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On August 24, Commissioners Paul Atkins and Harvey Goldschmid of the Securities and Exchange Commission (SEC) joined Dean Hubbard in a panel discussion of the costs and benefits of the Sarbanes-Oxley Act. The event inaugurated the School’s new ethics initiative, “The Individual, Business and Society: Tradeoffs, Choices and Accountability” (IBS), which teaches students to think critically about the conflicts and trade-offs they will face during their careers.
The 2002 Sarbanes-Oxley Act, which set new standards for corporate governance and financial disclosure, illustrates the trade-offs involved in government regulation of the economy. The law was designed to protect investors from unscrupulous managers, but the costs of increased transparency and accountability could stifle economic growth and discourage firms from taking risks.
“The consequences of getting this wrong are very large,” said Hubbard, who served as chairman of the President’s Council of Economic Advisors from 2001 to 2003, a period when accounting scandals rocked the U.S. economy. “The integrity and liquidity of U.S. capital markets is important for the world economy. If we’re too heavy-handed in dealing with the problem, we will intrude too much. If we’re too light-handed, we may reduce the transparency of information.”
Investor protection relies on a combination of legal institutions, external market forces and internal governance. In the policy realm, reform efforts focus on improving information disclosure and avoiding conflicts of interest. Thus many of the new law’s provisions focus on strengthening auditor independence and improving the accuracy and accessibility of financial information.
Sarbanes-Oxley both imposed higher standards of accountability on top executives and enhanced the SEC’s power to bring offenders to justice. “Sarbanes-Oxley is the most important piece of legislation in the securities area since the New Deal and provides a fundamental framework for the current healing process,” said Goldschmid. “It has gone a long way toward restoring investor confidence.”
Both commissioners acknowledged, however, that Sarbanes-Oxley entails significant risks and that firms must expend considerable costs to comply with its certification requirements.
“I think you can say that Sarbanes-Oxley does contain many advances in corporate governance, but it also represents a formerly unimaginable incursion of federal government into corporate governance,” said Atkins.
The biggest risk, Hubbard noted at the outset of the discussion, is that the new law will dampen economic activity by intruding too far into the private sector.
“We must not frighten off good people from serving as directors,” said Goldschmid. “And we must not intimidate firms into avoiding risk taking.”