Main Advantages and Disadvantages of Sarbanes-Oxley Act (SOX) – disadvantages

On the disadvantages end, SOX compliance has been associated with various direct costs and indirect costs that could affect firm’s investment potential. For instance, much of the direct costs goes to improvement of internal control systems (Hermason, 2005), which could be defeated by collaboration among employees thus resulting in inefficacy of SOX as a fraud deterrent tool. Surveys cited by Hermason (2005) for instance indicate that entities burdened by initial compliance costs of SOX have reduced investment in such areas as research and development and capital expenditures, areas important in enhancing innovation and thus competitiveness of an entity. A second disadvantage of SOX is that it provides little options for compensation of investors who lose their investments or employees who lose their jobs following fraudulent activities by management. Additionally, although the Act has provisions to ensure auditors act in a prudent manner, it lacks provisions that would deter retaliation (e.g. dismissal) of auditors who resist the pressure to collaborate in perpetuating fraud.

Although SOX offers incentives (negative and positive) for improved financial reporting, it does not offer a guarantee for the accuracy of the financial statements of public firms. The evidence of such failure of SOX as a guarantee is provided by failure of various entities during the recent financial crisis. For instance, financial institutions that cheated investors into buying low-rated mortgage-based securities previously pooled and subsequently rated highly, facilitated the development of the crisis (Duca, Muellbauer & Murphy, 2010). Such actions are indicative of non-disclosure of material information, for instance where an entity continues holding the securities at a higher value despite the continued defaults on the subprime mortgages that comprised the pooled securities. Despite such failure of SOX to act as a guarantee to the accuracy of financial statements, the Act helps in enhancing prudent management practices since it establishes liability for CEOs and CFOs for endorsing statements that contain misleading information regarding financial condition of the firm. CEOs and CFOs also show great concern for the Act since, as provided in section 304, it requires the forfeiture of bonuses and profits that they receive based on financial statements that are subsequently restated for failure to comply with financial reporting requirements. Accordingly, the act provides a financial incentive to the CEO and CFO to ensure the compliance of the financial statements with financial reporting requirements.


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