A Costly Accounting Oversight
February 07, 2003
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The recent news that the members of the accounting oversight board, established under the Sarbanes-Oxley Act last year, voted to give themselves salaries of more than $450,000 (Euros 421,000) and would pay the board's chairman over $560,000, has finally focused the public's attention on the act's specifics.
Adopted in haste by Congress and signed by President George W. Bush in the wake of the Enron and WorldCom collapses, the act could turn out to be a classic policy blunder, where the unintended consequences are far worse than any possible benefits.
The salaries of the board members point to one of these unintended consequences--the huge costs that the oversight board will impose on the economy. The board--a private company, not a government agency--was given authority by Congress to pay itself, its staff, and consultants, market rates of compensation, and to collect the necessary funds for its operations by levying fees on all public companies. Apart from the questionable constitutionality of such an arrangement, this gives the board carte blanche to grow into a costly regulatory agency, but one that is not subject to oversight by anyone wishing to limit its expenditures. As with all bureaucratic bodies, the board's jurisdictional reach, its staffing, and its requirements for additional offices, travel, consultants, lawyers, and other advisers, will grow. So will the salaries of its members and staff and the fees of its consultants and advisers. This will impose onerous costs that public companies will have to meet. The Securities and Exchange Commission has authority to approve the board's budget, but the SEC's incentives are to push the board into greater activity. Why should the SEC take responsibility for limiting the board's activities by limiting its bud get? It would get little credit for this but much blame if another auditing crisis came to light.
Moreover, the SEC--which will control the board through its authority to appoint the board's members--is bound to discover that it can offload projects to the board, thus saving its own appropriated funds and increasing the board's costs.
The oversight board will impose substantial costs on the accounting industry, which, in turn, will result in higher audit fees to public company clients. The act authorises the board to register all accounting firms that audit public companies; to establish auditing, quality control, ethics, independence, and other standards for accounting firms engaged in auditing; to conduct inspections and investigations; to carry out enforcement functions; and to perform such other duties or functions as the board (or the commission, by rule or order) determines necessary to promote high professional industry standards. Again, there is no legislative or financial limit on what these activities may entail, and all related costs of compliance will be borne initially by the accounting industry and eventually by the public companies they audit.
As with all regulatory activities, the costs imposed on the regulated industry will serve as a barrier to entry for smaller firms. It is obvious that a small auditing firm with, say, fifty clients will find its regulatory compliance costs consume a much higher proportion of its revenues than the similar costs of a firm with 4,000 clients. With the demise of Arthur Andersen as a significant factor in the business of auditing public companies, only four big accounting firms remain active in this field to service about 16,000 public companies. Accounting firms will have significant market power to raise the rates for their audit services, and the costs imposed by the oversight board will prevent smaller firms from breaking into the oligopoly that now prevails. These additional costs, together with the new liabilities for certifications placed on chief executive officers and chief financial officers, could cause many companies to withdraw entirely from the public securities markets.
Moves of that sort are likely to become more widespread as managements see greater profitability--and the chance to escape extensive personal liability and harassing lawsuits--in operating as private companies. As it is, many companies go public only because a publicly traded stock makes it possible to attract high quality management with stock options. If the value of this compensation mechanism is cut, fewer companies will offer their shares to the public and many that are already public will devise ways to go private. The long-term effects of this are likely to be smaller and less well-capitalised companies as well as a reduction in the range of investments available to U.S. investors.
None of this, one hopes, was ever contemplated by the members of Congress who designed this structure, but it demonstrates the validity of the old adage: act in haste, repent at leisure.
Peter J. Wallison is a resident fellow at the American Enterprise Institute. He was general counsel of the Treasury and White House counsel during the Reagan administration.
Adopted in haste by Congress and signed by President George W. Bush in the wake of the Enron and WorldCom collapses, the act could turn out to be a classic policy blunder, where the unintended consequences are far worse than any possible benefits.
The salaries of the board members point to one of these unintended consequences--the huge costs that the oversight board will impose on the economy. The board--a private company, not a government agency--was given authority by Congress to pay itself, its staff, and consultants, market rates of compensation, and to collect the necessary funds for its operations by levying fees on all public companies. Apart from the questionable constitutionality of such an arrangement, this gives the board carte blanche to grow into a costly regulatory agency, but one that is not subject to oversight by anyone wishing to limit its expenditures. As with all bureaucratic bodies, the board's jurisdictional reach, its staffing, and its requirements for additional offices, travel, consultants, lawyers, and other advisers, will grow. So will the salaries of its members and staff and the fees of its consultants and advisers. This will impose onerous costs that public companies will have to meet. The Securities and Exchange Commission has authority to approve the board's budget, but the SEC's incentives are to push the board into greater activity. Why should the SEC take responsibility for limiting the board's activities by limiting its bud get? It would get little credit for this but much blame if another auditing crisis came to light.
Moreover, the SEC--which will control the board through its authority to appoint the board's members--is bound to discover that it can offload projects to the board, thus saving its own appropriated funds and increasing the board's costs.
The oversight board will impose substantial costs on the accounting industry, which, in turn, will result in higher audit fees to public company clients. The act authorises the board to register all accounting firms that audit public companies; to establish auditing, quality control, ethics, independence, and other standards for accounting firms engaged in auditing; to conduct inspections and investigations; to carry out enforcement functions; and to perform such other duties or functions as the board (or the commission, by rule or order) determines necessary to promote high professional industry standards. Again, there is no legislative or financial limit on what these activities may entail, and all related costs of compliance will be borne initially by the accounting industry and eventually by the public companies they audit.
As with all regulatory activities, the costs imposed on the regulated industry will serve as a barrier to entry for smaller firms. It is obvious that a small auditing firm with, say, fifty clients will find its regulatory compliance costs consume a much higher proportion of its revenues than the similar costs of a firm with 4,000 clients. With the demise of Arthur Andersen as a significant factor in the business of auditing public companies, only four big accounting firms remain active in this field to service about 16,000 public companies. Accounting firms will have significant market power to raise the rates for their audit services, and the costs imposed by the oversight board will prevent smaller firms from breaking into the oligopoly that now prevails. These additional costs, together with the new liabilities for certifications placed on chief executive officers and chief financial officers, could cause many companies to withdraw entirely from the public securities markets.
Moves of that sort are likely to become more widespread as managements see greater profitability--and the chance to escape extensive personal liability and harassing lawsuits--in operating as private companies. As it is, many companies go public only because a publicly traded stock makes it possible to attract high quality management with stock options. If the value of this compensation mechanism is cut, fewer companies will offer their shares to the public and many that are already public will devise ways to go private. The long-term effects of this are likely to be smaller and less well-capitalised companies as well as a reduction in the range of investments available to U.S. investors.
None of this, one hopes, was ever contemplated by the members of Congress who designed this structure, but it demonstrates the validity of the old adage: act in haste, repent at leisure.
Peter J. Wallison is a resident fellow at the American Enterprise Institute. He was general counsel of the Treasury and White House counsel during the Reagan administration.
