The Pros and Cons of Sarbanes-Oxley

Cohen, D. Dey, A. and Lys, T. (2007). The sarbanes-oxley act of 2002: Implications for compensation contracts and managerial risk-taking. Retrieved February 15, 2010 from: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1027448

This study, originally done in 2004 and revised in 2007, researches the pros and cons of the Sarbanes-Oxley Act of 2002 (SOX). The act was passed, in part, because of corrupt business practices such as Enron’s and gave the federal government more power over corporations. However, the research concluded that SOX is not reaching its goal of controlling illegal business practices. As a result of SOX, firms have switched from accrual-based earnings to real earnings management, which disadvantages shareholders but is more difficult to detect. Even though executive’s overall compensation has stayed the same, the research shows that SOX has lead to a reduction in stock option grants. This lack of equity-based compensation has lead to less risky investment decisions, which is negatively related to future stock return volatility. This article is good for managers to understand because it is important to understand this act and how it affects your business, but it’s also important to know that sometimes government regulations can go too far and have a negative impact on the firm and on the economy.