Monday, June 14, 2004

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The effect of Sarbanes-Oxley

The Hackett Group has an interesting finding on the effect of Sarbanes-Oxley -- you know, the corporate governance bill passed in the wake of the 2002 corporate scandals. The results are pretty interesting. [How interesting can that be?--ed. Definitely less interesting than speculation about possible future roles for Kristin Davis, but more interesing than your average post about corporate governance.]

Where was I? Oh, yes, here's a summary of the findings:

Largely as a by-product of their Sarbanes-Oxley compliance efforts, companies have dramatically improved the reliability of their financial forecasting over the past year, according to 2004 Book of Numbers research into world-class finance performance from The Hackett Group....

Findings from The Hackett Group's 2004 Finance Book of Numbers show that more than two thirds of all companies said they were now confident with their financial forecasting and reporting outputs. Only 9 percent of average companies made the same claim just a year ago.

But the improved forecasting capabilities have not come easily, and companies are also struggling with Sarbanes-Oxley compliance. In a reversal of long-term trends, companies were for the most part unable to reduce their overall finance costs, and monthly closing cycles have actually extended slightly over the past two years. Median companies now spend 1.08 percent of revenue on finance, according to Hackett. While that number has come down by 43 percent since Hackett began its research in 1992, median companies have seen little to no net cost reductions over the past few years. Companies are still finding ways to cut costs, but increased spending on compliance is largely offsetting these savings, according to Hackett. In addition, Hackett's research showed that a long-term trend towards shorter closing cycles saw a clear reversal in 2004, with both median and world-class companies now taking more than a week to close their books each month.

While perusing the Hackett web site, I came across another Hackett study on the outsourcing (both onshore and offshore) of finance operations:

A total of 74 percent of the companies surveyed by Hackett do not currently outsource any complete finance processes. In addition, 60 percent state that their outsourcing levels have not changed in the past three years. When asked to break down their current use of outsourcing of four major finance processes (accounts payable, accounts receivable, general accounting and payroll), only payroll showed any significant number of companies (26 percent) using outsourcing. Another five percent of the companies indicate that they outsource accounts payable, while no companies outsource accounts receivable or general accounting.

Looking forward, most companies report that they are unlikely to outsource any of the four processes in the next three years.

"There's no question that outsourcing is a very hot discussion topic right now in the finance world. But our research provides compelling evidence that perception far exceeds reality," said Hackett Senior Business Advisor Penny Weller. "Companies may be comfortable outsourcing sub-processes such as rekeying of vendor invoices or other data, check printing, or managing freight payments. Yet when companies have already expended significant time and energy to centralize complete processes such as accounts payable and accounts receivable within shared services, they are unlikely to consider outsourcing these processes today unless the economic benefits of doing so become overwhelmingly clear."

posted by Dan on 06.14.04 at 11:53 PM


It's pretty pathetic that companies have to be forced by the government to get enough handle on their own financial status to be "now confident with their financial forecasting and reporting outputs."

Why do they even have boards of directors, anyway?

posted by: mac on 06.14.04 at 11:53 PM [permalink]

"now confident with their financial forecasting and reporting outputs." What do you expect them to say? It's incredible that a situation essentially enabled by contributory accounting firms results in a mandate requiring more accountants. I love this country!

posted by: RD on 06.14.04 at 11:53 PM [permalink]

My tentative opinion is that Sarbanes-Oxley is doing far more good than bad. The firms which can’t handle the expense probably should not be public concerns. Perhaps they should seek private funding. Also, I suspect that costs will diminish over time once these companies master the process.

posted by: David Thomson on 06.14.04 at 11:53 PM [permalink]

Mac and RD,

I appreciate your high standards on behalf of American financial institutions, but you don't seem to have a clue about how they stack up compared with foreign competitors (yes, even Western European concerns have books as transparent as the East River). This was true before the scandals, and is even more true today. Global capitalism is like sausage-making; we ain't perfect but we're the gold standard even so.

