Ten Years of Quack Corporate Governance

Ten years ago today, President Bush signed another one of his great bipartisan accomplishments, the Sarbanes-Oxley Act.  You may recall the failures of Enron and WorldCom, driven by accounting fraud and a stock market bubble.  A lot has been written on Sarbanes-Oxley or SOX as it’s known to its friends, such as Cato’s Corporate Aftershock.  I continue to believe that the most insightful analysis was that of Yale Law Professor Roberta Romano, who in the Yale Law Journal, described SOX as “Quack Corporate Governance”.

Professor Romano observed that despite Enron being the claimed rationale, the provisions of SOX bear “absolutely no relation to the source of that firm’s demise.”  In her more generous moments, Professor Romano notes that “with the scholarly literature at odds with the proposed governance mandates being treated as though it did not exist, the quality of decisionmaking that went into the SOX legislative process was, to put it mildly, less than optimal.”

As her long analysis repeatedly shows, there is a large academic literature, both empirical and theoretical, whose generally robust conclusions outright contradict the policies pushed by SOX. For instance, despite the obvious failings of the credit rating agencies, remember it was the short-sellers who first called attention to problems at Enron and WorldCom, not the regulators or the rating agencies, SOX absolutely fails in correcting these flaws, even after spilling considerable ink on the topic.  Had the rating agencies been reformed, the most recent financial crisis would likely have been smaller.

Perhaps more troubling should be the fact that some of the same Congressional staff authors of SOX, individuals whom I like personally and believe are well-intended, are the same people who drafted the Dodd-Frank Act.  It is unlikely a coincidence that much of Title IX of Dodd-Frank reads like it was directly lifted from SOX, but replacing “auditor” with “rating agency”.  Given the failure of SOX to even moderate the recent crisis, we should be doubly skeptical as to Dodd-Frank’s ability to forestall future crises.