Man Without Qualities

Friday, April 15, 2005

Vuja De IV

One of the more remarkable aspects of the preposterous over reaction to the Enron scandal is that most of the adverse consequences to the various "reforms" enacted in the wake of the scandal and government enforcement actions taken in response to the scandal were well foreseen and publicly articulated at the time such "reforms" were enacted and such actions were taken. Fallout from the absurd Sabanes-Oxley legislation has already begun in earnest - and it all has exactly the qualities predicted when Sarbanes-Oxley was perpetrated. One could write for many pages on how Sarbanes-Oxley defies cost-benefit analysis and is especially harsh for smaller companies ("The costs, and practical and financial consequences, appear disproportionately harsh to smaller issuers. While the actual costs of legal and outside accounting fees may be the same, the fiscal consequences are more significant for micro, small, and mid-cap issuers as a percentage of their revenues and net income.").

The federal legislative action coincided with the amazing federal persecution and annihilation of Arthur Andersen, about which the Man Without Qualities noted at the time:
Now, whatever else the accounting industry may lack, it does not lack for political activism and sophistication, and it has plenty of "political power to utilize the state." Indeed, with the obliging annihilation of Andersen by the Department of Justice, the accounting industry is now positioned as something approximating a good old fashioned oligopoly - complete with the new "independent oversight board" to serve as its monopolistic, rent seeking coordinator. Indeed, once the dust from the Andersen demolition job settles, it will be interesting to calculate the Herfindahl-Hirschman Index of the accounting market. Would the anti-trust division at the Department of Justice have allowed the big accounting firms to achieve by merger the same level of market concentration that the Department has itself imposed through prosecution of Andersen? A concentrated national oligopoly of a key industry with its own, private, independent regulator! How comfy cozy for the regulated.Wasn't it nice of the Congress - and especially the Democrats in Congress - to do this for the big accounting firms, even as those firms pleaded with the Congress "please do not fling me in that briar patch."? Brer Rabbit hollered out, "Born and bred in the briar patch. I was born and bred in the briar patch!" And with that he skipped out just as lively as a cricket in the embers of a fire.

Now the consequences of the market concentration and restrictive regulatory environment have started to come in, and there seem to be no surprises whatsoever. Indeed, an astute and helpful reader has forwarded to me the following announcement:

"A Clash of Policies: Arthur Andersen vs. the Department of
Harvard University
Harvard Business School
Date: March 25, 2005
Postal: Harvard University
Harvard Business School
Soldiers Field
Boston, MA 02163 UNITED STATES
Andersen's demise in an already concentrated market for the provision of auditing services to large public firms is expected to increase market power and the prices of auditing services. This paper first documents the increase in concentration. Since Andersen's exit was driven by a choice of public policy, an appropriate reference point for appraising the concentration changes is the Department of Justice's 1992 Merger Guidelines' delineation of acceptable concentration levels and changes. These suggest that Andersen's disappearance, viewed as if it were a horizontal merger, would have violated those Guidelines. Consistent with this prediction, we find evidence of anticompetitive price changes for auditing services. Percent changes in audit fees are found to be significantly correlated with percent changes in market concentration, and former Andersen clients are shown to have faced significantly larger increases in their audit fees than other firms that changed auditors within the same time period. The paper concludes that the policy of putting Andersen out of business has foreclosed future policy options for the government in its dealings with the accounting industry, the structure of which is now more vulnerable to both criminal and catastrophic civil litigation.

On the other hand, the prosecution and annihilation of Arthur Andersen did help to create a sense that the Bush Administration was "doing something" about the Enron scandal and thereby helped to neutralize the Administration's critics (including many Democrats and sundry writers for the New York Times, including Paul Krugman and Maureen Dowd) who were screaming that the President was in cahoots with the Enron devils.

Nobody can legitimately say that such consequences were not expected or predicted (although many will likely say exactly that). Too bad every investor in a public company, and every single consumer, has to pay for such hysterical decisions every single day ... forever.

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