The Impact of Sarbanes–Oxley on Small Businesses

George A. Haloulakos, CFA DBA Spartan Research and Consulting, Core Adjunct Finance Faculty – National University

Co-authored with: Farhang Mossavar-Rahmani, DBA, Professor of Finance – National University

In 2002 Congress passed the Sarbanes-Oxley (SOX) Act after a series of fraudulent accounting and finance activities and questionable behavior by many high level corporate executives during the early part of the 21st century. The Act set new or enhanced standards for corporate officers and directors of all publicly traded US companies, as well as public accounting firms servicing those companies. In the context of Agency Theory, the main purpose was to restore investor confidence, prevent or reduce the management misconduct, and protect stockholder interest. The Act also holds both Chief Executive Officers and Chief Financial Officers of the companies criminally and civilly accountable for the financial reports of their companies.

Since passage of the SOX Act, many studies have been conducted to find out the impact of the Act on businesses. The results have been mixed. In some cases the value of stocks increased, but in other cases companies experienced a significant increase in costs. The Act also has created obstacles and has made it increasingly difficult for new or small companies to go public. In such cases the compliance costs were a major issue. In this study, we are examining three such companies that were negatively impacted by the SOX Act.


The Sarbanes-Oxley Act of 2002 also known as the “Public Company Accounting Reform and Investor Protection” Act, consists of 18 sections that serve multiple regulatory functions. The overall goal of the Act was to restore investor confidence by reinforcing corporate accountability as well as improving the accuracy and reliability of information provided to investors (Jain et al., 2006). The Act specially focuses on management responsibilities for internal control and auditing independence. The Act required the SEC to take certain actions to ensure that there are regulatory structures in place to implement it.

Kenneth Lehn (2008) summarized the key provisions of the Sarbanes-Oxley (SOX) Act as follows,

  • Increased disclosure requirements of public companies
  • Increased role of independent directors
  • Expanded liability of officers
  • Required companies to assess and disclose adequacy of internal controls
  • Created the Public Company Accounting Oversight Board (PCAOB) to regulate auditors
  • Prompted the Securities & Exchange Commission (SEC) and exchanges to adopt new corporate governance rules

In this landmark paper, Prof. Lehn cited very mixed results as measured by empirical financial research.  Specifically, he noted the following conclusions from various studies:

  • Zhang (2007) – SOX related events had negative effect on companies’ stock prices.
  • Li, Pincus, and Rego (2006) and Jain and Rezaee (2006) – SOX related events had a positive effect on companies’ stock prices.
  • Chhaochharia and Grinstein (2007) – Stock prices of large firms not in compliance with SOX increased around SOX’s passage; those of small firms not in compliance with SOX declined.
  • Wintoki (2007) – Stock prices of small, young, high growth companies declined around passage of SOX.
  • Litvak (2007) – Stock prices of foreign firms cross-listed in the U.S. declined vis-à-vis non-cross-listed matched firms around key SOX events.
  • Zingales (2007), Litvak (2007) – The premium for foreign firms cross-listing in the U.S. declined after SOX.
  • Doidge, Karolyi, and Stulz (2007) – The premium for foreign firms cross-listing in the U.S. did not change significantly after SOX.

Other studies confirm that the cost of implementation of the SOX Act were proportionally higher for small businesses than large ones. According to the finding of the SEC Advisory Committee on Smaller Public Companies (88):

From the earliest stages of its implementation, Sarbanes-Oxley Act Section 404 has posed special challenges for smaller public companies. To some extent, the problems smaller companies have in complying with Section 404 are:

  • Lack of clear guidance;
  • An unfamiliar regulatory environment;
  • An unfriendly legal enforcement atmosphere that diminishes the use and acceptance of professional judgment because of fears of second-guessing by regulators and the plaintiffs’ bar;
  • A focus on detailed control activities by auditors; and
  • The lack of sufficient resources and competencies in an area in which companies and auditors have previously placed less emphasis.

In this paper we study the impact of Section 3: Corporate Responsibility, Section 4: Enhanced Financial Disclosures and especially 4.1: Disclosures Controls, Section 4.4: Assessment of Internal Control and Section 4.5: Smaller Public Companies.

