May 23, 2006
The Shape of Sox
Posted by Fred Tung

Political scientist John Cioffi has a new and interesting paper on the political economy of Sox.  He argues that Sox took the form of structural regulation--regulation of internal governance structures like board composition and committee composition--in part because expanded private litigation was off the table after private securities litigation reform in the 90s.  Here's the abstract:

Congress passed the Sarbanes-Oxley Act of 2002 in reaction to the enormous political pressures generated by the wave of corporate financial scandals during 2001-2002. The Act's innovative reforms of corporate governance law were shaped by powerful political constraints on the use of private litigation and tensions over the use of "structural regulation" to alter the internal governance structures and procedures of publicly traded corporations. The conservative political realignment during 1990s precluded the development or expansion of litigious enforcement mechanisms (i.e., private causes of action) to curb corporate and managerial financial misconduct. Consequently, a number of the Sarbanes-Oxley Act's core provisions took the form of structural regulation intended to function as non-litigious, self-executing mechanisms of regulation. Political constraints on the use of private litigation as an enforcement mechanism entailed a more direct intervention of state power within the corporation and blurred the established boundaries between the public and private spheres. However, the legislative reforms did not alter the core processes of corporate managerial power - the nomination and election of directors to the board. When the SEC attempted to do so, it threatened encroachment on the private sphere and the institutional bases of managerial power and autonomy and produced a backlash by business elites against further reforms and against the underlying logic of Sarbanes-Oxley itself.

Interesting read.

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Comments (3)

1. Posted by William Henderson on May 23, 2006 @ 11:40 | Permalink

Fred, this is both interesting and ironic. Reviewing the political mood of the country in the 1960s, there is some evidence that the rise of the private right of action in the securities context was favored by conservatives as a way to dampen the rise of the administrative state. With amendments to the federal securities laws in 1964 and 1968, the scope of SEC authority was growing. Shifting enforcement to the private sector was seen as a welcomed compromise.

In contrast, throughout the 1990s, the SEC was not a source of worry by most publicly held companies--the agency was understaffed and suffering horrible attrition right when the stock and IPO markets were frothing. Further, Congress--Democrats and Republicans alike--blocked Chairman Levitt's reform agenda. So, from a public choice perspective, Coiffi's thesis makes sense. If the economy had undergone a major recession (such as during the 1930s), a different regime might have emerged.

With all the SOX bashing going on, it will be interesting to see what is left of the law in five to ten years.

2. Posted by Robert Schwartz on May 23, 2006 @ 13:06 | Permalink

"the underlying logic of Sarbanes-Oxley itself."

I don't think SOX had any internal logic to begin with. Indeed the only logic I could see was the Dem's saying: "Let's use Enron to bash Bush," And the R's saying: "If we have to throw private enterprise under the bus, so be it. Our tenure is more important than our principals."

3. Posted by Jake on May 23, 2006 @ 20:39 | Permalink

Even if lacking in internal logic, SOX was propelled by the inevitable tendency of large companies to neglect fundamental internal controls. The companies may complain bitterly about section 404, but none of them, to my knowledge, have published their pre-SOX budgets for internal audit functions to support the popular argument that enough was already being spent on such matters, therefore 404 is unnecessary. Internal controls aren't the sexy side of big business. It's a pity that the business sector's neglect of sound business principles led to the SOX brick in the forehead, but the complainers deserve little sympathy. Anyone who dislikes SOX can always go private.

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