others see darker reasons, rooted in serving insiders' self interest. A new study co-authored by Wharton accounting professor Christian Leuz entitled, Why Do Firms Go Dark? Causes and Economic Consequences of Voluntary SEC Deregistrations, analyzes this recent trend.

In 2002, responding to a spate of accounting scandals that threatened to undermine confidence in the American securities market, Congress enacted the Sarbanes-Oxley Act of 2002 (SOX). Designed to promote transparency, the Act mandated increased disclosure, required new board oversight and internal controls, and promised to give investors better information. But in the year following its passage, the number of firms that went dark and ceased to issue detailed financial reports tripled, meaning more investors were receiving no information at all.

When a company goes dark it can no longer be listed on a big exchange like the NYSE but can continue to trade on the Pink Sheets, an electronic quotation medium for over-the-counter stocks. Stocks that list here do not have to meet minimum requirements or file with the Securities and Exchange Commission (SEC).

Why did they go dark? Cost was certainly a factor in some of the decisions, says Leuz. "Some smaller companies estimated that the cost of complying with SOX was as high as $500,000 per firm, while the cost for bigger companies could be in the millions," notes Leuz, who co-authored the study with Alexander Triantis and Tracy Wang from the University of Maryland's Robert H. Smith School of Business. Among the estimated increased costs are those related to "higher audit and legal fees, new internal control systems that need to be implemented, higher director and officer insurance premiums, and a host of other expenses associated with compliance."

Wharton study: Does Sarbanes-Oxley Hurt Shareholders and Hide Poor Management?

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