As part of this study we looked at the costs associated with implementing the SOX Act, which includes external auditor fees, director and officer insurance, board compensation, lost productivity, and legal costs. In general, each of these cost categories increased significantly between FY 2001 and FY 2006 (Foley & Larder Survey 2007).

Case study

Due to the aforementioned mixed results (as measured by stock price performance), and our view that perhaps the self-correcting nature of the financial markets had a greater impact than the passage of the SOX Act, we focused our research on how SOX affected risk taking. We examined real life case studies to assess how firms have incorporated SOX into their financial and strategic planning processes, and their corresponding outcomes.  While these real life examples do not necessarily represent an across-the-board or universal impact, the effect on risk-taking is noticeable and has material or significant financial consequences.

The following situations are offered with the permission of the participating firms subject to the aforementioned NDAs.[1]  These examples are provided to demonstrate how SOX affects risk-taking behavior, and in each case, the financial outcome associated with actions taken (or not taken) due to SOX.

We have selected three types of business models for this study: vision care solutions, oceanographic equipment and specialty consumer.  For simplicity, these companies will be denoted as follows:

VCS: Vision Care Solutions

OE: Oceanographic Equipment

SC: Specialty Consumer

Basic information (for more information please see Exhibit 1):


Revenues (E) in 3 years $8 million $1.5 million $4.5 million
Debt/Equity $50,000/$200,000 0/$500,000 0/$300,000
Number of  Employees (E) 18 6 15
Owners/Operators 1 2 3

(E) Estimate

Each of these companies or business models were owner-operated with the goal of eventually becoming publicly traded entities.  These case studies occurred between 2002-2010, in the aftermath of the passage of SOX.  In each case, the owner-operator developed a profitable specialty niche model that had scalability (i.e., could be replicated in different regions or potential for large scale production).

In each of these situations SOX proved to be costly, burdensome, time consuming and distracting.  The additional layer of costs and burdens in terms of time and implementation had the effect of diverting financial and intellectual capital away from innovation and product development and redirected toward compliance in the context of a very risk-averse internal environment.  The resulting financial outcomes in relation to both the explicit and implicit costs associated with SOX compliance are self-evident.  However, it should be noted that not all of these had unsatisfactory outcomes.  One instance proved to be very satisfactory, but nevertheless was influenced by the preoccupation with the danger and risk of making the slightest mistake that potentially could undermine years of work.

VCS (Vision Care Solutions)

The Situation: In the very early 2000s, VCS was founded by an electrical engineer who was inspired to create this company in response to the onset of his own visual impairment and his empathy for others who like him, were “legally” blind.  The VCS founder developed and patented three different vision care solutions that would provide glare protection without obstructing one’s line of sight.  Specifically, VCS’s strategy was to provide solutions for potential clients seeking improved safety, increased productivity and greater comfort by enhancing various eye-care products [e.g., prescription, plain or dark glasses, goggles, helmets and related] with enhanced glare protection.  As such, VCS identified three mass markets, each aligned with its specific vision care solution: (1) individual consumers of prescription and non-prescription eye glasses; (2) professional and amateur athletes; and (3) commercial drivers, truckers, pilots, railway drivers and ship captains.  The total value (US$) of these three mass markets was conservatively estimated to be in the range of $25 to $30 billion.

What Happened Next:  VCS developed a prototype product for each of the aforementioned mass markets, lined up future engineering, technical, sales and support staff and a proposed manufacturing site.  Given the very large target markets, VCS sought equity financing via the public markets.  [Bank financing proved unsatisfactory given the inherently conservative nature of commercial lenders who deemed the business model extremely risky due to perceived over dependence upon the founder and being an emerging/early stage situation.]  The model VCS adopted was similar to the same one used by microbrewers that went public in the mid-to-late 1990s to capitalize on the growing public demand for craft beer.  In this instance microbrewers essentially used the Internet as well as financial literature attached to its product shipments to solicit equity capital.  However, by the time VCS was ready to embark on its capital raising efforts, the passage of Sarbanes-Oxley (SOX) created a whole new set of compliance protocols and filing of additional paperwork.

VCS diverted a portion of its limited capital to hiring attorneys and accountants to aid in compliance, but the financial cost associated with this process (even with self-help services) proved to be above plan.   Moreover, the additional 3 to 6 month period required to comply with new SOX standards proved very costly with a negative collateral development: loss of the manufacturing site and specialized personnel that had been previously lined up. These individuals could no longer afford to wait for a capital infusion, and thus sought employment elsewhere.   In a last ditch effort to sustain momentum, VCS sought grant funding from public and private sources, but the enormous paperwork and review process associated with this process proved to be an obstacle that the VCS founder was unable to overcome.

