Sarbanes-Oxley and the Ebbers Conviction

The recent conviction of Bernard Ebbers, the former chairman of WorldCom, has once again raised the question of whether the Sarbanes-Oxley Act was necessary or cost-effective. Supporters of the act have argued that Ebbers’s wrongdoing demonstrates the need for a law that mandates strict oversight of corporate managements. Opponents note that imposition of civil or criminal penalties after the fact--the way that financial fraud has traditionally been handled--would have been sufficient, and that it is not good policy to burden all businesses in order to catch a few wrongdoers. Even if we assume that the strictures of the act will be effective, they will only reduce or prevent losses for those companies where losses from financial fraud would have occurred but for the act’s requirements.

Accordingly, to justify the act on a cost-benefit basis, it would be necessary to find that the benefits received by the shareholders of these few unknown companies will be greater than the costs that will be borne by the shareholders of all companies--including those who would have suffered no fraud losses even if the act had never been adopted. Even if this were a fair distribution of costs, it seems highly unlikely that the benefits will outweigh the costs.

The only other way that the act can be justified is through some generalized effect in restoring investor confidence, thus raising all corporate values. But the data on market activity around the time it became clear that the act would become law clearly shows that, if anything, the act caused a decline in investor confidence rather than a restoration.

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