Every large corporate failure in the US will keep on increasing regulatory requirements for corporate governance. They have names like Sarbanes Oxley, Dodd Frank, FATCA and so on. The result is that companies spend millions of dollars on advisor’s fees, director salaries, external auditors, internal auditors, and compliance efforts to satisfy a long list of rules, regulations, and procedures imposed by regulators.
The trouble was that regulations tried to replace trust and rules replaced principles. A critical question which comes up all the time is, Will regulations improve governance? or on the other hand, Will governance improve with less regulations and controls? These questions come with the complaint that the cost of compliance is too exorbitant. However, the social cost of non compliance probably exceeds the corporate cost of compliance. The investors lose money, employees lose their jobs, customers lose their warranties, suppliers lose their livelihood, depositors in bank lose their investments, etc, etc.
If regulatory actions are to reduce, there needs to be more trust in the corporate system. Research suggests that companies might benefit by emphasizing trust over regulations. Like in a marriage both parties should understand the limits of acceptable behavior even when these are not fully specified. Both parties being the regulator and the company.
“Managers thinking about accounting issues should never forget one of Abraham Lincoln’s favorite riddles: How many legs does a dog have, if you call a tail a leg? The answer: Four, because calling a tail a leg doesn’t make it a leg.” — Warren Buffett
If trust has to replace contracts, people have to be principled like in the above quote, a dog has four legs is the principle. However, thats not a practical solution. So we are going to have more rules and regulations and Corporates should get ready to improve their compliance system. The mindset should be to reduce the cost of non compliance.
The public are not interested in the cost compliance, but of non compliance!