The Outcome: Following a promising start, VCS essentially went “dark” and suspended filing any further paperwork seeking equity financing.  Financial capital that had been earmarked for product and business development, and then later diverted to compliance with the new SOX regulations, evaporated.  As a result, VCS sought a more risk-averse strategy to pursue product licensing and/or a long-term special services employment contract to develop its products for a large company serving the vision care markets.  This has proven unsatisfactory as the perceived failure to raise equity from the public markets in its earlier efforts created a “stigma” for VCS thus deterring potential corporate suitors from investment.

The Verdict:  VCS believes that SOX and the resulting environment of inordinate preoccupation with compliance issues proved burdensome and ultimately a major obstacle to securing equity capital.  The negative effect of missing its window of opportunity with available skilled personnel and prime manufacturing space was due to the delay associated with compliance.   In addition, the financial capital was not available to retain those resources because it was being paid to attorneys and accountants.  VCS has never been able to recover from this as the founder personally financed development and patent filings for his work, and no further personal capital (debt or equity) was available to him.  As such, VCS is left to wonder what might have been!  It should be noted that the VCS founder has no illusions but would have preferred that the negative verdict be dictated by market forces (competition, supply & demand, and so forth) rather than the vagaries and delays associated with regulations that ultimately deter risk-taking.

OE (Oceanographic Equipment)

The Situation: In early 2007, OE was financially exhausted after having spent more than 5 years developing a technology product for personal and commercial uses in oceanography.  In the aftermath of SOX the company did not wish to pursue going public due to compliance costs, nor did it wish to disclose its technology with “angel” and venture investors because of the potential of giving up too much control and financial benefits of its intellectual properties.  OE considered forming a Limited Liability Corporation (LLC) and selling units to hobbyists, scientists and others who would have interest in the company’s technology, but ultimately vetoed this option due to potentially being overly cumbersome and time consuming.  Despite a potentially very large end-user market for its technology, the idea of investing additional financial and intellectual capital in order to navigate through the SOX protocols or satisfy the insatiable desire for control by venture investors and financial angels was viewed as unacceptable.  This forced OE to solely concentrate on how to monetize its intellectual properties in a timely manner, especially given its diminishing financial resources.

What Happened Next:  OE hired a consultant to establish a valuation for its technology and develop a combined licensing strategy and special services contract to help the founders recover its cumulative investment, provide a future stream of recurring income from its technology and stable employment.  While this was being done, a suitable candidate firm was found that was willing to pay for the technology, manufacture and distribute the product. This was done with the OE founders working in a consulting role to help implement this process.  Armed with a valuation study, OE proposed formation of a strategic alliance that called for an upfront payment to the founders (allowing the buyer access to the technology), and then a recurring income stream arising from a percentage licensing fee applied to future revenues. Additionally, there would be a long-term special services contract whereby the founders would receive compensation for helping bring the product to market and sustain its expected commercial success.  In principle, this agreement was accepted by the candidate firm with what proved to be minor adjustments or concessions by OE: the upfront payment would be paid in three equal installments over a 3-month period instead of a lump sum. Further, the majority of those payments would be classified as engineering fees rather than licensing fees so that it would not have to be treated as a capitalized expense item.

The Verdict:  OE believed this financial solution was optimal from the standpoint of reflecting its mission and values.  The technology was developed out of a love for oceanography, and this commitment was reflected by the founders putting their personal financial position at risk.  OE was created as a vehicle for the founders to create and develop the technology for commercial application.  Once completed—and after considering the further additional commitment of time and financial capital—OE determined that monetizing its intellectual properties and recovering its investment was not available only through the Initial Public Offering (IPO) venue, it could be fulfilled in a more efficient and less risky manner through a licensing agreement.  Hence, the aforementioned strategic alliance with the upfront installment payments, recurring licensing fee income plus the special services contract.  In this case, the new hurdles posed by SOX caused OE to reconsider carefully and ultimately pursue a strategic alternative that provided a much better fit in terms of reward and risk.  Since then, OE founders concede that had it been “easy” to go the IPO route, the sustainable financial returns might have been much lower (or non-existent) because OE was better suited as a product group for a large firm rather than a stand-alone entity.  SOX protocols ultimately proved to be a blessing for OE in securing an optimal financial strategy for its technology that enabled it to thrive in a more suitable venue than the publicly traded securities markets.

