RAND Study Shows Sarbanes-Oxley Act Had Short-Lived Effect on Small Businesses

For Release

May 8, 2006

Small publicly traded companies were disproportionately affected by the Sarbanes-Oxley Act – a federal law that tightened financial reporting requirements for publicly owned companies – in the first year after the law was enacted in 2002, according to a RAND Corporation report issued today.

The report found that the propensity for small public companies to be purchased by private firms, which are not subject to Sarbanes-Oxley, increased by 53 percent during the first year. The estimate was calculated relative to similar foreign companies, which are also not subject to Sarbanes-Oxley.

This effect was found only in firms smaller than approximately $20 million in market capitalization and was not found in firms of any size after five quarters.

The study was conducted within the Kauffman-RAND Center for the Study of Small Business and Regulation, which is funded by the Ewing-Marion Kauffman Foundation.

Congress passed the Sarbanes-Oxley Act in 2002 in the wake of the accounting scandals at companies such as Enron and WorldCom. The law makes significant changes in the governance, accounting, auditing and reporting requirements for firms traded in U.S. securities markets.

One key concern raised by Sarbanes-Oxley is whether the cost of complying with regulations has driven businesses in general – and small firms in particular – to leave the public capital market and “go private.”

The study is one of the first to identify the effects of the new regulations by comparing the experiences of U.S.-based companies to businesses in other nations not covered by the accounting reforms.

“This trend could be interpreted in different ways,” said study co-author Eric Talley, a RAND economist and professor at the USC School of Law. “Either it is a sign that Sarbanes-Oxley created a burden on entrepreneurship, inefficiently forcing companies out of public capital markets, or alternatively it provided some protection to investors by inducing smaller firms that should never have been public to begin with to abandon that status.” Under either interpretation, the authors conclude, the new scrutiny introduced by Sarbanes-Oxley likely induced poorly adapted firms to go private immediately after passage.

Researchers say their findings bear on the ongoing debate about Sarbanes-Oxley and the regulatory regime it created.

Other authors of the study are Pinar Karaca-Mandic of RAND and Ehud Kamar of the USC School of Law.

The Kauffman-RAND Center for the Study of Regulation and Small Business is dedicated to assessing and improving legal and regulatory policymaking as it relates to small businesses and entrepreneurship.

The study is titled “Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis” and is available at http://www.rand.org/pubs/working_papers/WR300-2/.

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