Cost of Capital in uncertain times

Topics: Corporate governance, Board of directors, Stock Pages: 32 (5141 words) Published: September 28, 2014
For the exclusive use of K. Peng

REV: MAY 9, 2006


Corporate Reform in the United States
During 2002, public trust in U.S. capital markets took a sharp decline as investors learned of financial misreporting in dozens of well-known companies. According to surveys conducted in July 2002, nearly 80% of the U.S. public said that executive self-dealing was “very” or “somewhat” widespread, and only 16% thought that the revealed cases of corporate wrongdoing were isolated instances.1 To stem this decline and restore public confidence in the U.S. system of corporate governance, many public and private bodies, including the U.S. Congress, launched reform efforts. (See Exhibit 1.) This note summarizes a few of these initiatives. It focuses on efforts of national significance undertaken during 2002 and 2003. (See Exhibit 2.)

Legislation and Regulations
Sarbanes-Oxley Act
On July 30, 2002, President George W. Bush signed the Sarbanes-Oxley Act into law.2 The act was widely viewed as the federal government’s most significant response to the loss of confidence in corporate reporting. Initially spurred by the collapse of Enron in December 2001, the bill gained momentum from the WorldCom accounting scandal in June 2002, and within a month, it was passed almost unanimously by the U.S. Senate and House of Representatives. The legislation, which applies to U.S. audit firms and public issuers of securities as well as overseas companies listed on U.S. exchanges, was intended to protect investors, improve corporate disclosures, discourage fraud, and restore confidence in securities markets. The act established a new accounting oversight board, the Public Company Accounting Oversight Board (PCAOB), described below, and imposed new requirements on companies, audit committees, and corporate executives, as well as audit firms and corporate lawyers.

Under Sarbanes-Oxley, chief executives and chief financial officers are required to certify the accuracy and completeness of their companies’ financial reports. Companies must implement effective internal controls and disclose whether they have adopted a code of ethics for their senior financial officers and, if not, why not. Executives and directors are banned from trading their company’s stock during pension fund blackout periods (i.e., whenever plan participants’ ability to acquire or transfer interests in the stock is suspended) and, as a rule, may not receive personal loans from their companies.

________________________________________________________________________________________________________________ Professor Lynn Sharp Paine and Research Associate Kim Eric Bettcher prepared this note from public sources as the basis for class discussion. Research Associate Christopher M. Bruner, J.D., assisted in preparing Exhibit 3 of the note. Copyright © 2004 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.

This document is authorized for use only by Kang Peng in Burns 4211 Corporate Finance taught by Burns OHIO STATE UNIVERSITY from August 2014 to December 2014.

For the exclusive use of K. Peng

Corporate Reform in the United States

The act increases criminal penalties for securities fraud to as much as 25 years in prison. It also extends the statute of limitations in securities fraud cases to five years, or two years from the time of discovery, and introduces a new felony for shredding documents or otherwise impeding a federal investigation into fraud. “Whistle-blower” employees—those who report...
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