Sarbanes-oxley as quack corporate governance: How wise is the received wisdom?

Georgetown Law Journal

Volumn 95, Issue 6, 2007, Pages 1843-1909

  Prentice, Roberta ^a   Spence, David B ^a  

^a UNIVERSITY OF TEXAS AT AUSTIN   (United States)

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[No Author keywords available]

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EID: 34548329956     PISSN: 00168092     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (83)

1. Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 YALE L.J. 1521, 1526-28 (2005).
2. Robert Charles Clark, Corporate Governance Changes in the Wake of the Sarbanes-Oxley Act: A Morality Tale for Policymakers Too, 22 GA. ST. U. L. REV. 251, 255, 291-307 (2005).
3. Larry E. Ribstein, Sarbanes-Oxley After Three Years, 3 N.Z. L. REV. 365, 376 (2005) (arguing that the empirical literature does not support SOX); Larry E. Ribstein, Sarbox: The Road to Nirvana, 2004 MICH. ST. L. REV. 279, 293 (arguing that SOX is an example of "Sudden Acute Regulatory Syndrome").
4. HENRY N. BUTLER & LARRY E. RIBSTEIN, THE SARBANES-OXLEY DEBACLE: WHAT WE'VE LEARNED; HOW TO FIX IT 3-5 (2006).
5. Stephen M. Bainbridge, Sarbanes-Oxley: Legislating in Haste, Repenting in Leisure 10-15 (UCLA Sch. of Law Law & Econ. Research Paper Series, Research Paper No. 06-14, 2006), available at http://ssrn.com/abstract= 899593.
6. See Gregory Carl Leon, Stigmata: The Stain of Sarbanes-Oxley on U.S. Capital Markets 7 (GWU Law Sch. Pub. Law, Research Paper No. 224, 2006), available at http://ssrn.com/abstract=921394 (noting that "[t]he voices of those that persist in the opinion that SOX is beneficial to the U.S. market are few and far between").
7. Otto von Bismarck supposedly stated that "[i]f you like laws and sausages, you should never watch either one being made." RESPECTFULLY QUOTED: A DICTIONARY OF QUOTATIONS FROM THE LIBRARY OF CONGRESS 190 (Suzy Platt ed., 1992).
8. Churchill, of course, famously stated that "democracy is the worst form of Government except all those other forms that have been tried from time to time." Winston Churchill, Address Before the House of Commons (Nov. 11, 1947), in 7 WINSTON S. CHURCHILL: HIS COMPLETE SPEECHES 1897-1963, at 7566 (Robert Rhodes James ed., 1974).
9. TXO Prod. Corp. v. Alliance Res. Corp., 419 S.E.2d 870, 884 n.9 (W. Va. 1992).
10. We have our own criticisms of many of SOX's other provisions, but they lay beyond the scope of this paper.
11. Romano, supra note 1, at 1549-68.
12. This suspicion may be motivated in part by cynicism or worry about the role of corporate campaign contributions in the legislative process. However, as the remainder of this section illustrates, there are far fewer and far more innocuous reasons for concluding that business sometimes gets its way even when the general public might prefer a different outcome.
13. Much of this literature emphasizes the ways in which agencies can take advantage of Congress. It includes: CHARLES E. LINDBLOM, POLITICS AND MARKETS 5 (1977) (analyzing resource advantages); THEODORE J. LOWI, THE END OF LIBERALISM 50-56 (1969) (discussing the rise of "interest-group liberalism"); WILLIAM A. NISKANEN, JR., BUREAUCRACY AND REPRESENTATIVE GOVERNMENT (1971) (emphasizing the ways bureaucrats use their information advantages to take advantage of politicians); Sam Peltzman, Toward a More General Theory of Regulation, 19 J.L. & ECON. 211 (1976) (portraying regulation as a private rent-seeking activity); and George J. Stigler, The Theory of Economic Regulation, 2 BELL J. ECON. & MGMT. SCI. 3, 3-4 (1971) (same). C. Wright Mills also argued that dominance of the policy process by "elites" effectively shuts out the interests of non-elites: From the individual's standpoint, much that happens seems the result of manipulation, of management, of blind drift; authority is often not explicit; those with power often feel no need to make it explicit and to justify it. That is one reason why ordinary men, when they are in trouble or when they sense that they are up against issues, cannot get clear targets for thought and for action; they cannot determine what it is that imperils the values they vaguely discern as theirs. C. WRIGHT MILLS, THE SOCIOLOGICAL IMAGINATION 169-70 (1959). There are at least two different varieties of capture theory. Under one version, capture takes place with the complicity of