northwestern law searle center on law, regulation, and economic growth

September 15, 2009 - 3:26 PM

“There’s no such thing as a free lunch.”

This favorite line of the late Nobel laureate economist Milton Friedman is more than just a catchy slogan. It is also a sound, common sense principle that underlies the work that we do here at the Searle Center on Law, Regulation, and Economic Growth.

Simply put: any law or regulation does not happen in a vacuum. Every one of these government actions has benefits – and costs.

Common sense tells us that if benefits are greater than costs, then the activity will provide a net benefit to society. If the costs are greater than the benefits, then moving forward with the government activity will do more harm than good. Implementing this common sense notion, however, is easier said than done. In the political world, politicians and regulators are prone to exaggerate the ostensible benefits of their pet projects and ignore the costs.

Case in point: the Sarbanes-Oxley (SOX) Act.

Hastily passed by Congress in the summer of 2002, following the implosions of Enron and WorldCom, we were assured this legislation would force firms and their auditors to clean up their books and to disclose their "internal controls" and procedures for ensuring the accuracy of their financial reporting.

Instead, SOX has imposed huge direct and indirect costs on American businesses and the American economy – without achieving its professed goal of promoting transparency and accuracy in corporate reporting and preventing another financial crisis.

The act could also prove to be a litigation time bomb. SOX has created potential liability for all corporate employees, not just officers and directors -- and for contractors and sub-contractors too. Innocent individuals may have to defend themselves against SEC investigations or civil suits.

Disgruntled employees may exploit more expansive whistleblower protections to sock it to their supervisors. American companies may forgo expansion or close their doors. Foreign companies may avoid setting up shop on our shores.

In fact, the constitutionality of SOX is currently being challenged in the U.S. Supreme Court in Free Enterprise Fund et al., v. Public Company Accounting Oversight Board – a case in which I have signed on as amicus curiae with the Cato Institute and University of Illinois Law Professor Larry Ribstein.

So, is there a way to circumvent the serious side effects of SOX, short of scrapping the whole thing?

How about giving American companies and American investors a say on SOX?

Let SOX stand, but give American firms the option of letting shareholders vote to opt out of some or all of its provisions. Or let the firms themselves opt in or out, and leave it to potential investors to buy or avoid their stock.

Talk about shareholder power!  If shareholders should have a say on executive compensation, as many corporate governance reformers insist, surely they should have a say on SOX. Let’s empower American firms and shareholders and let them decide if SOX is a luxury they can afford.

Larger firms may consider the costs of compliance less burdensome than the stigma of going SOX-less. Smaller firms may suffer the stigma for the sake of the savings. Either way, the shareholders have the final say.

If Say on Pay is a step toward corporate democracy, Say on SOX is a veritable leap forward. If you truly believe in shareholder power, give the shareholder a Say on Sox.