Professor Bainbridge...on law, politics, religion, culture & food

We get mail: SOX and business ethics

A reader writes:

Given that the 33 and 34 acts were designed to separate from participation in the securities market, those who act unethically, and that President Bush and the Congress stressed a desire to return the market to a higher ethical plane; it might be useful to reflect upon whether Sarbox accomplishes this goal.

I'm pessimistic, but grateful for the opportunity to pull together some of the arguments I've made in this space over the last weeks.

The ethics provisions of Sarbanes-Oxley strike me as likely to have positive effects, but only at the margins. First, for reasons explained here, I am very skeptical of the utility of principles-based ethical systems (as opposed to those based on virtue). Second, as I argued here, I am doubtful that SOX section 307 (the legal ethics provision) will be all that effective (see also here).^* Third, the mandated ethics codes are a joke, as one of my readers pointed out a while back.

The disclosure provisions are the best hope for improved ethical standards following from SOX. Louis Brandeis famously observed: "Sunlight is said to be the best of disinfectants; electric light the most efficient policeman." To the extent SOX leads to greater transparency, that will discourage unethical practices. The problem is that we may be drowning investors in disclosure. A rational shareholder will expend the effort to make an informed decision only if the expected benefits of doing so outweigh its costs (see here for more). To the extent we drown investors in information, the benefits of enhanced transparency are lost, because the opportunity costs of processing those disclosures rises without apparent benefit to the individual investor (note that monitoring of management is a public good).

The basic reason I'm pessimistic, however, is that CEOs are pessimistic. A Foley & Lardner survey found that only 46% of CEOs thought Sarbanes-Oxley has "made investors more confident in the integrity of your financial and other public reporting." Sixty percent thought corporate governance reform had gone too far, while 93% (!) thought compliance costs would continue to rise. Not encouraging numbers.

^* Ed.: I continue to work on 307 issues in preparation for a conference in the spring, and will be continuing to post on it periodically.