Sarbanes-Oxley

Perhaps the law of unintended consequences strikes again. Seen at Business Insurance:

A study of 4,000 U.S. companies shows the Sarbanes-Oxley corporate reform law has a chilling effect on risk-taking as many companies seek to conserve cash instead of developing new products or services, a University of Pittsburgh researcher said Monday.

U.S. companies significantly cut research and development spending and capital expenditures, while at the same time increasing cash holdings in the period after the 2002 law compared with their United Kingdom counterparts, the study found.

The article cites changes to board of directors introducing risk-averse decision-makers to the process in the U.S., as well as the tainting of decisionmaking by a fear of litigation.

I can buy that, but I am disappointed that the article doesn’t discuss to what extent the R&D budget differentials is a result of other factors, such as changing economic fortunes between the U.S. and the U.K.

As seen on the wires:

North American insurers increasingly are seeking the services of external or unaffiliated actuarial firms to provide actuarial opinions for annual statutory filings.[...]

At work here, according to the report, appears to be some spirit of the Sarbanes-Oxley Act of 2002, with not only companies moving away from the use of internal or affiliated actuarial opinions to the use of independent actuarial firms, but also the survey results show some insurers moving away from using the same firm in both auditing and actuarial functions.

I suppose this means that my actuarial brethren should be expecting more calls from recruiters about consulting gigs.

You may be familiar with the backdating scandals of the recent past, in which it was revealed that some corporations retroactively dated options awards to senior executives to maximize the financial value of those awards.

Today’s Wall Street Journal includes an article (subscriber link) discussing another dimension to the scam — using backdating to reduce taxes:

In a paper that began circulating in recent days, a Securities and Exchange Commission economist concludes there is strong statistical evidence that executives manipulated the exercise dates of their options as part of a tax dodge. And a review of corporate filings turns up some companies with startling options-exercise patterns.[...]

Consider an executive who holds options on 100,000 shares with a strike price of $10. If he exercises and sells when the price is $20, he realizes $1 million in income and must pay $350,000 in income taxes.

If he instead can claim an exercise price of $16, he lowers his income tax to $210,000. If he then sells a year later and the stock is at the same price of $20, he pays $60,000 in capital-gains levies, for a total tax bite of $270,000. In other words, he has the same $1 million gain but saves $80,000 in taxes. The problem arises if the executive misrepresents when the exercise occurred to claim a lower exercise price.

The article mentions that the patterns discussed in the SEC paper disappeared once Sarbanes-Oxley came into force.

I saw an interesting quote in a front-page article in today’s Wall
Street Journal (subscriber link):

The U.S. used to be “the market of choice for all Russian
companies…, where the most liquidity and investors could be found,” says
Andre Bliznyuk, head of capital markets at Russian conglomerate AFK Sistema
OAO. “There was also the advantage of perceived prestige.” Sistema listed
one of its subsidiaries, Mobile Telesystems OJSC, on the NYSE in 2000. But
in the past two years, the conglomerate has listed two other companies,
including itself, in London.

Part of this was because of the LSE’s nearness to Moscow and reputation
for attracting emerging-market investors, but the LSE also has a “more
favorable regulatory environment,” says Mr. Bliznyuk. “Mr. Sarbanes and Mr.
Oxley have obviously contributed to the decision-making process. It is
obvious that regulatory changes have influenced foreign companies’ listing
decisions.”

There is something to be said for accountability being beefed up in the
world of corporate finances, particularly when we aren’t too far removed
from the days where words like “Enron” dominated the headlines. However,
working towards that accountability has been nightmarish for those who have
been unfortunate enough to have to live with the new regulations. One
wonders if accountability could have been achieved in a less burdensome way.