PHASE II -- QUESTION 3
Through the Sarbanes-Oxley Act, Congress addressed certain problems, issues, and deficiencies that were facing the managers in the financial reporting process.
a. Prior to SOX, what problems, issues, or deficiencies were facing the managers? (Bloggers, tackle one per comment.)
b. Post Sox, how does the Sarbanes-Oxley Act of 2002 resolve or reduce the problems, issues, or deficiencies noted above in part a?
posted by Dr. Scott @ 9/20/2005 02:28:00 AM
22 comments
22 Comments:
The main problem managers were facing prior to SOX was a moral problem. Executives stock options were growing during the 1990s. Such stock options, according to Coffee, created an obvious incentive to engage in short-term stock price maximization because executives could exercise their stock options. Many executives accomplished this through premature revenue recognition or other classic earnings management technique.
Post SOX, the Act seems to resolve or at least reduce the problems faced by managers, in that the managers now face a “code of ethics.” This code enforces standards such as honest and ethical conduct, fair, accurate and understandable disclosures in the reports, and compliance with government rules and regulations. Such standards and codes promoted by the SOX reduces the incentive to mislead or alter any statements and reports, as post SOX, managers will now be held liable for the deceiving statements. Thus, under the codes and regulations implemented by the Act, managers will be more likely to report reliable and accurate statements, even if these statements are not what the managers want to reveal.
Although SOX has been effective and companies are finding errors in their systems, they are also experiencing the burden of how much time and money is required to comply with SOX. Managers now have to supervise the people behind the scenes, like the IT staff, who are not used to being monitored so intently, which causes strain among the staff and managers. The IT department is not one managers usually play with, and therefore, do not understand their language fluently. Regardless of these difficulties, I think it is good that managers are being forced to learn more about their business and all that goes one.
In addition to my last blog: Thanks to SOX, when mistakes occur CFOs can no longer say it was a technological problem that they were unaware of, they are now bound by law to know exactly whats going on.
Section 304 of the Sarbanes-Oxley Act of 2002 requires that a manager, primarily a chief executive officer or a chief financial officer, forefeit any profit made from stock options in a 12 month period following the filing of an inflated earnings report. This cancel the incentive to inflate earnings and then bail out, like so many managers attempted prior to SOX.
A major problem facing managers prior to SOX involved the gray area off-balance sheet transactions. Certain things were being discluded from the balance sheet that would cause discrepancies in the final draft of the financial reports. Managers prior to SOX argued that some transactions were merely pursued in an attempt to meet certain "economic flucuations" of the business.
Coffee talks about the role of managers and the grwoth of stock options. Is Coffee justifying managers' lack of moral character primarily on the pursuit of more compensation? Have you looked at the proxy statements lately at the dollar amounts of exeuctive compensation for these large companies under SEC investigation? (SEC filings are also on Lexis Nexis) Check it out. Is it simply the money that are motivating exeuctives?
Coffee states that some blame these scandals on a few "rogue" managers. Or is it part of a bigger problem such as the loss of an ethical consensus in our society as mentioned by James Copeland "Ethics as an Imperative"?
See my webpage "Ethics as an Imperative"
http://www.buec.udel.edu/scottw/Speech.doc
As James Copeland said, the loss of ethical consensus is not suprising. In this industry it is especially devastating because managers, auditors, and clients rely heavily on honesty. Copeland also points out a bigger picture of the entire world's ethics shattering (media, church, govt, education). Managers are leaders, and ethics should be a key characteristic in every leader; as well as individuality and the ability to resist pressures in order to maintain public interest as top priority. Copeland agrees that enticing financial compensation was a factor in fraud, but also that managers lacked the support they needed to encourage ethical behavior. Copeland concludes that, reevaluating account options is not the only answer; there is no easy solution.
SOX helped this ethical problem by "vesting responsibility for the auditor's relationship with an independent Audit Committee rather than management has had a profound and positive impact on the independence of auditors."
"Ethics as an Imperative"?
By James Copeland
I don't really know if the whole business world is becoming more unethical. Yet it seems as if it's becoming more conscious of the rewards and benefits that can come from bending the rules a little bit. Is it unethical? Yes. Is it smart? Definitely. There will always be loop-holes in the business world and managers/companys will look to exploit them to make the highest profits possible, which should be expected with a capitalist economy such as America's. I think it's very hard to regulate ethics in business. How do you rate ethical people from one another? Whose to say Company Manager A is more ethical than Company Manager B? It's a very sticky situation that I don't see being resolved anytime soon.
I completely agree with Zak's comment. The business world isn't becoming more unethical, it's just with the SOX Act more things are coming out into the open and more things are being seen as wrong and unethical even though they have been going on for so long. Managment, CEO's, DM, these are all people companies rely on heavily but there is so much controversy within these postions because they make friends with poeple lower then them and cut breaks where ever they can. Is it fair?, not at all. There is really no way to get to the bottom of every unethical decision that was made by the company. Hopefully more things will come out because of the SOX but that doesn't mean these things will stop happening because not ALL of the issues will be discovered.