SC: (Specialty Consumer)

The Situation: From 2001–2003 SC was formed with the objective of further leveraging the “third space” concept that had taken hold during the 1990s.  The “third space” concept was based on the view that with flextime and the boundaries between home and work becoming ambiguous, more people were spending leisure time outside the work place and home.  The “third space” concept includes, but is not limited to, a gourmet coffee store model (e.g., Starbucks), health club, recreation centers, etc.  SC created a combined wine bar and retail store that would provide a channel of distribution for small west coast wineries that were thus far unable to compete for retail shelf space in traditional wine & liquor stores or in grocery stores.

What Happened Next:  SC worked closely with a financial consultant to create a business model that would be located in urban areas characterized by high foot traffic (e.g., tourists, hotel guests, cruise ship patrons, restaurant customers and so forth).  The SC model would allow such patrons to enjoy sampling premium quality wines from small wineries, purchase wine and complementary food offerings along with souvenirs, all the while enjoying quiet time with friends and/or business associates.  Essentially SC positioned itself as a wine version of Starbucks, and thus a scalable model that could be strategically placed to capitalize on the strong demand growth for wine while providing a distribution channel for small wineries located nationwide.

Due to the scalability factor, SC wanted to raise private equity to finance two (2) wine bars as a way of demonstrating its financial viability. Once those two operations were up and running, SC sought to tap the public equity markets to finance a large-scale expansion that would occur concurrently in various regions nationwide.  SC formed a series of contractual relationships with multiple wineries eager to participate, engaged other wine and food enthusiasts to run the operations.  Due to the aggressive (albeit achievable) growth plans, the imposition of SOX necessitated the use of significant financial capital to comply with the requirements of going public.  While necessary and appropriate given the desire to be a vital, active and growing public entity, this ultimately diverted funds away from retaining the specialized personnel for wine & food needed to run the operation; it also provided credibility with the investing public.  Without these people on hand, SC essentially became a “still born” idea as it became extremely difficult to move forward without their presence.  With the funds diverted to SOX compliance, it was a company that existed only on paper.

The Verdict:  SC initially believed that had it been able to spend its capital on retaining the specialty personnel needed to launch its flagship operation and building a “brick-and-mortar” business (i.e., deploy physical capital assets), which would have created a going-concern that would attract investor interest.  Ideally, SC thought of how the McDonalds brothers attracted the interest of Roy Kroc, who had the vision to transform the brothers’ burgers-and- fries outlet into a global enterprise.  But upon further reflection and additional research it became evident that, had the growth idea been confined to a small scale (i.e., build a single successful wine bar business first) and refine the concept so that it developed a track record that would later attract investment funding for scaling upward, this might have been more feasible.  SC sought to move forward way too fast.

While the idea of a wine bar was most feasible in terms of demand growth, profitability and return on capital, the near instantaneous formation of a large scale public enterprise might have proven to be very difficult to manage.   The cost estimate for SOX compliance associated with a near instantaneous formation of a publicly traded enterprise was approximately $1.5 million.  SOX compliance certainly absorbed a disproportionate amount of capital that otherwise would have been used for developing the business, but to cast blame for SC’s failure to become a reality solely upon SOX would be inaccurate.

Ultimately, the SC founders maintained their hobbyist interest in wine, but refrained from spending additional capital as their personal resources were exhausted and they had no interest in selling or licensing the model they created.  Preliminary feelers to prospective buyers or investors indicated that SC lacked sufficient product differentiation and a track record to warrant financial participation.  In a sense, the all or nothing approach taken by SC may have been its undoing.

The very rapid financial success each of the founders experienced in their individual corporate careers prior to pooling their resources for the SC wine bar venture resulted in overconfidence because they expected similar growth progression in the entrepreneurial venue.  Whether that would have occurred pre-SOX is unknown, but certainly the presence of SOX proved to be a formidable influence upon their business decisions and risk-taking behavior.