congressional committees, via iron triangles, subgovernments, and the like. See DOUGLASS CATER, POWER IN WASHINGTON 26-50 (1964); JOHN LEIPER FREEMAN, THE POLITICAL PROCESS: EXECUTIVE BUREAU-LEGISLATIVE COMMITTEE RELATIONS (1965); Stigler, supra, at 3. Another version of capture theory argues that after an initial burst of interest in regulation, the general public eventually loses interest in agency policymaking, leaving only regulated interest groups to participate in the process. Eventually, the agency is persuaded to adopt the policy preferences of the regulated industry, based in part upon the skewed information set with which the agency is presented. See generally MARVER H. BERNSTEIN, REGULATING BUSINESS BY INDEPENDENT COMMISSION (1955); GABRIEL KOLKO, RAILROADS AND REGULATION, 1877-1916, at 3-6 (1965); John A. Ferejohn, The Structure of Agency Decision Processes, in CONGRESS: STRUCTURE AND POLICY 441 (Matthew D. McCubbins & Terry Sullivan eds., 1987); see also David B. Spence, Managing Delegation Ex Ante: Using Law to Steer Administrative Agencies, 28 J. LEGAL STUD. 417 n.19 (1999) (summarizing this literature); THE BUDGET-MAXIMIZING BUREAUCRAT: APPRAISALS AND EVIDENCE (André Biais & Stéphane Dion eds., 1991) (analyzing and testing via a collection of essays the self-interested models of bureaucratic behavior, specifically Niskanen's arguments).
14. E.E. SCHATTSCHNEIDER, THE SEMISOVEREIGN PEOPLE: A REALIST'S VIEW OF DEMOCRACY IN AMERICA 35 (1960).
15. MANCUR OLSON, JR., THE LOGIC OF COLLECTIVE ACTION: PUBLIC GOODS AND THE THEORY OF GROUPS (Schocken Books 1968) (1965).
16. Id. at 33-34.
17. Id. at 141.
18. See id. at 141-6.
19. Two good post-Olsonian examinations of Olson's ideas are RUSSELL HARDIN, COLLECTIVE ACTION (1982) and TODD SANDLER, COLLECTIVE ACTION: THEORY AND APPLICATIONS (1992).
20. The most cynical versions of capture theory posit that regulation happens when business wants it to - that is, when regulation offers businesses rent-seeking opportunities. According to this view, public utility regulation was enacted not to protect consumers but to guarantee chartered monopolies a return on their investments. See, e.g., BERNSTEIN, supra note 13; KOLKO, supra note 13, at 231-36. For a refutation of this dubious argument, see David B. Spence and Frank Cross, A Public Choice Case for the Administrative State, 89 GEO. L.J. 97, 121-23 (2000).
21. Professor Romano uses the term "policy entrepreneurs" to describe the securities experts who devised and championed the provisions that ultimately comprised SOX, people like Arthur Levitt and Lynn Turner of the Clinton Administration SEC. Romano, supra note 1, at 1563. As she uses the term, a policy entrepreneur is a champion of an idea rather than a political organizer. This is a different concept from the kind of political entrepreneur who bears the organizational costs of an otherwise latent group.
22. For general summaries of this literature in the public choice context, see Christopher H. Schroeder, Rational Choice Versus Republican Moment - Explanations for Environmental Laws, 1969-73, 9 DUKE ENVTL. L. & POL'Y F. 29, 33-56 (1998); David B. Spence, Paradox Lost: Logic, Morality, and the Foundations of Environmental Law in the 21st Century, 20 COLUM. J. ENVTL. L. 145, 168-71 (1995).
23. Anthony Downs, Up and Down with Ecology - The "Issue-Attention Cycle," 28 PUB. INT. 38, 38 (1972) (noting that only during the times of intense public pressure for action is it possible to overcome the usual legislative inertia and produce major regulatory legislation).
24. See Schroeder, supra note 22, at 31. Politicians can tap into latent public interest groups in an effort to win support and, ultimately, to gain or retain office. In this way, politicians absorb many of the costs of collective action on an issue-by-issue basis. Without incurring any collective action costs beyond voting, a latent group can exert policy influence through its elected representative. Two well-known examples from environmental law include then-Representative Jim Florio's leadership in the passage of the 1980 Superfund law and Representative Henry Waxman's efforts on behalf of various clean air initiatives. For detailed discussions of political entrepreneurship, see HARDIN, supra note 19, at 35-37 and also MICHAEL TAYLOR, THE POSSIBILITY OF COOPERATION 223-36 (1987) (discussing rational choice theory).
