The effects of the
Sarbanes/Oxley Act,
Specifically Section 404, on
Innovation in America’s
Publicly Held Corporations
By Wendy Vidlak
Background
Accounting + Creativity =
Accounting Scandals Made
Headlines In the Early 2000’s
And Forced the Government
to Act
Enron
WorldCom
General Re
Arthur Anderson
Xerox
Freddie Mac
Sunbeam
Tyco
Key Points of Sarbanes/Oxley
(SOX) Legislation
• Does not add many extra protections for investors
• CEOs of fraudulent companies’ such as Enron are being
tried using the old rules and laws Lambert (2003), Adams
(2004), Fisch (2004), Romano (2005)
• Now a criminal offense for a CEO to sign a
fraudulent Annual Report
(http://www.aicpa.org/info/sarbanes_Oxley_summary.htm)
• Section 404 requires a company to account for all
financial risks and put processes in place to reduce
those risks Cobb (2004)
What is Needed for Innovation
at Companies?
•
Embrace Risks Nickerson (1999), Farson and Keyes (2002),
Blumentritt (2004), Green (2005), Thain (2004), Carroll (2004)
•
•
Capital
Organizational Flexibility Galunic and Rodan (1998),
Seaden (2001)
Purpose of the Project

To ascertain the effects of the
Sarbane/Oxley Act, specifically section 404,
on innovation in America’s publicly held
corporations
Thesis Statements
The costs of Implementing
Section 404 are Quite High
and Many Corporations are
Funding the Increased
Accounting Costs by
Reducing Research and
Development
Section 404’s Emphasis on
Measuring Corporate Risk is
Creating a Culture of Risk
Aversion Among Top
Executives and Stifling
Innovation in Areas of New
Product Development
That Section 404 is Creating
Some Innovations in the Areas
of Financial Reporting and
Procedures as Companies
Attempt to Reduce Costs of
Compliance and Open Their
Financial Processes to
Public Scrutiny
Data Gathering Techniques

Compiled a random sampling of 50
companies from S&P 500 and 50 from the
Russell 2000 Index
 Looked at the number of new patents and
trademarks each company had before and
after SOX
 Compared R&D costs with the
Administration costs of the companies
Data Gathering Techniques

Send a short e-mail survey to the 100 companies
in the sample to help determine if there is a
connection between the new law and innovation
 Conduct several in-depth phone or e-mail
(participant preference) interviews with several
companies to try to indicate there is causation to
the correlation of the quantitative findings
Results So Far. . .
Trademark Search

S&P 500 Companies trademarks increased
from 15.42 per company in 2002 to an
average of 18.6 in 2004
 The average from 1992-2002 was 12.4
 Russell 2000 companies trademarks
increased from 1.52 per company in 2002 to
an average of 1.63 in 2004
 The average from 1992-2002 being 1.16
Possible Implications of
Trademark Search

Increased risk and processes increases
trademark applications
 Many companies had no trademark
applications, especially smaller companies
Patent Search Results

Patents approved in 2002 for the S&P 500
sample averaged 25.74 per company in
2002 and 4.5 in 2004
 The average from 1992-2002 was 21.6
 Patents approved in 2002 for the Russell
2000 sample averaged 1.14 per company
and in 2004 the average was .2 per company
 The average from 1992-2002 is .74
Patent Search
Implications/Problems

Numbers taken at face value indicate thesis
is true
 Companies can keep patent applications
secret until approved, which would
artificially decrease 2004 numbers
 Some industries do not file for patents
Financial Analysis

S&P 500 companies increased R&D
spending an average of 17.28% between
2002 and 2004
 Administrative expenses increased 23.4%
 Russell 2000 companies decreased R&D
spending by 1.3% between 2002 and 2004
 Administrative expenses increased 15.91%
Financial Analysis Results

Significant difference between sample company
spending at S&P 500 versus Russell 2000
 Russell 2000 supports the thesis well. S&P 500
numbers still support it but less convincingly
 Many of the preliminary trade reports are showing
similar issues where the law is hitting smaller
companies harder
Literature Review


New products are often used as formal
measurements of innovation Thomas (1990),
Schnee (1979)
Preliminary results in trade papers show the costs
of 404 compliance run an average of $1.9 million
for companies with less than $25 million of
revenue, approximately 7.6% of revenue
 Compliance costs run $4.7 million for companies
with more than $5 billion revenue, approximately
.09% of revenue
(http://www.fei.org/files/spacer.cfm?file_id=788)
Literature Review