As all three cases show, the cost of compliance with SOX requirements have been the main reasons for the three cited companies not to pursue equity financing via the public market, and as a result they were not able to materialize their dreams.+++++++++++++++++++++++++++++++++++++++++

In short our finding indicates that SOX:

  • Reduces incentives for innovation and risk taking among entrepreneurs while increasing attention toward compliance because of inordinate fear of financial and legal penalties.
  • Has influenced diversion of personal capital by entrepreneurs from product development and related activities toward the hiring of attorneys and accountants in order to tap the public equity markets for capital funding.
  • Has reduced the flexibility of entrepreneurs in creating business models that otherwise would attract equity capital pre-SOX from prospective investors.

Exhibit 1


Explanatory Notes:

  • Employees for each firm are “independent contractors” and therefore not “permanent.”  Each firm sought or considered equity via the public offering route as a means to secure permanence in their “human resource” assets.
  • Only SC would have “internet” based sales as part of its expected revenue stream ($1 million or 22% of sales).  VCS and OE models did not have revenue-generating/transaction internet portals.
  • VCS would be a lab/manufacturer, OE would be contractor/vendor and SC would be retail (brick-and-mortar + internet portal).
  • Total owner capital $250,000 for VCS (with $50,000/$200,000 debt/equity mix), $500,000 for OE (all equity) and $300,000 for SC (all equity).  VCS owner committed 100% of personal financial resources as did OE owners, with the difference being that OE eschewed the use of debt.  SC owners set a limit or threshold on equity capital at risk, and would not commit any further.


Chhaochharia, Vidhi and Yaniv Grinstein, “Corporate governance and firm value: the impact of the 2002 governance rules,” Journal of Finance 62 (2007), 1789-1825.

Doidge, Craig, Andrew Karolyi, and Rene Stulz, “Has New York become less competitive in global markets? Evaluating foreign listing choices over time?,” (July 2007). Fisher College of Business Working Paper No. 2007-03-012. Available at SSRN:

Haloulakos, George A., (DBA Spartan Research and Consulting), Case Studies of Private Clients – Spartan Research,  2000 – 2010.

Li, Haidan, Morton Pincus, and Sonja Olhoft Rego, “Market reaction to events surrounding the

Sarbanes-Oxley Act of 2002 and Earnings Management,” Journal of Law and Economics, February, 2008.

Litvak, Kate, “The impact of the Sarbanes-Oxley Act on Non-U.S. Companies cross-listed in the U.S.,” Journal of Corporate Finance 13 (2007), 195-228.

Litvak, Kate, “Long-term effect of Sarbanes-Oxley on cross-listing premia,” European Financial Management, forthcoming, 2008. Available at

Wintoki, M. Babajide, “Corporate boards and regulation: the effect of the Sarbanes-Oxley Act and the exchange listing requirements on firm value,” Journal of Corporate Finance 13 (2007), 229-250.

Zhang, Ivy Xiying, “Economic consequences of the Sarbanes-Oxley Act of 2002,” Journal of Accounting and Economics 44 (2007), 74-115.++++++++++++++++++++++++++++++++++

Zingales, Luigi, “Is the U.S. capital market losing its competitive edge?” (November 2007). ECGI – Finance Working Paper No. 192/2007. Available at SSRN:

Kenneth Lehn, “Sarbanes-Oxley: A Review of the Empirical Evidence and a Proposal for Reform”, May 13, 2008.

SEC Advisory Committee on Smaller Public Company, Washington D.C., April 2005

What’s the use of economics?

Dr. Diane Doyle runs the consultancy Enlightenment Economics. She is a BBC Trustee and member of the Migration Advisory Committee and of the independent Higher Education Funding Review panel, and was for eight years a member of the Competition Commission (until September 2009). She is also visiting professor at the University of Manchester. She has a PhD from Harvard.

This article is published here in by permission of Vox. (

Five years after Lehman’s collapse, economics is under fire both from outside and inside the profession for irrelevance, arrogance and more. This column introduces a new Vox debate focused on two questions: What’s the use of economics, and how should we be teaching it to the next generation?

If economics emerges from the Global Crisis unchanged, it will lose all credibility. That is certainly not the view of all economists, but many do think so. There are plenty of examples of criticism of our subject from within and without. Some are ill-informed rants, but others – such as the recent article ‘Economics in Denial’ by Howard Davies (2012), founding chairman of the Financial Services Authority – must be taken seriously.

