How Sarbanes-Oxley Led to Pricier Audits for Everyone
While SOX forced better oversight for publicly traded companies, its effects on other organizations have been less clear.How Sarbanes-Oxley Led to Pricier Audits for Everyone
A business’s longevity and profitability depend on owners and managers making sound decisions. An important part of accomplishing that is to have as much accurate data about the operation as possible.
That’s about as straightforward as it gets, and I’d guess few would argue with me on those points. So, I’ll ask this: Do you have all the information you need to make the best possible decisions? And are you sure of your numbers?
I’ve long believed that one important way a business owner or manager can honestly and confidently answer those questions in the affirmative is if they’re obtaining third-party audits. Financial statement audits are fairly common in large businesses, but they’re not required and are often just seen as time-consuming and expensive endeavors for smaller operations.
But there are potentially big benefits. Hear me out.
Prior to my time in academia, I witnessed the merits of audits as both an outside auditor and CFO for-hire at a number of companies. When owners and managers saw audit results, they were often surprised to see the ways in which they could reduce inventory losses, improve accounts receivable collections and improve overall profitability.
Through research, I’ve found evidence to back up those anecdotes.
In theory, we’d expect that companies with equal inputs should have essentially equal outputs. But that isn’t the case in the real world. Instead, we find companies in the 90th percentile are about twice as productive as those in the 10th. There is a lot of research aimed at finding the causes for that disparity.
With Booth and University of Boston colleagues, I was able to show that the quality of a company’s financial measurement could account for 10 to 20 percent of productivity variability. In other words, up to one-fifth of the difference between highly productive and less productive companies may be tied to audits.
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Some could argue that these companies could be more successful simply because they have better managers. Maybe the connection to audits is correlation and not causation. My ongoing research seeks to understand the causal mechanisms underlying this result. But even if the quality of management is the cause, it’s worth noting that good managers are investing in audits.
Other studies I have conducted find that companies getting audits were 5 percent more likely to survive the financial crisis from 2008 to 2010, and this magnitude nearly doubles when focusing on smaller businesses or those in the construction industry. Moreover, of those companies surviving from 2008 to 2010, those with audits had 1.7 percent more growth than their nonaudited counterparts.
I suspect that those businesses that survived and even thrived during one of the worst economic downturns did so because they had better data to back their requests for loans. They had clear pictures of their business operations when making decisions. They had a lot of accurate data to work with.
For some companies, the cost of an audit will surpass the benefits. But when making that assessment, don’t forget to count on the less tangible benefits that come with better information to make business decisions.
Michael Minnis is a professor of accounting and a Charles E. Merrill faculty scholar at the University of Chicago’s Booth School of Business.
This column is part of the Chicago Booth Insights series, a partnership with Crain’s Chicago Business, in which Booth faculty offer advice for small businesses and entrepreneurs on the basis of their research.
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