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Counter-Conventional Wisdom On SOX 404 Costs
Location: BlogsAAO Weblog (Public)    
Posted by: Jack Ciesielski 10/6/2006 6:42 AM
Last week, PCAOB member Charlie Niemeier delivered a speech at The Atlantic magazine's "Idea Tour." Charlie presented a point of view you don't often see in the general financial press: that the costs of regulation haven't been excessive and haven't cost the United States its international capital competitiveness.

Before ignoring his remarks on the grounds that any regulator will defend regulation, take note: Niemeier backs up his assertions with facts.

Niemeier makes the point that overseas companies are more likely to be controlled by founders, who often still take part in the management of the business. They don't care to raise capital in countries that have strong protection of minority interests; they can feed their need for remuneration quite well by staying in their own country when they need capital. Why give up their private benefits? When such insiders perceive that their share of growth opportunities will exceed their private benefits if they can fund them with more "protected capital," they'll forego their private benefits and come to the U.S. for their capital.

A few of the interesting nuggets from his speech:

While emotions may run high with concern about the personal burdens of compliance and enforcement on managers, as the Head of Nasdaq's International Listings office has said, “The key reasons companies are still coming to the U.S. remain the same. International listing activity is still driven by U.S. valuations.”

The U.S. share of IPOs throughout the world – which is so often cited as an indicator that Sarbanes-Oxley has deterred companies from going public – declined dramatically beginning in 1996 and through 2001 (from about 60 percent of all IPOs to less than 8 percent), after which it has on average increased somewhat (to about 15 percent in 2005).

...[S]everal countries are in the midst of multi-year programs to privatize state-owned businesses. For example, the top five IPOs last year were privatizations of state-owned entities in China and France. Notwithstanding the significant valuation premium in the U.S., there are considerable political, cultural and other influences on such companies to list locally when their markets offer sufficient liquidity...

... [C]ompanies have consistently endured relatively higher fees in the U.S., because of the net savings in cost of capital (and net valuation premium) in the U.S. Indeed, I understand even today the greatest costs companies listing in the U.S. face are not compliance costs but rather are these underwriting fees. One recent study has estimated that underwriting fees consume 6.5 to 7 percent of IPO receipts in the U.S., compared to 3 to 4 percent in Europe.

In addition, part of the drop in the U.S. share of worldwide IPOs is clearly due to the dramatic decrease in the number of IPOs by U.S. companies, from about 375 in 2000 to less than 100 in 2001... Important to an evaluation of the competitiveness of the U.S. markets themselves, there was no commensurate shift by U.S.-based companies to markets in other countries.

It was reported this week that the scandal over backdating stock options to reward insiders with undisclosed compensation has cost $7.9 billion in lost market value of the companies involved. As I mentioned earlier, Sarbanes-Oxley and a new accounting standard on option compensation have significantly limited insiders' opportunity to engage in such practices, but even without the new requirements it is easy to see the benefits, both to companies and their investors, of ensuring that financial reporting and disclosures are accurate. As one prominent securities lawyer recently said of clients involved in restatements: “[T]he concept of cost for a 404 audit is nothing compared to what happens when you face a restatement . . . . [E]very CFO I work with comes to a very simple conclusion, that being penny-wise and pound-foolish with respect to the costs of the audit really was a stupid thing to do.”

Again, you're not going to see Niemeier's points of view being pushed in the popular press very often. But they're valid points; just because they're not popular doesn't mean they're wrong.
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