However, it is not obvious what shape an effective response to even well-founded criticisms could take. After all, engaging in a professional debate about the content and methodology of economics, supported by research, will take years.

One starting point, identified at a conference organized by the Bank of England earlier this year, is the teaching of economics, beginning with the undergraduate level. Participants included both employers of economists (including the Bank and the Government Economic Service) and academic economists. A book with the pre-conference papers and papers by conference participants is published this month (What’s The Use of Economics: Teaching The Dismal Science After The Crisis, London Publishing Partnership).

Feedback from the employers of young economists

Some clear themes have emerged from the conference and the book. One is the extent of employer dissatisfaction with the teaching of economics in universities, for all that economics graduates remain highly employable. Employers of graduates in any subject have some consistent complaints about the lack of certain skills among new graduates, and employers of young economists are no different. For example, the prevalence of poor communication skills is a common theme. Economists working outside the academic world will all need to communicate their technical expertise to non-technical colleagues and customers, so it is a core skill for them. For example, in a 2012 survey of economists in the Government Economic Service – the single biggest employer of economists in the UK – they described the two main areas of their work as the production of briefing material and the preparation of policy advice. City economists and economists in consulting will often have to present research to their firm’s non-economist clients.

Perhaps more surprising is the consistent view among all the employers, as well as some of the academics, that undergraduates need to learn more about both economic history and the history of economic thought, and moreover to be made to pay attention to the economic conjuncture, to economic institutions, to the operation of actual markets in the economy and current policy debates. For instance, as Stephen King, Group Chief Economist at HSBC, put it: “Young economists arrive in the financial world with little or no knowledge of how the financial system operates. This is a matter of collective guilt. Economic models typically assume the financial system is a black box.” Although employers all recognize the need to be realistic about fitting more into the curriculum, and about what a new graduate can reasonably be expected to know, the level of dissatisfaction with current shortfalls is striking.

These gaps in graduates’ knowledge seem not to be due to any lack of interest in economics on their part. In the UK, the number of students beginning an undergraduate degree in economics rose 8.5% to 7,800 in 2011, compared with a 1% rise in the total number of undergraduates, and although the number declined by 2% in 2012, this compared with a 7% decline in the total. The number taking the economics A level has been rising since 2006. It is hard to believe that these figures do not reflect young people’s interest in the dramatic economic events of recent years.

Questions about methodology

A second theme is the way the crisis has given added urgency to some questions or doubts about economic methodology. It is probably true to say that a majority of academic economists do not believe the financial crisis seriously undermines the theoretical framework of their discipline. Even so, a number of participants raised concerns about the emphasis on reductive rather than inductive thinking in economics, and about the use of mathematics without meaning.

Andrew Lo of MIT argues that mathematical techniques in economics only gain meaning from application to actual empirical questions and should be taught in that context. Paul Seabright of the Toulouse School of Economics says students must be taught not that economics is an ever more successful approach to true knowledge about how the economy works, but rather as an empirical investigation of an ever-evolving phenomenon. There was a strong consensus on the need to demote the role of theory and promote empiricism. As Andrew Lo expressed it: “We economists wish to explain 99% of all observable phenomena using three simple laws, like physicists do, but we have to settle instead for ninety-nine laws that explain only 3%, which is terribly frustrating.”

Role of macroeconomics

On the third area, the role of macroeconomics, there was little consensus, but rather a wide array of opinions. These ranged from the view that modest adjustments to the existing models and curriculum would suffice to take account of recent real world economic events, all the way to the more radical view that a new methodological approach to modelling the macroeconomy is required. What to teach on macroeconomics is obviously a secondary question to the current debate about macro analysis (covered in some detail by Simon Wren-Lewis on his blog, for example).

However, when Benjamin Friedman of Harvard describes pre-crisis macro as “wrong headed” and Andrew Haldane of the Bank of England describes representative agent models with expectations reflecting fundamentals as “fundamentally ill-suited” to today’s worlds, it would take someone who is either very confident or very complacent not to reflect some of these doubts in what they teach the next generations of economists.

