the effects of the sarbanes/oxley act, specifically section 404, on innovation in america’s...
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The effects of the The effects of the Sarbanes/Oxley Act, Sarbanes/Oxley Act,
Specifically Section 404, on Specifically Section 404, on Innovation in America’s Innovation in America’s
Publicly Held CorporationsPublicly Held Corporations
By Wendy Vidlak
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BackgroundBackground
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Accounting + Creativity =Accounting + Creativity =
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Accounting Scandals Made Accounting Scandals Made Headlines In the Early 2000’s Headlines In the Early 2000’s And Forced the Government And Forced the Government
to Actto ActEnron
General Re
Tyco
Xerox
Arthur Anderson
Sunbeam
Freddie Mac
WorldCom
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Key Points of Sarbanes/Oxley Key Points of Sarbanes/Oxley (SOX) Legislation(SOX) Legislation
• Does not add many extra protections for investors• CEOs of fraudulent companies’ such as Enron are
being tried using the old rules and laws Lambert (2003), Adams (2004), Fisch (2004), Romano (2005)
• Now a criminal offense for a CEO to sign a fraudulent Annual Report (http://www.aicpa.org/info/sarbanes_Oxley_summary.htm)
• Section 404 requires a company to account for all financial risks and put processes in place to reduce those risks Cobb (2004)
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What is Needed for Innovation What is Needed for Innovation at Companies?at Companies?
• Embrace Risks Nickerson (1999), Farson and Keyes (2002), Blumentritt (2004), Green (2005), Thain (2004), Carroll (2004)
• Capital • Organizational Flexibility Galunic and Rodan (1998),
Seaden (2001)
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Purpose of the ProjectPurpose of the Project
To ascertain the effects of the Sarbane/Oxley Act, specifically section 404, on innovation in America’s publicly held corporations
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Thesis StatementsThesis Statements
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The costs of Implementing The costs of Implementing Section 404 are Quite High Section 404 are Quite High and Many Corporations are and Many Corporations are
Funding the Increased Funding the Increased Accounting Costs by Accounting Costs by
Reducing Research and Reducing Research and DevelopmentDevelopment
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Section 404’s Emphasis on Section 404’s Emphasis on Measuring Corporate Risk is Measuring Corporate Risk is
Creating a Culture of Risk Creating a Culture of Risk Aversion Among Top Aversion Among Top
Executives and Stifling Executives and Stifling Innovation in Areas of New Innovation in Areas of New
Product DevelopmentProduct Development
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That Section 404 is Creating That Section 404 is Creating Some Innovations in the Some Innovations in the
Areas of Financial Reporting Areas of Financial Reporting and Procedures as and Procedures as
Companies Attempt to Companies Attempt to Reduce Costs of Compliance Reduce Costs of Compliance
and Open Their and Open Their Financial Processes to Public Financial Processes to Public
ScrutinyScrutiny
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Data Gathering TechniquesData Gathering TechniquesCompiled a random sampling of 50
companies from S&P 500 and 50 from the Russell 2000 Index
Looked at the number of new patents and trademarks each company had before and after SOX
Compared R&D costs with the Administration costs of the companies
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Data Gathering Techniques Data Gathering Techniques Send a short e-mail survey to the 100 companies
in the sample to help determine if there is a connection between the new law and innovation
Conduct several in-depth phone or e-mail (participant preference) interviews with several companies to try to indicate there is causation to the correlation of the quantitative findings
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Results So Far. . . Results So Far. . .
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Trademark SearchTrademark Search
S&P 500 Companies trademarks increased from 15.42 per company in 2002 to an average of 18.6 in 2004
The average from 1992-2002 was 12.4Russell 2000 companies trademarks
increased from 1.52 per company in 2002 to an average of 1.63 in 2004
The average from 1992-2002 being 1.16
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Possible Implications of Possible Implications of Trademark SearchTrademark Search
Increased risk and processes increases trademark applications
Many companies had no trademark applications, especially smaller companies
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Patent Search ResultsPatent Search Results
Patents approved in 2002 for the S&P 500 sample averaged 25.74 per company in 2002 and 4.5 in 2004
The average from 1992-2002 was 21.6Patents approved in 2002 for the Russell
2000 sample averaged 1.14 per company and in 2004 the average was .2 per company
The average from 1992-2002 is .74
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Patent Search Patent Search Implications/ProblemsImplications/Problems
Numbers taken at face value indicate thesis is true
Companies can keep patent applications secret until approved, which would artificially decrease 2004 numbers
Some industries do not file for patents
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Financial Analysis Financial Analysis
S&P 500 companies increased R&D spending an average of 17.28% between 2002 and 2004
Administrative expenses increased 23.4% Russell 2000 companies decreased R&D
spending by 1.3% between 2002 and 2004Administrative expenses increased 15.91%
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Financial Analysis ResultsFinancial Analysis Results
Significant difference between sample company spending at S&P 500 versus Russell 2000
Russell 2000 supports the thesis well. S&P 500 numbers still support it but less convincingly
Many of the preliminary trade reports are showing similar issues where the law is hitting smaller companies harder
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Literature ReviewLiterature Review New products are often used as formal measurements of
innovation Thomas (1990), Schnee (1979)
Preliminary results in trade papers show the costs of 404 compliance run an average of $1.9 million for companies with less than $25 million of revenue, approximately 7.6% of revenue
Compliance costs run $4.7 million for companies with more than $5 billion revenue, approximately .09% of revenue (http://www.fei.org/files/spacer.cfm?file_id=788)
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Literature ReviewLiterature Review Innovative firms take on more risk Farson and Keyes
(2002), Guifford and Howe (2004), Blumentritt (2004), Green (2005)
Companies living with fear tend to respond with tests and measures and become more risk averse Meckler (2004), Pearson (2002)
SOX requires many tests and measures Verschoor (2005), Audit committee Brief, Deloitte Development
Organizations are less likely to take new risks for fear of running afoul of SOX Green (2005), Thain (2004), Carroll (2004)
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Other Major Regulatory Other Major Regulatory Changes’ Effects on Changes’ Effects on
InnovationInnovation 1979 FDA regulations caused new drug
introductions to decline 50% Schnee (1979), Thomas (1990)
– Large companies increased innovation– Small companies ceased to innovate
Nuclear Regulations after 3 Mile Island (TMI) Marcus (1988)
– Companies that were rule bound before TMI became more rule bound
– Companies that were autonomous before TMI used the regulations to innovate
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Where Do I Go From Here?Where Do I Go From Here?
