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Inadequate Management of Sarbanes-Oxley: Hazardous to Financial Health Published: Sunday, January 23, 2005 By: Eng. Ulises Pabón

As a general rule, I’m always suspicious of “solutions” proposed by bureaucrats, whether from the public or private sector. Bureaucrats attempt to solve everything through rules and regulation, and seldom, if ever, understand the systemic implications of their measures. The latest case in point is the Accounting Reform and Investor Protection Act of 2002 often referred to as the Sarbanes-Oxley Act of 2002, for the legislators that sponsored it.

The Sarbanes-Oxley Act seeks to improve the accuracy of financial statements and to insure full disclosure of information in these statements. At first sight, the regulatory requirements of Sarbanes-Oxley seem proper, particularly in the after-shock of the Enron and WorldCom scandals. However, corporations, large and small, are beginning to realize that the millions being spent to comply with Sarbanes-Oxley are, to a large extent, dollars wasted in non-value-added activity. For example, a single feature of Sarbanes-Oxley, Section 404, has prompted corporations to hire an army of internal auditors to check what another army of internal inspectors have already checked and to fill, of course, the required paperwork.

Of course, there are some professionals and specialized firms that are not complaining. In what looks very much like the bonanza information-systems companies rode during the Y2K craze, independent accountants and lawyers are approaching corporations with six-figure invoices to help them manage the minutiae and particulars of compliance. A survey by Financial Executives International found that companies with average revenues of $2.5 billion are adding, in average, $3.1 million to their cost structure as a result of Sarbanes-Oxley.

For those of you about to argue that this is a small price to pay as long as we have the investment community in mind, consider a recent study of 1,200 firms with market capitalization over $1 billion. During the five-year period from 1999 through 2003 (recall that the Enron and WorldCom scandals occurred during 2001), more shareholder value was wiped out as a result of mismanagement and bad strategy execution than was lost by all of the most recent scandals combined! A review of the 360 worst performing companies shows that only 13% of the value reduction was caused by regulatory compliance failure or was a result of poor oversight of the company by corporate boards – the kind of stuff Sarbanes-Oxley attempts to address. On the other hand, 87% of the value lost by these firms was due to strategic missteps such as management ineffectiveness in reacting to competitive pressures, poor forecasting of customer demands, or operational blunders such as cost overruns and poor execution of mergers and acquisitions.

It’s time that bureaucrats learn what quality theory taught us 100 years ago: you can not achieve quality through inspection! Corporate executives that believe they can sleep at ease because they are complying with the Sarbanes-Oxley regulation are hanging their hopes in what amounts to a vulgar inspection system that does nothing to protect, let alone develop, the real source of competitive advantage and corporate value.

Whenever growth and innovation are superseded by bureaucratic compliance as the principal topic of discussion within the organizational context, the negative performance results are predictable.

Comply with Sarbanes-Oxley you must. But don’t let compliance to Sarbanes-Oxley sequester you from customer insight and strategic foresight. Compare how much time and energy you are investing in competitiveness and strategic development vis-ŕ-vis compliance. If the ratio is not, at least, 10 to 1 – in favor, of course, of strategic thinking – you are paving the road to your demise.

 


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