Changing the teaching of economics courses in universities faces numerous hurdles, and reforming the content of the curriculum may not even be the hardest to overcome. Universities in many countries face financial challenges at present, needing to teach more students with no additional funding. So the demands on academics’ time are increasing. In the UK university system and elsewhere, there are also strong incentives for academics to devote their time to research rather than teaching. What’s more, their research profile and promotion will benefit from their publishing a large number of papers that are incremental to an existing literature. According to academic contributors, the UK’s Research Excellence Framework keeps researchers focused on writing papers, not books, and also on quite a narrow range of journals.

Meanwhile, student surveys suggest many are already rather dissatisfied with the extent of their contact with lecturers or the quality of teaching. In addition, where they face incurring large loans to pay fees, they are becoming more instrumental about their university education: it needs to ensure they do well in their exams and get a good job. Finally, undergraduates are the product of a schooling that has strongly emphasised ‘teaching to the test’ to improve school results in league tables, rather than encouraging intellectual exploration and independent study.

A number of contributors suggest practical steps, not all that time-intensive, to improve undergraduate teaching. Mechanisms for sharing best practice and making use of online resources are among them. As Michael McMahon of Warwick University points out, however, students themselves need to appreciate that in order to benefit in the fullest sense from university, they need to read widely, engage in discussion and above all stop expecting to be spoonfed. As for wider reforms of academic incentive structures, they are under discussion by a post-conference working group that plans to issue a report next year making recommendations for reform.

Economists are in the best position to understand the intellectual power and rigour of our subject, and its ability to contribute to tackling the enormous range of challenges in problems in today’s world, not least the continuing financial and economic crisis. Any intellectually honest economist will acknowledge that the length and severity of the crisis demand at least a certain amount of professional introspection and self-evaluation. Many will agree that economics does need to change. Surely the education of young economists is the best place to start?


Davies, Howard (2012), “Economics in Denial”,, 22 August.

About the Author

Diane Doyle runs the consultancy Enlightenment Economics. She is a BBC Trustee and member of the Migration Advisory Committee and of the independent Higher Education Funding Review panel, and was for eight years a member of the Competition Commission (until September 2009). She is also visiting professor at the University of Manchester. She has a PhD from Harvard.

Diane specializes in the economics of new technologies, including extensive work on the impacts of mobile telephony in developing countries. Recent projects include work for NESTA on the wider conditions for innovation, and a study on the effects of mobiles in India. She is the author of several books, including The Soulful Science (Princeton University Press 2007), Sex, Drugs and Economics (2002, Texere), Paradoxes of Prosperity (2001, Texere), Governing the World Economy (2000, Polity) and The Weightless World (1997, Capstone/MIT Press), all translated into many languages. She has also published numerous book chapters, reports and articles, and was formerly a regular presenter on BBC Radio 4’s Analysis. Her next book is to be published by Princeton University Press in 2010.

Diane has acted as a member of the advisory board of ING Direct UK and of the stakeholder advisory panel of EDF Energy, and is a member of the advisory council of the think tank Demos. She was previously Economics Editor of The Independent, and earlier worked at the UK Treasury and in the private sector as an economist. Diane was awarded the OBE in January 2009.



Character, Policy and the Selection of Leaders

Mr. George Friedman is the CEO and chief intelligence officer of Stratfor, a private intelligence company located in Austin, TX.

This article is published here in by permission of Stratfor.

The end of Labor Day weekend in the United States traditionally has represented the beginning of U.S. presidential campaigns, though these days the campaign appears to be perpetual. In any case, Americans will be called on to vote for president in about two months, and the question is on what basis they ought to choose.

Many observers want to see intense debate over the issues, with matters of personality pushed to the background. But personality can also be viewed as character, and in some ways character is more important than policy in choosing a country’s leadership.

Policy and Personality

A candidate for office naturally lays out his plans should he win the election. Those plans, which may derive from an ideology or from personal values, represent his public presentation of what he would do if he won office. An ideology is a broadly held system of beliefs — an identifiable intellectual movement with specific positions on a range of topics. Personal values are more idiosyncratic than those derived from an ideology, but both represent a desire to govern from principle and policy.

As we all know, in many cases the presentation of intentions has less to do with what the candidate would actually do than it does with what he thinks will persuade the voters to vote for him. But such a candidate, possessing personal ambition more than principle, would not be opposed to doing what he said, since it suited the public. He has no plans himself beyond remaining in office.

