In the span of two years, corporate governance researchers, such as Dr. Suresh
Radhakrishnan, of The University of Texas at Dallas School of Management,
have been busy looking at the impact of the
Sarbanes-Oxley Act on businesses.
“While things have settled down in the
business world in respect to Sarbanes-Oxley compliance issues, there are
many valuable trends that have emerged
that businesses can learn from,” says
Radhakrishnan, an accounting and information management professor and director of research for the Institute of
Excellence in Corporate Government at
the university.
Smart Business learned more from
Radhakrishnan about the important developments that have emerged surrounding
corporate governance.
What trends have surfaced as a direct result
of the Sarbanes-Oxley Act?
Two major trends have emerged. One has
to do with Section 302 of the Sarbanes-Oxley Act, which requires that public companies report, on a quarterly basis, any
errors that have been found and corrected
in accounting policy, etc. The second trend
relates to Section 404, which requires disclosing any significant weaknesses in internal controls in the annual report.
Based on our analysis, we found that
companies reporting significant or, in its
legal term, material weakness in internal
controls that are part of corporate governance have gone down by 40 percent.
These are ‘weaknesses’ in control systems
that are in place that could result in exposure to fraud and misstatements leading to
potentially unreliable information. For
example, having only one person sign off
on a check can be a material weakness that
can be remedied by having two people sign
a check of, let’s say, over $500. Companies
have done a very good job in zeroing in on
material weaknesses and enhancing the
internal control systems.
However, we also found that reporting of
errors — Section 302 — has gone up by
about 25 to 30 percent. While this may be
counterintuitive, it actually makes sense
because when a business has a good internal control system in place it is bound to
red flag more errors.
Are there other corporate governance trends
you have found in recent years that are not
directly related to Sarbanes-Oxley?
Executive compensation at the moment
is a hot trend. The Securities and Exchange
Commission (SEC) now requires public
companies to disclose executive compensation to investors and stockholders in a
more transparent fashion in the Compensation Disclosure and Analysis. While
there was initially a fear that this disclosure
would lead to bad publicity about executives’ compensation, the fact is that the
opposite has been true.
Yes, there have been articles in the Wall
Street Journal and New York Times about
companies with excessive CEO compensation, but overall, this SEC rule has actually
led to fewer inquiries in the media because
the disclosure is simple to understand and
is transparent.
Another trend that is emerging on the
executive compensation front is the ‘say on pay’ proposals. This gives shareholders
and investors a say in what executives get
paid. This has not been legislated, nor, in
my opinion, should it be. But it is on the
table for discussion in many companies.
What do all these trends mean for small and
medium-sized businesses today?
When the Sarbanes-Oxley Act was
passed, there was a legitimate concern that
small- to medium-sized companies would
be hesitant to go public to raise capital in
order to avoid the expense of compliance.
This, in fact, has happened. However, an
exit strategy is often desired for founders
of these smaller companies. The preferred
strategy at the moment is to be bought out
by larger companies. The irony is that
these small- to medium-sized companies
can’t get away from the compliance issues
because the larger companies buying them
out require best practices and will pay a
premium to companies that have good corporate governance practices already in
place.
Other than preparedness for a buyout or
going public, are there other benefits for
small- to medium-sized companies to establish corporate governance policies?
Our research has shown that the link
between governance and the establishment of long-term wealth [i.e., enhancing
shareholder value] is nebulous at best. The
Sarbanes-Oxley Act has improved the
transparency, disclosure and reliability of
information.
What we have found, however, is that
more disclosure and reliable information is
associated with a lower cost of capital in
publicly traded companies. In other words,
there is less risk involved when stockholders invest in a company with good corporate governance in terms of more reliable
and transparent disclosure; however, a
reduced risk does correlate with a lower
return. <<
DR. SURESH RADHAKRISHNAN is a professor of accounting and information management at The University of Texas at Dallas and
the director of research for the Institute of Excellence in Corporate Government. Reach Radhakrishnan at [email protected] or (972)
883-4438.
