Sarbanes-Oxley helps cost of capital: study.

Despite current calls in Congress to ease the impact of the Sarbanes-Oxley Act, an MIT Sloan School of Management professor and coauthors find that the Act's reporting and disclosure standards have brought significant financial benefits for businesses, including smaller firms that some have been seeking to exempt from the law.

Far from just adding to corporate costs, says MIT Sloan Assistant Professor Ryan LaFond, "our findings tell a very different but consistent story about Sarbanes-Oxley. Firms with strong internal controls already in place and firms that remediate prior control weaknesses are rewarded with a significantly lower cost of capital," which falls by as much as 150 basis points for firms that can demonstrate such compliance.

LaFond compared unaudited financial disclosures by companies prior to Sarbanes-Oxley to audit opinions issued after the law was enacted. "Our results indicate that the market was adding higher costs of capital borrowing even before the formal internal control reporting required by [the law]," he says. "Companies with poor internal controls tend to have poorer quality financial information, which indicates problems to investors, which causes the market to assess a higher cost of capital."

But that market penalty is reversed--and capital costs are lower--after Sarbanes-Oxley compliance enables companies to prove to investors they have maintained or established solid financial systems. "A subset of the firms that we reviewed had poor internal controls," says LaFond. "The real test of our study is whether their cost of capital goes down once the Sarbanes-Oxley audit demonstrates to the market that the internal control problems are fixed. And those costs do consistently go down."

LaFond agrees that Sarbanes-Oxley does add costs for businesses, but predicts that burden will most likely ease over time. "Most audit firms will tell you that there was a large, one-time cost to get companies up to speed to meet SOX requirements, but going forward, things won't be so costly. There is already some evidence that audit fees are going down."