Expect Adverse Effects From New Rules
by Alan Reynolds
August 15, 2002
Alan Reynolds is a senior fellow with the Cato Institute.
Requiring corporate officers to certify the accuracy of their companies' accounting is simply irrelevant when it comes to preventing or punishing fraud.
Criminal charges will still require proof the officer "knowingly" submitted false reports, which is no different from current law.
That does not mean the certification ritual will have no effects, only that the real effects will be largely unexpected.
The most serious effect will be to discourage risk. Certification amounts to promising the impossible: indisputable accounting. That invites disputes and regulatory harassment, which invites lawsuits.
As a result, executives will naturally become ultra-cautious, even timid. Bold new ventures will be shunned, just to play it safe.
By penalizing risk, certification threatens chronic economic paralysis. This whole game is mainly a political gift to trial lawyers who chase sick companies the way ambulance chasers go after sick people. CEOs and CFOs have just become an inviting new target for class-action suits.
This added risk of litigation scared the stock market for weeks because it must shrink future profits by inflating the cost of insurance and compensation. Companies will have to pay much more for insurance to cover the risk that their executives might be sued. And a fat new risk premium must likewise be added to executive pay. Troubled companies, being most vulnerable to lawsuits, will have to pay premium salaries for the talent required to turn things around.
Certification applies only to companies that sell shares to the public. We can expect more of the promising new companies to stay private, which means potential shareholders will miss out.
Despite the market's relief that this ordeal is over, stocks remain much cheaper today than on June 26, when this certification scheme was first announced. Investors lost confidence in bureaucratic regulations that increase the cost of corporate insurance and compensation, discourage risk and discourage private companies from going public. The only investors who benefited from that kind of help are those who bet that stocks would fall before Aug. 14.
This article orignally appeared in USA Today on August 15, 2002.