The article discusses the significance of the Sarbanes-Oxley Act 2002 for corporate governance and corporations’ accountability to their shareholders. In the wake of scandals of WotldCom, Enron and Tyco, the issue of corporate governance and public disclosure has become very topical. It remains very topical nowadays as well, in the midst of the global financial crisis triggered to a large extent by irresponsible behavior of major private financial institutions.
The article traces the history of corporate governance in the U.S. and discusses various pieces of legislation aimed at protecting shareholders’ interests. The separation between ownership and management is a well-entrenched practice in the U.S.; however, during the 1970s and 1980s, executives dominated corporate governance, which resulted in weak oversight and excessive compensation and bonuses for top officials. Hostile takeovers were another alarming trend that decreased firms’ overall efficiency and benefited financial manipulators, corporate raiders, speculators, lawyers, and investment bankers.
In the 1990s, board of directors became more prominent as two theories of corporate governance were increasingly accepted. The first theory, the stakeholder theory, holds that corporations are responsible to their stakeholders including major customers, creditors, employees, community and suppliers. The second theory, the agency theory, advocates that board of directors is legally responsible for all actions of the corporation. Shareholders became recognized as owners of the corporation and empowered to take a more active role in running the company. Shareholders’ campaign to remove Disney’s CEO from his position can serve as a prime example. Several decades ago, shareholder were not only disempowered but also scattered around the country, co collective action appeared problematic. With the proliferation of new information and communication technologies, such collective action becomes possible.
Another model, the co-determination model, was practiced in continental Europe. Under this two-tier model, both capital and labor are represented on governing boards.
The Sarbanes-Oxley Act 2002 was passed with a view to ensuring greater efficiency and transparency of corporate governance. It includes provisions on independence of auditors and directors and strengthens penalties for violations of corporate governance standards. Signing officers are now responsible for accuracy and fairness of all statuary financial reports filed. All internal control deficiencies and fraud should be reported as well. Information on accuracy of the managements’ internal control structure should be a part of periodic disclosures. Disclosure requirements were also extended to include all off-balance sheet liabilities, obligations, or transactions. Disclosure should happen in a timely manner and be accompanied by easily understandable information such as trends and graphs. The penalties for violating or failing to meet these requirements may result in up to 20 years of imprisonment and heavy fines.
The Sarbanes-Oxley Act 2002 stimulated companies to pay greater attention to financial reporting and ethics, to recruit more qualified and independent board and audit members, to communicate more extensively with audit committees, and to use risk reviews for areas associated with high financial risk.
While the Sarbanes-Oxley Act 2002 has made U.S. accounting standards more complex, America and Europe are moving in the same direction when it comes to ensuring sound corporate governance. The Act might be the first of a series of legislative reforms aimed at restoring confidence in corporate America.
Alkhafaji, Abbass F. (2007). Corporate governance: the evolution of the Sarbanes-Oxley Act and its impact on corporate America. Competitiveness Review, 17(3), 193-202.