Innovative firms take on more risk Farson and
Keyes (2002), Guifford and Howe (2004),
Blumentritt (2004), Green (2005)
 Companies living with fear tend to respond with
tests and measures and become more risk averse
Meckler (2004), Pearson (2002)
 SOX requires many tests and measures Verschoor
(2005), Audit committee Brief, Deloitte
Development
 Organizations are less likely to take new risks for
fear of running afoul of SOX Green (2005), Thain
(2004), Carroll (2004)
Other Major Regulatory
Changes’ Effects on
Innovation

1979 FDA regulations caused new drug
introductions to decline 50% Schnee (1979), Thomas
(1990)
– Large companies increased innovation
– Small companies ceased to innovate

Nuclear Regulations after 3 Mile Island (TMI)
Marcus (1988)
– Companies that were rule bound before TMI became
more rule bound
– Companies that were autonomous before TMI used the
regulations to innovate
Where Do I Go From Here?

Send out surveys

Finish interviews and documentation

Hopefully the surveys and interviews will
help strengthen the link between the
numbers to the effects of SOX
Things I Learned

Regulations have tremendous impacts on
business
 Measuring the direct effects of regulations
is quite difficult
 In a time of global economy, innovation is
the key for the U.S. staying competitive, yet
we are potentially regulating ourselves out
of business
References

Summary of the Sarbanes Oxley Act. AICPA
Website. Retrieved November 10, 2005, from
http://www.aicpa.org/info/sarbanes_oxley_summary.htm

Audit Committee Brief [Brochure]. (August
2004). Deloitte Development LLC.
 Adams, R. B. (2004) Cost, Quality, and Sarbanes
Oxley. AACE Internal Transaction, PM81, 3
pages.
References (Cont.)

Blumentritt, T. (2004). Does Small and Mature
Have to Mean Dull? Defying the Ho-hum at
SMEs. The Journal of Business Strategy, 25 (1)
27-34.
 Carroll, J. (2004, December). Could SOX Kill
Innovation? CA Magazine. 137 (10) 14.
 Cobb, C.G. (2004). Sarbanes-Oxley: Pain or
Gain?. Quality Progress, 37 (11) 48-53.
 Farson, R. And Keyes, R. (2002). The FailureTolerant Leader. Harvard Business Review, 80
(8), 64-72.
References (Cont.)

Fisch, J. E. (2004, Fall). The New Federal
Regulation of Corporate Governance. Harvard
Journal of Law and Public Policy, 28(1), 39-49.
 Galunic, D.C. and Rodan, S. (1998). Resource
Recombinations in the Firm: Knowledge
Structures and the Potential for Schumpeterian
Innovation. Strategic Management Journal, 19,
1193-1201
 Green, S. (2005, March). The Limitations of the
Sarbanes-Oxley Act. USA Today, 133 (2718) 6668.
References (Cont.)

Guifford, R.H. & Howe, H. (2004). Regulation
and Unintended Consequences: Thought on
Sarbanes-Oxley. The CPA Journal, 74 (6), 6-10.
 Lambert, P. W. (2003) Worlds Are Colliding: A
Critique of the Need for the Additional Criminal
Securities Fraud Section in Sarbanes-Oxley. Case
Western Reserve Law Review, 53 (3), p839, 17p
 Marcus, A. (1988). Responses to Externally
Induced Innovation: Their Effects on
Organizational Performance. Strategic
Management Journal, 9 (4) 387-403.
References (Cont.)

Nickerson, R.S. (2002). Enhancing Creativity. In
R.J. Sternberg (Ed.), Handbook of Creativity (pp.
392-430). United States: Cambridge University
Press.
 Pearson, A. E. (2002). Tough-Minded Ways to
Get Innovative. Harvard Business Review, 80 (8),
117-125.
 Romano, R. (2005, May). The Sarbanes-Oxley Act
and the Making of Quack Corporate Governance.
Yale Law Journal, 114 (7), p1521-1612, 92p
References (Cont.)

Seaden, G. (2001). Public Policy and
Construction Innovation. Building
Research and Information. 29 (3) 182-197.
 Schnee, J. (1979). Regulation and
Innovation: U.S. Pharmaceutical Industry.
California Management Review. 22 (1) 2333.
References (Cont.)

Thain, J. (2004, May 27), Sarbanes-Oxley: Is the
Price Too High? Wall Street Journal, p. A20
 Thomas, L.G. (Winter 1990) Regulation and Firm
Size: FDA Impacts on Innovation. RAND Journal
of Economics, 21 (4) 497-518.
 Verschoor, C. (2005) Sarbanes-Oxley Section
404 Implementation Needs Modification.
Strategic Finance, 86 (9), 17-19