America puts such a large value on wealth and power today that people are willing to do anything to obtain it. The quest for glory is so consuming that the value of ethics and morals are brushed aside until it is convenient to have them. This "do whatever it takes" attitude may be one of the reasons America is the economic juggernaut that it has become, but greed can only take someone so far until they fall victim to the downward spiral they have created. If year after year companies were left unregulated the business world would unravel. Luckily, the foresight of certain individuals may stop this negative trend before it is too late. SOX is a turn for the better and is influenced other nations to reevaluate their own systems of regulation. There will always be greedy people but hopefully acts like SOX will make it more difficult for the greedy to hurt the innocent.
Prior to SOX, the problems with managers was their "primarily equity-based" (Cornell Law Review, 297) pay. During the 90's the salary of managers from their stock options increased dramatically, therefore creating the problem of having a great incentive to make the stock price jump dramatically in a short period of time. Therefore being able to create great personal gains by manipulating price of stock.
In Dr. Scott’s speech it says “The loss of an ethical consensus in our society should not have been a surprise for any of us. It didn’t occur overnight.” This is true. This statement is also what Ashley Smith was saying. Also, Ashley’s comment stated the business world isn’t becoming more unethical it is all just coming out in the open. While this is true, Dr. Scott’s speech says, “And unfortunately the problem is even worse than this litany of horrors. It is important to recognize that our entire society—not just the business community—is facing an ethical breakdown of crisis proportions. Every sector of our society from business to education to government to the press to the church is experiencing its own ethical failures.” It is not just the business world that is facing “ethical failures.”
Post SOX also creates a system of checks and balances within a corporations' financial reporting. Management takes a more active role in the responsibility of financial reporting and evaluation of internal controls. These controls are set up according to standards created by the PCAOB. As stated on the SEC's testimony of SOX, by ensuring these standards are met, "investors will be better able to evaluate management's stewardship responsibilities and the reliability of a company's disclosure". This strict evaluation of internal controls also allows management to recognize any future problems or discrepancies in the financial reporting process.
http://www.sec.gov/news/testimony/090903tswhd.htm
Bofore the SOX bill came out, there were many problems that the managers faced, including moral all the way to money problems. One of the major factors that faced the managers before the this bill was the fact that they were pressured to do well by investors and the board. In order to do that, managers would do whatever it takes to make sure that the company looked good. According to one source, "the perception that uninterrupted earnings growth was the hallmark of sound corporate progress caused too many managers to adjust financial results with the purpose of meeting projected results — in ways that were sometimes large and sometimes small, but, especially given the purpose, in all cases unacceptable."
SITE USED: http://www.sec.gov/news/testimony/090903tswhd.htm
I agree with Brian that the insatiable expectations from the shareholders can force managers and ceo's to take fraudulent actions. This by no means justifies their activities but the constant pressure for increased prosperity and met quotas is a huge reason as to why these managers behave the way they do. They do not want to let down the people who have invested their money so the managers try to company worth and profit look amazing to satisfy the stockholders, but in the end this only ends up hurting everyone.
I agree with a comment that Zak made earlier. I believe that no legistation can totally prevent the way managers and business men will run the company. After all they are the managers for a reason. They have obvioulsy shown great work in the past to move up into thier current position. If they do not continue to do well, then the board and owners will have to let them go. Thats what brings on the pressure for managers to do well no matter what the circumstances are. The board has the prospective that they the managers will have to do whatever it takes in order for the company to make money, even if its unethical. Therefore the board, saying they didnt know the manager was unethical, can get away with it, and the manager takes the fall. The ongoing pressure of managers has to make it a very stressful job.
Section 404 of SOX requires the public company's management to take an active role in creating and maintaining the internal control structure that governs financial reporting, and to report on the status of internal controls in its annual report. Once again, the public accounting firm must attest to the fairness and accuracy of management's assessment.
In the pre-SOX era I believe, in accordance with Nicholas, that a major problem concerning managers was their primarily equity-based pay which had the effect of making many managers money hungry and opened them up to the thought of committing fraud. Additionally, I believe managers had too much power with not enough checks and balances to keep their actions from being selfish. This combination is all the necessary ingredients for fraud, and that was the main problems, concerning manager’s, of the pre-SOX era.
I believe that in Dr. Scott's speech, she makes an excellent point..."The loss of an ethical consensus in our society should not have been a surprise for any of us. It didn’t occur overnight. About 15 years ago, a small group of our Partners at Deloitte was asked by our CEO at the time to identify long-term threats to the viability of our firm and our profession." She is absolutely right. There has always been unethical people that worked in the business world. Managers, especially those paid on a commission basis as others described, have always exsisted and always been money hungry. After all, money hungry people have exsisted since the beginning of the universe (ex..the gold rush) and now people are really realizing what these money hungry people are doing for the economy and corporate america. These people were not born over night. I believe that people have forgotten the old saying, the best dollar is a well earned dollar.
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