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Mercatus Center at George Mason University
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Mercatus On Policy: Sarbanes-Oxley and Innovation By Public Companies
December 31, 2007
Economic innovation is a process that leads to new goods, services, methods of production, and forms of business organization. In response to several corporate governance failures such as accounting fraud by Enron and WorldCom, Congress enacted the Sarbanes-Oxley Act of 2002 (SOX) to reduce corporate managers' ability to abuse accounting rules or otherwise act opportunistically at the expense of investors. Innovation has specific characteristics, such as undertaking long-term risky activities that implicate the tradeoff between objectively monitoring corporate managers and facilitating innovation. Complying with SOX likely impacts this tradeoff to the detriment of innovation.
SOX increases monitoring over corporate executives by outsiders, requires more extensive internal control over financial reporting, and stiffens civil and criminal penalties for fraud and other violations of federal securities law. By focusing corporate governance towards a more objective monitoring of corporations by outsiders, SOX likely reduces the innovative potential of a significant portion of public companies. Because innovation has increased and continues to increase in importance, SOX will likely impose a hidden and growing cost in the form of foregone benefits from innovation.