25. This is the working assumption of most Congressional scholars in political science. See DAVID R. MAYHEW, CONGRESS: THE ELECTORAL CONNECTION (2d ed. 2004), which is often credited as the best argument for this working assumption. This is not to suggest that re-election is legislators' only goal-only that it is an overriding goal in that other goals (such as making voters aware of the policy issue in question) are secondary. Political scientist Mark Smith has documented the tendency of legislators to be responsive to public opinion on the salient issues even when business interests are united against popular opinion. MARK A. SMITH, AMERICAN BUSINESS AND POLITICAL POWER: PUBLIC OPINION, ELECTIONS, AND DEMOCRACY 114 (2000) ("Democracy does not cease to exist when business unifies. To the contrary, democracy begins to approach its potential during instances of business unity.").
26. We distinguish here between preference intensity and "salience, " and use the latter term to refer to how aware voters are of the policy issue in question. Of course, these two will be related in many cases. That is, voters may tend to care more about certain issues when they know more about them. Likewise, the direction of preferences themselves can change as issue salience changes, which is discussed infra at note 28 and accompanying text.
27. See David B. Spence, A Public Choice Pmgressivism, Continued, 87 CORNELL L. REV. 397, 423-26, 436 (2002). In this piece, Professor Spence explores the interaction of preference distribution, preference intensity, and issue salience in legislative decision making, examining the dialogue between political scientists and legal scholars on this issue and using spatial modeling to illustrate how "republican moments" move Congressional decisions closer to the preferences of the median voter.
28. The Love Canal discovery heightened public concern, while the election of Reagan led Jimmy Carter to call a lame-duck Congress that passed the law. Similarly, the 1969 Santa Barbara oil spill and Cuyahoga River fire heightened concern that led to the Clean Water Act of 1977, Pub. L. No. 95-217, 91 Stat. 1566 (codified as amended in scattered sections of 33 U.S.C.), and the Clean Air Amendments of 1970, Pub. L. No. 91-604, 84 Stat. 1676 (codified as amended in scattered sections of 42 U.S.C.).
29. See, e.g., Marcel Kahan & Edward Rock, Symbiotic Federalism and the Structure of Corporate Law, 58 VAND. L. REV. 1573, 1589 (2005) (noting that with regard to the 1933 and 1934 securities acts, as well as SOX, "we had major scandals that coincided with the bursting of a stock market bubble that left investors licking their wounds and looking for someone to blame. Congressional hearings were held and there was a feeling that 'something must be done.' Congress felt pressure to act, and act it did") (footnote omitted).
30. JONATHAN P. CHARKHAM, KEEPING BETTER COMPANY: CORPORATE GOVERNANCE TEN YEARS ON 5 (2005); see Stephen J. Choi, Behavioral Economics and the Regulation of Public Offerings, 10 LEWIS & CLARK L. REV. 85, 123 (2006) (noting that "[o]nly after a scandal arises does the SEC (Congress) typically move forward with new, comprehensive sets of regulations").
31. CHARKHAM, supra note 30, at 5 (pointing out that it took an unexpected collapse to stimulate appointment of the Cadbury Commission in 1992 that began the move toward modern governance in the United Kingdom).
32. See Stuart Banner, What Causes New Securities Regulation? 300 Years of Evidence, 75 WASH. U. L.Q. 849, 850 (1997) (observing that "most of the major instances of new securities regulation in the past three hundred years of English and American history have come right after [stock market] crashes"); CHARKHAM, supra note 30, at 149 (noting that "[progress in improving corporate governance in much of the Western world has not come by a considered programme of reform, but rather as a spasmodic reaction to scandal or incompetence").
33. CHARKHAM, supra note 30, at 5.
34. The phenomenon is not limited to these examples. For examples from the Progressive Era, see infra notes 48-49.
35. See Romano, supra note 1, at 1523; see also Richard D. Cudahy & Willliam D. Henderson, From Insull to Enron: Corporate (Re)Regulation After the Rise and Fall of Two Energy Icons, 26 ENERGY L.J. 35, 102 (2005) (noting that SOX "added more evidence in support of the well-established thesis that major movements in securities regulation only occur in the aftermath of a market bubble").
36. The Adelphia, Tyco, and Global Crossing scandals - some of which involved extreme cases of extravagance and greed-were also contemporaneous events in this saga.
