Can Sarbanes-Oxley influence investors' trust?

March 1, 2006 -- What is a 'fair' price for fairness? New research from Washington University's Olin School of Business reveals that a just system of governance may not enhance trust when returns do not meet investors' expectations. This is sobering news for businesses that have spent countless hours and large amounts of money complying with the Sarbanes-Oxley Act (SOX) in the hopes of building stronger corporate governance.

Ron King, the Myron Northrop Professor of Accounting in the Olin School of Business conducted research on how trust is created under different combinations of procedural justice and payout fairness. King makes the following observations based on his research:

Fairness might be a trade-off for smaller returns.

• SOX proponents argue that the extra compliance costs can be justified because these costs are offset by the benefits of increased investors' trust and reduced investors' skittishness. "The central question raised by this policy issue relates to how people make tradeoffs between a fairer system and a smaller pool of resources (because the fairer system is costly)," King says. "That is, this is an issue of procedural and distributive justice."

Investors like the pie big

• The most critical case that demonstrates the benefits of better corporate governance occurs when returns are low - which can happen even with good governance. King finds that when returns are below expectations, investors do not have more trust in a firm with better governance. Rather, it appears that good outcomes trumps good process.

• "If people have high expectations, they turn a blind eye to procedural justice when returns are low," King says. "The takeaway for policy makers is that they should take care to balance the costs of a fairer system with the expenditure of resources to achieve the fairer system."