No abstract

PurposeThe purpose of this paper is to analyze the efficiency of the internal control reporting (ICR) requirements imposed by Sections 302 and 404 of the Sarbanes‐Oxley Act of 2002 (SOX). The lessons learned are then applied to the current financial crisis.Design/methodology/approachThe Coase Theorem is applied to the events leading up to the collapse of Enron and the enactment of SOX. The paper then analyzes the efficacy of the various examples of ICR regulation, both pre‐ and post‐SOX, noting the ways in which they effectively mitigate transaction costs and the ways in which they over‐regulate.FindingsUS investors continue to invest in foreign markets despite the fact that those markets maintain less demanding ICR requirements than those required by Section 404. Moreover, investors do not respond negatively to Section 404 disclosures. The research demonstrates that Section 404 does not provide useful information in the minds of investors. Considering Section 404's ineffectiveness and the burdensome costs it imposes on reporting companies, it is clear that Section 404 is an example of over‐regulation and should be repealed.Practical implicationsThe transaction costs that caused the collapse of Enron and the enactment of SOX bear strong similarities to those causing the more recent subprime mortgage crisis. The lessons learned from the enactment of SOX Section 404 are directly applicable to the current financial crisis and should be noted moving forward.Originality/valueBy utilizing a law and economics perspective, the paper more clearly demonstrates how Section 404 is an example of over‐regulation and draws links to the current economic crisis.

PurposeThe purpose of this paper is to analyze a recent proposal by the State of New York that would subject a large portion of the credit default swap (CDS) market to state‐based insurance regulatory oversight.Design/methodology/approachUsing the collapse of AIG as an example of the systemic risk inherent in unregulated CDS transacting, the Coase Theorem is then applied to determine the optimal level of CDS regulatory oversight.FindingsAlthough CDSs resemble insurance contracts in many respects, they are also uniquely complex financial instruments that are continually changing and thus not well suited for the antiquated state‐based model of insurance regulation. Furthermore, the external forces that influence state‐based regulatory decision‐making are likely to produce inefficient regulation.Practical implicationsThe Coase Theorem states that the optimal level of regulatory oversight is the one that causes market participants to internalize the risk inherent in transacting and does so at the lowest cost. Because of the complexity of CDS contracts and the unique forces that guide state‐based regulatory decision‐making, the State of New York's proposal is ill advised.Originality/valueBy utilizing a law and economics perspective, it becomes clear that although a state‐based model of regulatory oversight may force market participants to internalize systemic risk, it is nevertheless suboptimal because it does not do so at the lowest cost.