37. Gary Strauss, How Did Business Get So Darn Dirty?, USA TODAY, June 12, 2002, at 1B, available at http://www.usatoday. corn/educate/college/business/casesrndies/2M30227-corporatetrust.pdf. The article quotes several management "experts" to the effect that greed and lax enforcement yielded the scandals of 2001-2002: "There is always greed and misconduct in the business world. But in today's society, more people tend to believe they can get away with it," says Seth Taube, a former SEC enforcement chief who heads the securities litigation and business crimes practice at law firm McCarter & English." Id.
38. See Judy Olian, Trusting Big Business, (July 2002), http://www.smeal.psu.edu/news/releases/jul02/trusting.html. A CBS-New York Times poll in July 2002 reached similar results. See CBS-New York Times, The Market, the Economy, and the Scandals, (July 18, 2002), http://www.cbsnews.com/ htdocs/c2k/poll0717_back.pdf.
39. On a single day in early July 2002, the stock market lost $1.4 trillion in value because of the burgeoning scandal. See David R. Francis, The Corporations Strike Back, CHRISTIAN SCI. MONITOR (Boston), June 6, 2005, at 17. Even many who are deeply suspicious of federal regulation recognize that in July 2002, "a strong regulatory response was needed, at least in the short run, to boost investor confidence." Troy A. Paredes, After the Sarbanes-Oxley Act: The Future of the Mandatory Disclosure System, 81 WASH. U. L.Q. 229, 232 (2003).
40. Romano, supra note 1, at 1549.
41. Id. (emphasis added).
42. She ascribes most of the credit (blame) for pushing SOX to former SEC Chair Arthur Levitt. Id. She sees the revival of Levitt's "agenda for accounting regulation" as "remarkable," yet acknowledges that his proposals were at least two years old and "ready-made" for exactly the kind of problems that the Enron and other corporate scandals seemed to present. Id. at 1549-50.
43. Romano ably recounts this history. See id. at 1534-35.
44. Id. at 1551. Romano notes: [A]t no point in the House debate did anyone mention audit committee independence or executive loans, the subjects of the SOX corporate governance mandates most intrusive on state law jurisdiction, nor did those mandates appear in the House Democrats' bills. In fact, few representatives participated in the debate at all; of those who did, virtually all were members of the Financial Services Committee that had produced the bill. Id. (footnote omitted). Presumably, Professor Romano is suggesting that it was disingenuous of Democrats to support these provisions, which ended up in the bill produced by the conference committee, when the conference bill later came before the House.
45. Romano, supra note 1, at 1554.
46. Professor Romano poses and answers the question of why Republicans would force a rushed legislative process: like others, they believed (wrongly, says Professor Romano) that they were responding to an emergency. Id. at 1557. Legislators tend to impose restrictions on debate in emergencies because it is the best way to ensure that some legislative action is taken, where no action is the worst alternative politically in such situations. Id.
47. Id. at 1559 (footnotes omitted) (emphasis added).
48. THE READER'S COMPANION TO AMERICAN HISTORY 889-90 (Eric Foner & John A. Garraty eds., 1991). Reader's describes the passage of the 1906 Pure Food and Drug Act this way: By 1900 most American states had enacted food laws, but they were poorly enforced. The effort to enact a federal law was led by Dr. Harvey W. Wiley, head of the Bureau of Chemistry in the Department of Agriculture. Wiley enlisted the support of the more responsible food producers and pharmaceutical manufacturers, the American Medical Association, the General Federation of Women's Clubs, and other consumer groups. He faced the entrenched opposition of the politically powerful "Beef Trust," small producers of patent medicines, and southern congressmen concerned with the constitutional validity of the proposed law. The tide was turned in Wiley's favor by a series of sensational articles by muckraking journalists. Following the "embalmed beef scandal of the Spanish-American War in 1898 (this concerned the quality of food supplied to U.S. troops), Charles Edward Russell produced a series of articles exposing the greed and corruption of the Beef Trust. Samuel Hopkins Adams demonstrated that patent medicines were often pernicious compounds of alcohol and other drugs. Then, in January 1906, Upton Sinclair published his best-selling novel The Jungle, replete with hair-raising descriptions of the manner in which meat products were prepared in the Chicago stockyards. Amid a storm of public indignation, a Pure Food and Drug Act was passed on June 30, 1906.
49. For a good description of the Progressive Era politics of the passage of the Clayton Act and the Federal Trade Commission Act, see Robert H. Lande, Wealth Transfers as the Original and Primary Concern of Antitrust: The Efficiency Interpretation Challenged, 50 HASTINGS L.J. 871, 911-35 (1999).
