Sarbanes-Oxley:Risk of Too Little Risk
While much of the criticism of Sarbanes-Oxley has focused on Section 404 costs, a new study suggests that the greater damage may be its effect on corporate risk-taking. The study compared the investing behavior of U.S. companies with counterparts in the U.K. over the past 16 years. It found that American companies have reduced research and development (R&D) and capital spending and increased their cash holdings since the passage of SOX; also, the probability of an initial public offering taking place in the U.K., rather than the U.S., has risen in the period. Finally, the researchers argue that the reduction in stock price volatility is not proof of the market rewarding good governance and strong internal controls, but rather evidence of the market's assessment that companies are more adept at risk avoidance.
The research paper by Leonce Bargeron, Kenneth Lehn and Chad Zutter of the University of Pittsburgh, comparing 4,239 U.S. and 989 U.K. public companies for the periods 1995-1997, 1998-2000 and 2003-2005, finds that while the ratio of R&D to assets is greater at U.S. companies than at U.K. companies, the gap between the two groups has shrunk since Sarbanes-Oxley. The same was the case with capital expenditures to assets. In contrast, the cash to assets ratio at U.S. companies has risen in all three periods, jumping sharply since SOX; at U.K. companies, the ratio increased slightly before SOX, but has declined since.
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Of the 7,380 U.S. IPOs over the period of 1990-2006, only 13% have taken place since SOX; by contrast, 32% of the U.K. IPOs have taken place in the same time frame. More importantly, the percentage of IPO proceeds for companies in R&D-intensive industries fell substantially in the U.S. after SOX, from 34% to 17%, while it rose in the U.K. from 10% to 12%.
Finally, the academics analyzed three stock-based measures of risk and found that total risk has fallen at U.S. companies relative to U.K. companies in the SOX aftermath. "Companies are taking on less firm-specific risk," says Bargeron. "They are afraid of standing out."
Accounting-IFRS: Can One Size Fit All?
Standard & Poor's has added its voice to the call for global convergence on an accounting standard that would incorporate tenets of the principles-based International Financial Reporting Standards (IFRS) with the rules-based approach of U.S. Generally Accepted Accounting Principles (GAAP). The standard would likely resemble the IFRS more than the prescriptive GAAP. The current methodology is "a mixed bag," says Neri Bukspan, chief accountant of S&P's rating services and co-author of a recent report saying that the principles-based approach would reduce the number of restatements, while providing an economically based picture of a company's business, risks and opportunities. "Investors need a more consistent framework, better disclosure and more transparency," says Bukspan. Although a principles-based approach carries its own risks, such as a greater level of discretion and subjectivity, these are outweighed by the benefits.
Benefits:Suit Tests Goodyear VEBA
On July 3, the United Steelworkers (USW) filed a class-action lawsuit against the Goodyear Tire & Rubber Co. in federal court. But believe it or not, Goodyear is happy they did. The suit will test the validity of a new instrument that Goodyear and the USW created during contract negotiations late last year. The voluntary employee benefit association, or VEBA, is a healthcare trust into which Goodyear hopes to transfer all of its other postretirement employee benefits (OPEB). The move gets the company's OPEB liabilities, currently valued at $1.2 billion, off of the tire company's balance sheets in exchange for a one-time $1 billion cash payment into the VEBA. Already, Goodyear has been rewarded with a credit risk upgrade from Moody's Investors Service. Assuming the VEBA survives the court challenge, Moody's anticipates that other companies with large OPEB liabilities, such as General Motors, Ford and Chrysler, will attempt to negotiate something similar in their contract negotiations with the United Autoworkers. OPEB liabilities are said to add about $1,000 in costs per car to U.S. auto makers.
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