When I team-teach a
portion of our Business Ethics class in the Rollins MBA program, one of the
presentations by a team in the class is on the pros and cons of SOX. The side that discusses the cons always
questions the cost/benefit of compliance with SOX. After the presentation, I ask the class to
determine the percentage of stock traded, as a percentage of the shares
outstanding, in a publicly traded company on the New York Stock Exchange in a
given week. I'll suggest a large
company and tell them to go to Yahoo or some other site for this
information. They usually find that the
number of shares traded in a given week for that company is 2-3% of the
outstanding shares in the company.
Then, I ask the
class to tell me the market cap for that company based on the quoted price per
share at that time and most of the class gets the answer right - the share
price times the number of shares outstanding.
Then, I ask them to
predict the effect on the price per share if the New York Times or the Wall
Street Journal has a headline that the SEC is accusing one of more executives
of that company of wrongdoing. The
students are usually at a loss at predicting the price decline that will occur,
but some find a few companies where that has happened recently and excitedly
announce that the price per share went down 10-30% in one day resulting in a
decline in the market cap by several billion dollars. So, the alleged wrongful (unethical by
definition) conduct may have reduced the wealth of the shareholders in that
company by several billion dollars. How
could this be?
Because stock prices
are set by transactions at the margin (only 2-3% of the outstanding shares per
week) in normal trading. But, when a
public relations disaster hits, it would not be unusual for more than 5% of the
outstanding shares to be traded in one day driven by institutional
sellers. So, what is the lesson in my
Business Ethics class?
Unethical conduct by
one or more executives in a publicly held company can result in a reduction in
shareholder wealth by hundreds of millions (or billions) of dollars when the
wrongdoing may only have benefited the executives by a few million dollars or
less. So, the value of the increased
oversight by the board of directors and the audit committee caused by
compliance with SOX should by measured by avoiding the reduction in shareholder
value if wrongdoing is prevented. But,
how can shareholders know if wrongdoing is prevented? They can't; but, in my experience, the
invisible hand on the executives of the company due to SOX is a form of insurance
against wrongdoing and the premium paid is the cost of complying with SOX. Based on the public relations disasters many
companies have faced when wrongdoing is discovered, the premium for reducing
the likelihood of wrongdoing by complying with SOX is well worth it.