50. These included writers, such as biologist Rachel Carson, author of the influential 1960s book on ecology, Silent Spring; interest group leaders like David Brower, who championed the ideas of naturalist Aldo Leopold, who in turn had published his Sand County Almanac in 1949; and mathematician Garrett Hardin, whose seminal 1968 article The Tragedy of the Commons offered a straightforward, logical justification for regulation. For a summary of how these ideas found their way into American environmental law, see Spence, supra note 22, at 158-62.
51. Romano, supra note 1, at 1548-49.
52. See NICOLAS VÉRON ET AL., SMOKE & MIRRORS, INC.: ACCOUNTING FOR CAPITALISM 149 (George Holoch trans., Cornell Univ. Press 2006) (2004) (noting that "[t]he capital markets are not generally known for their fondness for government intervention," but observing that "[a] functioning public authority, however, is indispensable for the proper operation of the markets").
53. Id. at 1595, 1600-01. Professor Romano also suggests two fixes that are unrelated to the legislative process. First, she suggests that corporate governance be returned to the states who will govern via regulatory competition. See id. at 1597-99. Second, she suggests that corporate regulatory measures be voluntary rather than mandatory, so that corporations may opt out of them. Id. at 1595. These are important matters deserving article-length attention regarding their merits, and therefore will not be addressed here, although one of us has already written an article addressing state regulatory competition. See Robert A. Prentice, Regulatory Competition in Securities Law: A Dream (That Should Be) Deferred, 66 OHIO ST. L.J. 1155 (2005).
54. Romano, Ribstein and others are strong critics of the 1933 and 1934 securities acts. Although they were enacted in the aftermath of a scandal that activated the public, they were passed four and five years after the great stock market crash and pursuant to substantial legislative hearings. See generally J.S. ELLENBERGER & ELLEN P. MAHAR, LEGISLATIVE HISTORY OF THE SECURITIES ACT OF 1933 AND SECURITIES EXCHANGE ACT OF 1934 (1973) (compiling eleven volumes of legislative history).
55. Gail Russell, Pssst. K Street Delivers the Goods - For a Price, CHRISTIAN SCI. MONITOR (Boston), Aug. 8, 2006, at 2 (noting that those who want an earmark should hire a lobbyist "and start early").
56. As this Article moved toward publication, the SEC extended further the deadline for smaller firms to comply. In a December 2006 release, the Commission gave non-accelerated filers with less than $75 million in market cap until December 15, 2007 to file a section 404 Management Report and a year beyond that to file a 404 Auditor's Attestation. See Internal Control Over Financial Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers and Newly Public Companies, Securities Act Release No. 8760, Exchange Act Release No. 54,942, 17 C.F.R. 210, 228, 229, 240, 249 (Dec. 15, 2006).
57. See BUTLER & RIBSTEIN, supra note 4.
58. See Francis, supra note 39, at 17 (noting that organizations such as the U.S. Chamber of Commerce, the Business Roundtable, and the Financial Services Roundtable were leading the backlash against SOX).
59. John Tamny, Superfluous Sarbanes-Oxley, NAT'L REV. ONLINE, Feb. 20, 2006, http://www.nationalreview.com/ script/printpage.p?ref=/nrof_comment/tamny200602200909.asp.
60. E. O'Brien Murray, SOX is Costing America Its Capital Market Supremacy, CRAIN'S CHI. BUS., May 29, 2006, at 22.
61. Alex Epstein, Editorial, Presumed Guilty: The Injustice of Sarbanes-Oxley, BUS. PRESS/CAL., Sept. 12, 2005, at 31.
62. Ivy Xiying Zhang, Economic Consequences of the Sarbanes-Oxley Act of 2002, at 2 (Feb. 2005) (unpublished manuscript, available at http://w4.stern.nyu.edu/accounting/docs/speaker_papers/spring2005/ Zhang_Ivy _Economic_Consequences_of_S_O.pdf).
63. See Floyd Norris, Trusting Bosses Not to Cheat, N.Y. TIMES, June 23, 2006, at C1 (characterizing as disingenuous Zhang's argument that when the stock market went down it was SOX's fault and when it went up something else caused that and asking also how Zhang deals "with the fact that the market bottomed in the fall of 2002, about the time efforts to enforce Sarbanes-Oxley got under way, and has had a sustained rise since").
