President Bush at the signing of the Sarbanes-Oxley Act in July 2002. The President said at the signing: "Corporate misdeeds will be found and will be punished. This law authorizes new funding for investigators and technology at the Securities and Exchange Commission to uncover wrongdoing. The SEC will now have the administrative authority to bar dishonest directors and officers from ever again serving in positions of corporate responsibility. The penalties for obstructing justice and shredding documents are greatly increased. Corporate crime will no longer pay. CEOs who profit by betraying the public trust will be forced to return those gains to investors. And the maximum prison term for common types of fraud has quadrupled from five to 20 years."

The overall cost of being public in the US in 2005 dropped slightly from the historic levels seen in 2004, according to the fourth annual study conducted by law firm Foley & Lardner LLP on the costs associated with corporate governance reform.

The study revealed that costs associated with corporate governance reform dropped 16 percent for companies with under $1 billion in annual revenue and six percent for companies with over $1 billion in annual revenue.

These reductions between 2004 and 2005 were driven by large decreases in costs associated with lost productivity, legal fees and initial corporate governance reform set-up costs. However, these decreases were largely offset by year-over-year increases in audit fees, D&O insurance and board compensation for companies of all sizes.

“Because many of the provisions of the Sarbanes-Oxley Act required initial one-time implementation expenses, we expected to see an overall decrease in the cost of being public this year,” said Tom Hartman, study director and Foley partner. “However, we did not expect to see the continued increase in audit fees over fiscal year 2004 – a year in which Section 404 drove costs to an already unprecedented level.”

Audit Fees Continue Their Ascent

Contrary to many predictions made earlier this year, the study revealed that average audit fees have continued to increase for large and small public companies alike. The increases in average audit fees seen in 2004 with the implementation of Section 404 have been sustained in 2005.

The study, which analyzed data from more than 850 proxy statements of public companies for fiscal year 2005, found that audit fees increased 22 percent for S&P small-cap companies, six percent for S&P mid-cap companies and four percent for S&P 500 companies.

“While there has certainly been considerable public discussion about a dramatic reduction in costs associated with audit fees this year, our study found the opposite to be true,” explained Hartman. “In addition, the S&P small-cap companies were the only group analyzed to experience double-digit increases in average audit fees for fiscal year 2005. Corporate governance reform continues to present a more significant financial burden for smaller public companies than it does for larger ones.”

The Continued Disproportionate Impact on Smaller Public Companies

The double-digit increases experienced in 2005 for S&P small-cap companies provides factual support for the perception that Section 404 disproportionately impacts smaller public companies.

Based on four years of results from Foley's study, percentage increases in average audit fees year over year were generally the same for companies of all sizes until the Section 404 requirements phased-in during 2004. Since that time, S&P small-cap and S&P mid-cap companies have experienced larger percentage increases in average audit fees compared to S&P 500 companies.

Between 2003 and 2005, average audit fees increased an average total of $786,000 for S&P small-cap companies and $1.14 million for S&P mid-cap companies. These increases represented a 141 percent increase for S&P small-cap companies and a 104 percent increase for S&P mid-cap companies. Comparatively, S&P 500 companies experienced a 62 percent increase during this same period.

“There is no question that fees associated with Section 404 have driven up costs for companies of all sizes,” said Hartman. “However, based on our data, large public companies are more readily able to absorb these costs while smaller companies are hit with larger percentage increases. These increases have leveled somewhat, but there is no indication that average audit fees are decreasing, particularly for smaller public companies.” 

Companies Continue to Express Frustration With Compliance Costs 

Since the enactment of the Sarbanes-Oxley Act, the study reported that the average cost of compliance for companies with under $1 billion in annual revenue has increased more than    $1.8 million to approximately $2.9 million, a 174 percent overall increase.

Respondents to Foley's survey shared the following additional insights:

• 84 percent of respondents felt that their compliance costs had increased “somewhat” or a “great deal” in 2005.
• One in five survey respondents is considering going private as a result of corporate governance and public disclosure reforms.
• 34 percent of respondents still do not believe they are better able to predict costs associated with corporate governance reforms.
• For the second straight year, 82 percent of respondents felt that corporate governance and public disclosure reforms are “too strict.” For the first time in the history of Foley's survey, not a single respondent felt the reforms are “not strict enough.”
• One-third of the respondents said that Sarbanes-Oxley Act compliance has resulted in budget and/or staffing cuts in critical areas of their business.

Download the full study results.

Methodology
In January of 2006, Foley distributed public company and private organization surveys via mail and e-mail to approximately 9,000 CEOs, CFOs, General Counsel, Chief Compliance Officers, Board Members, Directors and other executives of both public companies and private organizations. A total of 114 public company surveys were returned. The firm also commissioned a statistical analysis of proxy statement data compiled and maintained by Standard and Poor's Investment Services Custom Business Unit. This database contains information from more than 850 public companies included in the S&P 500, S&P Mid-Cap 400 and S&P Small-Cap 600 indices.