Send out surveys
Finish interviews and documentation
Hopefully the surveys and interviews will help strengthen the link between the numbers to the effects of SOX
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Things I LearnedThings I Learned
Regulations have tremendous impacts on business
Measuring the direct effects of regulations is quite difficult
In a time of global economy, innovation is the key for the U.S. staying competitive, yet we are potentially regulating ourselves out of business
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ReferencesReferences
Summary of the Sarbanes Oxley Act. AICPA Website. Retrieved November 10, 2005, from http://www.aicpa.org/info/sarbanes_oxley_summary.htm
Audit Committee Brief [Brochure]. (August 2004). Deloitte Development LLC.
Adams, R. B. (2004) Cost, Quality, and Sarbanes Oxley. AACE Internal Transaction, PM81, 3 pages.
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References (Cont.)References (Cont.)
Blumentritt, T. (2004). Does Small and Mature Have to Mean Dull? Defying the Ho-hum at SMEs. The Journal of Business Strategy, 25 (1) 27-34.
Carroll, J. (2004, December). Could SOX Kill Innovation? CA Magazine. 137 (10) 14.
Cobb, C.G. (2004). Sarbanes-Oxley: Pain or Gain?. Quality Progress, 37 (11) 48-53.
Farson, R. And Keyes, R. (2002). The Failure-Tolerant Leader. Harvard Business Review, 80 (8), 64-72.
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References (Cont.)References (Cont.)
Fisch, J. E. (2004, Fall). The New Federal Regulation of Corporate Governance. Harvard Journal of Law and Public Policy, 28(1), 39-49.
Galunic, D.C. and Rodan, S. (1998). Resource Recombinations in the Firm: Knowledge Structures and the Potential for Schumpeterian Innovation. Strategic Management Journal, 19, 1193-1201
Green, S. (2005, March). The Limitations of the Sarbanes-Oxley Act. USA Today, 133 (2718) 66-68.
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References (Cont.)References (Cont.)
Guifford, R.H. & Howe, H. (2004). Regulation and Unintended Consequences: Thought on Sarbanes-Oxley. The CPA Journal, 74 (6), 6-10.
Lambert, P. W. (2003) Worlds Are Colliding: A Critique of the Need for the Additional Criminal Securities Fraud Section in Sarbanes-Oxley. Case Western Reserve Law Review, 53 (3), p839, 17p
Marcus, A. (1988). Responses to Externally Induced Innovation: Their Effects on Organizational Performance. Strategic Management Journal, 9 (4) 387-403.
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References (Cont.)References (Cont.)
Nickerson, R.S. (2002). Enhancing Creativity. In R.J. Sternberg (Ed.), Handbook of Creativity (pp. 392-430). United States: Cambridge University Press.
Pearson, A. E. (2002). Tough-Minded Ways to Get Innovative. Harvard Business Review, 80 (8), 117-125.
Romano, R. (2005, May). The Sarbanes-Oxley Act and the Making of Quack Corporate Governance. Yale Law Journal, 114 (7), p1521-1612, 92p
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References (Cont.)References (Cont.)
Seaden, G. (2001). Public Policy and Construction Innovation. Building Research and Information. 29 (3) 182-197.
Schnee, J. (1979). Regulation and Innovation: U.S. Pharmaceutical Industry. California Management Review. 22 (1) 23-33.
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References (Cont.)References (Cont.)
Thain, J. (2004, May 27), Sarbanes-Oxley: Is the Price Too High? Wall Street Journal, p. A20
Thomas, L.G. (Winter 1990) Regulation and Firm Size: FDA Impacts on Innovation. RAND Journal of Economics, 21 (4) 497-518.
Verschoor, C. (2005) Sarbanes-Oxley Section 404 Implementation Needs Modification. Strategic Finance, 86 (9), 17-19