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SOX
by leon on November 1, 2006
But at what costs?
Controls are costly, but no controls hurt the economy. Fraud has enormous social costs, according to a fascinating paper from Simi Kedia, of Rutgers, and Thomas Philippon, of NYU.
In their paper, The Economics of Fraudulent Accounting, the pair analysed companies known to have been managing earnings. The publicly traded firms that restated their earnings in 2000 and 2001 had created between 350,000 and 500,000 jobs between 1997 and 2000. But after restating, they destroyed between 250,000 and 600,000 jobs.
Not only that, firms that are managing earnings hire and invest more than comparable firms. But when they go belly-up, the job losses and social impact are enormous. Fraud is economically destructive.
"Bad managers who want to hide their poor quality must not only manage their earnings, but also hire and invest like good managers. It is not sufficient to merely misreport performance. In equilibrium, the bad managers hire and invest excessively, distorting the allocation of resources among firms."
The implications of the study: it's not just the shareholders that get screwed. Fraud can have a massive impact on the wider economy.
Permalink: SOX and the social impact of fraud
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Vote for SOX and the social impact of fraud:
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Rating: 8.67 out of 3 vote(s) cast.
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Response from:
Sam E. Antar (Former Crazy Eddie CFO and Ex-felon)
(10/31/06 8:24pm)
Response from:
There is no doubt that Sarbanes-Oxley is costly. But no controls are even more costly. A study has found that fraud has a massive impact on the economy.
Response from:
IndianPad
Sox First: SOX and the social impact of fraud posted at IndianPad.com
Response from:
news.fatpitchfinancials.com
There is no doubt that Sarbanes-Oxley is costly. But no controls are even more costly. A study has found that fraud has a massive impact on the economy.
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It affects not only the companies defrauded, their employees, creditors, and shareholders but the integrity of the financial markets.
The reliability and integrity of financial information is the main pillar of our capitalist economic system.
When the financial markets lose faith in the integrity of financial information the collective market capitalization of all companies are effected. The result is higher costs of capital and debt as well as reduced pension benefits, increased unemployment, lower tax revenue and other collateral damage to society.
Strong and verifiable internal controls evaluated by competent and independent external auditors strengthen the reliability of audits.
Strong internal controls and competent audits are NOT mutually exclusive. We cannot have effective audits of companies whose internal controls are weak.
For example in the Crazy Eddie fraud our company had almost nonexistent internal controls.
In 1986, we took some of the previously skimmed money from prior years (as a private company) in secret Antar family bank accounts in Israel and channeled back such funds back into the company as fictitious sales (now as a public company).
We overstated sales and net income and as a result Eddie Antar and his father sold $36 million in overvalued stock shortly thereafter.
The money was in the bank and the auditors assumed that the sales were made. However, they never examined how the money got there and did not consider our lack of internal controls.
Therefore, the evaluation of internal controls is a natural part of an effective audit. The presence of strong internal controls strengthens the integrity of financial information – the lifeblood of our economic system.