How Sarbox hurts shares

If anyone doubted the value-creating effect of regulatory compliance, new
research reveals that the rigours of Sarbanes-Oxley can have a real impact on
company share prices. Companies that are forced by Sarbox section 404 to
disclose shortcomings in their internal controls will underperform the rest of
the stock market.

A breakfast briefing on ‘The governance value chain’, hosted by Oracle in
association with Financial Director and sponsored by Deloitte, heard Bruce Weber
(pictured bottom right) of the London Business School explain how the share
prices of companies with IT system failings drop substantially on the day their
section 404 reports are published and continue to underperform the market until
the next report a year later.

Weber said, “If there are weaknesses in your financial systems, it will be
punished.”

He analysed 47 companies that disclosed in their 2005 regulatory filings that
their internal controls were ineffective because of inadequate computer systems
or staff skills, and found that they underperformed the market by 1.5%
immediately following the announcement and by 22% over the course of the year.

Those that reported in their next annual filing that they had fixed their
internal control problems would see their share prices regain some of the lost
ground, but those that still had to disclose problems saw their shares continue
to slump.

Among the other speakers at the briefing was Eric Anstee, former chief
executive of the ICAEW and a non-executive director of the Financial Reporting
Council. “Everyone knows there should be a sensible system of internal controls,
but is it really happening?” he said. “The problem is that there are issues
about how those internal control problems are being identified.”