64. See, e.g., Vidhi Chhaochharia & Yaniv Grinstein, Corporate Governance and Firm Value: The Impact of the 2002 Governance Rules, J. FIN. (forthcoming Aug. 2007) (manuscript at 24-25, available at http://www.afajof.org/afa/forthcoming/2312.pdf) (finding evidence that SOX's corporate governance rules gave a positive and statistically significant boost to the value of large firms, although not to small firms ); Haidan Li et al., Market Reaction to Events Surrounding the Sarbanes-Oxley Act of 2002 and Earnings Management, J.L. & ECON. (forthcoming 2008) (manuscript at 20, available at http://ssrn.com/abstract=475163) (concluding that their "results are consistent with investors expecting the provisions and enforcement of SOX to have a net beneficial impact" on shareholder wealth); Pankaj K. Jain & Zabihollah Rezaee, The Sarbanes-Oxley Act of 2002 and Capital-Market Behavior: Early Evidence, CONTEMP. ACCT. RES. 629, 651-52 (2006) (concluding that Sarbanes-Oxley "created an environment that promotes strong marketplace integrity, and investors considered its enactment as good news" and that it "served as a stimulus to encourage initiatives for rebuilding investor confidence in corporate governance, financial reporting and audit functions"); see also Aigbe Akhigbe & Anna D. Martin, Valuation Impact of Sarbanes-Oxley: Evidence from Disclosure and Governance Within the Financial Services Industry, 30 J. BANKING & FIN. 989, 989, 1005 (2006) (looking only at firms in the financial services industry and finding that, except for securities firms, they significantly benefited from SOX's adoption). It is really only Litvak's study that lends much event study support to SOX opponents. She found that stock prices of foreign companies cross-listed on American exchanges declined, compared to the stock prices of matched firms, during key announcements indicating that SOX would fully apply to cross-listed foreign issuers. Kate Litvak, The Effect of the Sarbanes-Oxley Act on Non-US Companies Cross-Listed in the US, 13 J. CORP. FIN. (forthcoming 2007) (manuscript at 2, 28-29, available at http://ssrn.com/abstract=876624). Yet there are arguably limitations on Litvak's results. See, e.g., Ehud Kamar et al., Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis 15 (U.S.C. Center in Law, Economics and Organization, Research Paper No. C06-5,2006), available at http://ssrn.com/abstract= 901769 (noting complications with Litvak's study). More generally, we strongly counsel that all events studies covering multiple events over extended periods of time be considered very cautiously. See generally Werner Antweiler & Murray Z. Frank, Do U.S. Stock Markets Typically Overreact to Corporate News Stories? 20 (Aug. 2006) (unpublished manuscript, available at http://ssrn.com/abstract=878091) (finding that the U.S. stock markets are only partly efficient, and that the typical response to a news story is a strong and prompt reaction followed by a gradual and lengthy reversal that often exceeds the initial jump, and concluding that this has very serious implications for event studies which typically ignore the longer time frame); Jeffrey S. Harrison et al., Over-Interpretation of Event Study Findings in Management Research: An Empirical Illustration of the Problem 17-18 (July 31, 2006) (unpublished manuscript, available at http://ssr.com/abstract= 665742) (noting various limitations of events studies); James S. Linck et al., The Effects and Unintended Consequences of the Sarbanes-Oxley Act, and Its Era, on the Supply and Demand for Directors 5 (Feb. 14, 2007) (AFA 2006 Boston Meetings Paper, available at http://ssrn.com/abstract=902665) (same).
65. Romano, supra note 1, at 1529-43.
66. Just as Romano did not limit her review to only academic literature available when Congress acted in July of 2002, we shall not limit ourselves to the literature available when she wrote her article. We believe the empirical literature on at least a couple of the key issues has shifted dramatically in the last couple of years and now provides substantially more support for some of SOX's provisions. We realize that the tide could shift yet again. We have attempted to be thorough in our literature search, yet we realize we probably have missed some of the avalanche of relevant empirical pieces to appear in the last few years. However, we cite only papers available before SOX's fourth anniversary in order to keep this Article within reasonable page constraints. For an updated and more comprehensive examination of the empirical evidence regarding SOX Section 404, see Robert A. Prentice, Sarbanes-Oxley: The Empirical Evidence Regarding the Impact of Section 404, 29 CARDOZO L. REV. (forthcoming 2007) (manuscript at pp. 8-48, available at http://ssrn.com/abstract=991295).
