Burden of Sarbanes-Oxley provokes growing disenchantment

2006

If there is one group of people in the U.S. who certainly aren't complaining about the effects of Sarbanes-Oxley, it is the big accountancy firms. But as audit fees continue to increase, smaller companies are being disproportionately impacted.

While the overall cost of being public in 2005 dropped slightly from the historic levels seen in 2004, the fourth annual study conducted by Foley & Lardner LLP on the costs associated with corporate governance reform found that the predictions that firms would only face one-off increases in costs have not been born out.

Although U.S-listed companies saw large decreases in 2005 in the costs associated with lost productivity, legal fees and initial corporate governance reform set-up costs, these were largely offset by year-over-year increases in audit fees, D&O insurance and board compensation for companies of all sizes.

Overall, the study revealed that costs associated with corporate governance reform dropped 16 per cent for companies with under $1 billion in annual revenue and six per cent for companies with over $1 billion in annual revenue.

But since the enactment of the Sarbanes-Oxley Act, the study calculates that the average cost of compliance for companies with under $1 billion in annual revenue has increased more than $1.8 million to approximately $2.9 million, a 174 per cent overall increase. Unsurprisingly, the survey also revealed growing disenchantment with the regulatory regime.

One in five said they were considering going private as a result of corporate governance reforms

One in five survey respondents said they were considering going private as a result of corporate governance and public disclosure reforms while a third said that Sarbanes-Oxley Act compliance has resulted in budget and/or staffing cuts in critical areas of their business.

More than eight out of 10 (82 per cent) felt that corporate governance is now "too strict" – with not a single respondent saying the reforms are "not strict enough."

"Because many of the provisions of the Sarbanes-Oxley Act required initial one-time implementation expenses, we expected to see an overall decrease in the cost of being public this year," said Tom Hartman, study director.

"However, we did not expect to see the continued increase in audit fees over fiscal year 2004 - a year in which Section 404 drove costs to an already unprecedented level."

Contrary to many predictions made earlier this year, the stud, which analyzed data from more than 850 proxy statements of public companies for fiscal year 2005, also revealed that average audit fees have continued to increase for large and small public companies alike.

It revealed that audit fees increased 22 per cent for S&P small-cap companies, six per cent for S&P mid-cap companies and four per cent for S&P 500 companies.

"While there has certainly been considerable public discussion about a dramatic reduction in costs associated with audit fees this year, our study found the opposite to be true," explained Hartman.

"In addition, the S&P small-cap companies were the only group analyzed to experience double-digit increases in average audit fees for fiscal year 2005."

In other words, he said, corporate governance reform continues to present a more significant financial burden for smaller public companies than it does for larger ones.

Based on four years of results from Foley's study, increases in average audit fees year over year were generally the same for companies of all sizes until the Section 404 requirements phased-in during 2004.

Since that time, S&P small-cap and S&P mid-cap companies have experienced larger percentage increases in average audit fees compared to S&P 500 companies.

Between 2003 and 2005, average audit fees increased an average total of $786,000 for S&P small-cap companies and $1.14 million for S&P mid-cap companies. These increases represented a 141 per cent increase for S&P small- cap companies and a 104 per cent increase for S&P mid-cap companies. Comparatively, S&P 500 companies experienced a 62 per cent increase during this same period.

"There is no question that fees associated with Section 404 have driven up costs for companies of all sizes," said Hartman.

"However, based on our data, large public companies are more readily able to absorb these costs while smaller companies are hit with larger percentage increases. These increases have levelled somewhat, but there is no indication that average audit fees are decreasing, particularly for smaller public companies."