An interesting perspective on Oxley-Sarbanes was offered recently by a group of analysts from Morningstar, the Mutual Fund ratings company with the "star system." They took out an ad in the Wall Street Journal saying that, while they appreciated the boost in business that they had received in the wake of the scandal (big firms like Merrill Lynch are now outsourcing research and analysis to them, rather than doing it in house) they considered themselves thoroughly UNPREPARED to take on the responsibilities. Yeah, that's right, they went public with their own self-doubts. Is this a great country or what?

The fact is, despite the shenanigans of guys like Henry Blodgett (is it just me, or does he sound like a Dickens character?) these big Wall Street firms did a pretty good job of reading the corporate landscape. Now that they're shutting down their research departments, there's danger as well as opportunity for new blindspots and scandals to emerge.

Nothing's perfect and I'm not saying this bill should not have been passed. I'm just saying the system was not completely rotten before and there will be unintended consequences coming out of the new one as well. So let's not whine about the corruption of the system, and let's not pat ourselves on the back too much for having "fixed" it. Muddling through is what humans do best.

posted by: Kelli on 06.14.04 at 11:53 PM [permalink]

I work as a business analyst/programmer for an oil company and the only result of S-O is increased expenses to my company ($10 million this year). Considering the tight ROI of this industry, these increased expenses will eventually find their way to the consumer. My opinion is that S-O is useless, wasteful and beside the point. A crook will still find a way to cook the books. Consider this: it is a lawyer mentality that we are confronting in S-O. The mentality that says that EVERYTHING can be anticipated with a rule, a regulation, a law, a standard or any other form of regulation. Heisenberg pointed out that if we observe something we change it; and if we change something we can't observe it. S-O believes we can report (observe) the minutae of finance without changing it. And without cost.

posted by: Jack on 06.14.04 at 11:53 PM [permalink]

Well, Jack, your comment tracks back to mac's question on this thread's first post. Why do companies have boards of directors anyway? A competent, engaged board would makes many of Sarbanes-Oxley's requirements superfluous, and some companies have such a board. There unfortunately is no way to apply a law like this only to companies that don't.

Dan's post seems to imply that Sarbanes-Oxley requirements are contributing to major firms' unwillingness to outsource the financial operations. I'm not sure this is true, first of all. If it were true it would support an idea I've found compelling, namely that organizations are most prone to outsource functions they do not value highly.

Outsourcing does take place for other reasons as well, of course. But in this case it is reasonable to expect that fear of running afoul of a new, fairly elaborate law would decrease some firms' willingness take the perceived risk of letting someone else handle their financial processes. It is also reasonable to expect this fear to dissipate over time.

Having said all that, the two Hackett reports Dan references may not be two pieces of the same puzzle. You don't need too much experience in the business world to understand why most businesses prefer to keep direct control over receivables and payroll, and the reasons don't have anything to do with Sarbanes-Oxley.

posted by: Zathras on 06.14.04 at 11:53 PM [permalink]


If you don't like S-O, what would your solution have been to the accounting scandals? Do you think the scandals were blown out of proportion?

posted by: MWS on 06.14.04 at 11:53 PM [permalink]


How would the added burden of financial accounting stemming from Sarbanes-Oxley lead to LESS rather than more outsourcing of ancillary services? Once a safe, efficient and timely provider is found for said services (I'm sure Indian accounting firms are revving up and Indian lawyers boning up on the S-O law even as we speak) the temptation to offset these new expenses with savings will be overwhelming.

Or am I missing something? Jack?

posted by: Kelli on 06.14.04 at 11:53 PM [permalink]

Kelli, I don't think you are missing anything. As time passes, law firms and other businesses able to provide services necessary to keep corporations in compliance with Sarbanes-Oxley will find a lot of customers. They just haven't yet, but this law hasn't been around that long.

Whether much outsourcing to India will be involved is another question. Compliance with American corporate law strikes me as one of those high-skill, high creativity functions businesses may find more prudent to keep in the hands of Americans.

posted by: Zathras on 06.14.04 at 11:53 PM [permalink]

Zathras: Actually, I was not inferring that S-O deters outsourcing -- the two studies are completely unrelated, except that they were both done by Hackett.

posted by: Dan Drezner on 06.14.04 at 11:53 PM [permalink]

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