67. See, e.g., ROBERTA ROMANO, THE ADVANTAGE OF COMPETITIVE FEDERALISM FOR SECURITIES REGULATION 20-21 (2002).
68. Romano, supra note 1, at 1523.
69. See, e.g., Brian J. Bushee & Christian Leuz, Economic Consequences of SEC Disclosure Regulation: Evidence from the OTC Bulletin Board, 39 J. ACCT. & ECON. 233, 260-61 (2005) (finding that the 1999 SEC requirement that OTC Bulletin Board companies comply with 1934 Act reporting requirements created positive increases in liquidity); Allen Ferrell, The Case for Mandatory Disclosure in Securities Regulation Around the World 54 (Harvard Law & Econ., Discussion Paper No. 492, 2004), available at http://ssrn.com/abstract=631221 (finding that the 1964 SEC requirement that OTC companies come within the 1934 Act periodic disclosure system improved pricing accuracy); Merritt B. Fox et. al., Law, Share Price Accuracy, and Economic Performance: The New Evidence, 102 MICH. L. REV. 331, 380 (2003) (finding that 1980s SEC requirements that every issuer's filing contain a management discussion and analysis section made share prices more accurate and improved capital allocation); Michael Greenstone et al., Mandated Disclosure, Stock Returns, and the 1964 Securities Acts Amendments, 121 Q. J. ECON. 399, 446 (2006) (finding evidence that the 1964 amendments for OTC companies created $3.2 to $6.2 billion in value for shareholders of the OTC firms required to improve their disclosures); see also Jeffrey N. Gordon, Independent Directors and Stock Market Prices: The New Corporate Governance Paradigm 70-90 (Columbia Law & Econ., Working Paper No. 301, 2006), available at http://ssrn.com/abstract=928100 (explaining how SEC rule changes and other factors dramatically improved stock price informativeness between 1950 and 2005); Robert A. Prentice, The Inevitability of a Strong SEC, 91 CORNELL L. REV. 775, 820-24 (2006) (citing additional studies).
70. See, e.g., Laura Nyantung Beny, Do Insider Trading Laws Matter? Some Preliminary Comparative Evidence, 7 AM. L. & ECON. REV. 144 (2005) (finding that "countries with more prohibitive insider trading laws have more diffuse equity ownership, more accurate stock prices, and more liquid stock markets"); Utpal Bhattacharya & Hazem Daouk, The World Price of Insider Trading, 57 J. FIN. 75, 78 (2002) (finding that when insider trading laws are enacted and enforced, the cost of equity is reduced); Louis Cheng et al., The Effects of Insider Trading on Liquidity, 14 PAC.-BASIN FIN. J. 467, 481 (2006) (finding that increased share trading by insiders impairs liquidity); Hazem Daouk et al., Capital Market Governance: How Do Security Laws Affect Market Performance?, 12 J. CORP. FIN. 560, 586 (2006) (finding that improvements in securities laws, including enforcement of insider trading laws are "associated with decreased cost of capital, higher trading volume, greater market depth... and reduced IPO underpricing").
71. Robert M. Bushman & Joseph D. Piotroski, Financial Reporting Incentives for Conservative Accounting: The Influence of Legal and Political Institutions, 42 J. ACCT. & ECON. 107, 140 (2006) (finding that strong public enforcement aspects of securities laws are linked with financial reporting).
72. See, e.g., Frank B. Cross & Robert A. Prentice, The Economic Value of Securities Regulation, 28 CARDOZO L. REV. 333, 386 (2006) (finding correlation between private enforcement of securities laws and reduced market volatility); Rafael La Porta et al., What Works in Securities Laws?, 61 J. FIN. 1, 27-28 (2006) (finding that laws requiring corporate disclosure and facilitating private enforcement, but not public enforcement, facilitate stock market development). Although this study and some others indicate that private rights to sue are more important than public enforcement of securities laws, Kenneth Dam recently noted that "where private litigation is not available as an enforcement tool, vigorous public enforcement is especially important." Kenneth W. Dam, Equity Markets, the Corporation and Economic Development 30 (Univ. of Chi. Law Sch., John M. Olin Law & Econ., Working Paper No. 280, 2006), available at http://ssrn.com/abstract=885196.
73. Cross & Prentice, supra note 72, at 387. See also FRANK B. CROSS & ROBERT A. PRENTICE, LAW AND CORPORATE FINANCE 152-89 (2007) (summarizing relevant empirical studies on value of securities regulation and present new findings).
74. Bernard S. Black, Information Asymmetry, the Internet, and Securities Offerings, 2 J. SMALL & EMERGING BUS. L. 91, 92-93 (1998); see also La Porta et al., supra note 72, at 27 ("Financial markets do not prosper when left to market forces alone.").
75. Prentice, supra note 69, at 832-37 (summarizing this convergence); cf. CHARKHAM, supra note 30, at 6 (noting increased global awareness of the need for good corporate governance).
76. Romano, supra note 1, at 1523.
77. See Jeffrey N. Gordon, Governance Failures of the Enron Board and the New Information Order of Sarbanes-Oxley 10 (Columbia Law Sch. Ctr. for Law & Econ. Studies, Working Paper No. 216 Harvard Law Sch. Ctr. for Law, Econ., and Bus., Discussion Paper No. 416, 2003), available at http://ssrn.com/abstract=391363 (noting that SOX's approach is "to reduce, if not eliminate, much of the board's discretion to permit the firm to operate with a financial structure that is opaque to securities markets"). Romano observes that the fifty states have not enacted the SOX corporate governance provisions and argues that "[t]he message of the empirical finance and accounting literature is that this absence is not fortuitous, because the literature suggests that the mandates will not provide much in the way of benefit to investors." Romano, supra note 1, at 1528. Although Romano implies state legislatures read the empirical financial and accounting journals and Congress does not, it is helpful to recall that no state has ever mandated financial disclosure or banned insider trading, see Mark J. Roe, Delaware's Competition, 117 HARV. L. REV. 583, 611-26 (2004), despite the very persuasive body of empirical evidence indicating the benefits that flow from such mandates. In the area of general corporate governance practices, it is Congress and not the states that has acted consistently with the empirical accounting and finance literature that Romano touts.
78. See, e.g., Ross Levine, Finance and Growth: Theory and Evidence, in 1A HANDBOOK OF ECONOMIC GROWTH 865, 921 (Philippe Aghion & Steven N. Durlauf eds., 2005) (summarizing a very strong body of empirical evidence demonstrating a strong positive link between the development of a country's capital markets and its overall economic growth).
79. See Cross & Prentice, supra note 72, at 337; Cally Jordan, The Chameleon Effect: Beyond the Bonding Hypothesis for Cross-Listed Securities, N.Y.U. J.L. & BUS. (forthcoming) (manuscript at 32 n.104, 34, available at http://ssrn.com/abstract=907130) (arguing that it remains an open question as to whether securities law has been able to fully compensate for the demise of shareholder rights caused by a race-to-the-bottom in corporation law led by Delaware).
80. Robert B. Ahdieh, From "Federalisation" to "Mixed Governance" in Corporate Law: A Defense of Sarbanes-Oxley, 53 BUFF. L. REV. 721, 740 (2005) (noting that "it is not federal law to which critics of [SOX's] 'federalization' object; it is law - or at least law in a command-and-control, regulatory sense"); Renee M. Jones, Does Federalism Matter?: Its Perplexing Role in the Corporate Governance Debate, 41 WAKE FOREST L. REV. 879, 883 (2006) (making these points and citing Romano specifically).
81. Bratton and McCahery have accurately noted that in America "[w]hen a problem with national market implications arises, all parties expect the national system to address it." William W. Bratton & Joseph A. McCahery, The Equilibrium Content of Corporate Federalism 12 (European Corp. Governance Inst. Law Working Paper Series, Working Paper No. 23, 2004), available at http://ssrn.com/abstract=606481. The Enron era scandals, intertwined with the dot-coM bust, created a national calamity in the form of a plummeting stock market, deep investor suspicion, and a hobbling economy. Congress was expected to provide an immediate remedy. Had it stood on the sidelines and left things for the states to clean up, public outrage would have justifiably matched the criticism that the federal government received for FEMA's late and lame response to Hurricane Katrina.
82. Despite its problems, it is worth remembering that the U.S. system is quite arguably the best in the world. See Bengt Holmstrom & Steven N.
83. There are many limitations, naturally. For example, common law nations and civil law nations go about things differently; features that work especially well in countries of one legal tradition do not work as well in countries of another. Cultural differences, path dependency, and entrenched interests fighting to preserve their power to exploit minority shareholders are other factors that will prevent complete cross-national legal convergence from occurring any time soon. Also, in some nations enterprises are funded primarily by banks rather than equity investors, so needs are different. In others, it is more common to have ownership concentrated in fewer hands so that the role of major shareholders is more important than in the United States, for example. In all nations, legal provisions must be applied effectively, so if a country adopts requirements but cannot enforce them because of the primitive state of its judicial system, a lack of trained lawyers or other problems, then a law on the books will mean little.