Then there are those who profoundly believe in their policies. They sincerely intend to govern based on what they have said. This is what many think elections ought to be about: ideas, policies, ideologies and beliefs. Thus, in the case of the current American election, many are searching for what the candidates believe and asking whether they actually mean what they say.

In the United States and other countries, policy experts decry the fact that the public frequently appears ignorant of and indifferent to the policies the candidates stand for. Voters can be driven by fatuous slogans or simply by their perception of the kind of person the candidate is. The “beauty pageant” approach to presidential elections infuriates ideologues and policy experts who believe that the election should not turn on matters as trivial as personality. They recognize the personal dimension of the campaign but deplore it as being a diversion from the real issues of the day.

But consider the relationships between intentions and outcomes in American presidencies. During the 2000 campaign, George W. Bush made the case that the American war in Kosovo, undertaken by President Bill Clinton, was a mistake because it forced the United States into nation-building, a difficult policy usually ending in failure. There is every reason to believe that at the time he articulated this policy, he both meant it and intended to follow it. What he believed and intended turned out to mean very little. His presidency was determined not by what he intended to do but by something he did not expect nor plan for: Sept. 11, 2001.

This is not unique to Bush. John F. Kennedy’s presidency, in terms of foreign policy, was defined by the Cuban missile crisis, Lyndon Johnson’s by Vietnam. Jimmy Carter’s presidency was about the Iranian hostage crisis. None of these presidents expected their presidency to be focused on these things, although perhaps they should have. And these were only the major themes. They had no policies, plans or ideological guidelines for the hundreds of lesser issues and decisions that constitute the fabric of a presidency.

Consider Barack Obama. When he started his campaign, his major theme was the need to end the Iraq war, but soon after Labor Day in 2008, the Iraq issue had become secondary to the global financial crisis. It was not clear that Obama had any better idea than anyone else as to how to handle it, and by the time he took office, the pattern of dealing with it had been established by the Bush administration. The plan was to prevent the market from inflicting punishment on major financial institutions because of the broader consequences and to redefine the market by flooding it with money designed to stabilize these institutions. Obama continued and intensified this policy.

Frequently, a campaign’s policy papers seem to imply that the leader is simply in control of events. All too often, events control the leader, defining his agenda and limiting his choices. Sometimes, as with the Sept. 11 attacks, it is a matter of the unexpected redefining the presidency. In other cases, it is the unintended and unexpected consequences of a policy that redefine what the presidency is about. Johnson’s presidency is perhaps the best case study for this: His policy in Vietnam grew far beyond what he anticipated and overwhelmed his intentions for his time in office. No president has had a clearer set of policy intentions, none was more initially successful in adhering to those intentions and few have so quickly lost control of the presidency when unintended consequences took over.

Fortune and Virtue

Machiavelli argues in The Prince that political life is divided between fortuna, the unexpected event that must be dealt with, and virtu, not the virtue of the religious — the virtue of abstinence from sin — but rather the virtue of the cunning man who knows how to deal with the unexpected. None can deal with fortuna completely, but some can control, shape and mitigate it. These are the best princes. The worst are simply overwhelmed by the unexpected.

People who are concerned with policies assume two things. The first is that the political landscape is benign and will allow the leader the time to do what he wishes. The second is that should the terrain shift the leader will have time to plan, to think through what ought to be done. Ideally, that would be the case, but frequently the unexpected must be dealt with in its own time frame. Crises frequently force a leader to go in directions other than he planned to or even opposite to what he wanted.

Policies — and ideology — are testaments to what leaders wish to do. Fortune determines the degree to which they will get to do it. If they want to pursue their policies, their political virtue — understood as cunning, will, and the ability to cope with the unexpected — are far better indicators of what will happen under a leader than his intentions.

Policies and ideology are, in my view, the wrong place to evaluate a candidate. First, the cunning candidate is the one least likely to take his policy statements and ideology seriously. He is saying what he thinks he needs to say in order to be elected. Second, the likelihood that he will get the opportunity to pursue his policies — that they are anything more than a wish list casually attached to reality — is low. Whether or not a voter agrees with the candidate’s ideology and policies, it is unlikely that the candidate-turned-leader will have the opportunity to pursue them.

Bush wanted to focus on domestic, not foreign policy. Fortune told him that he was not going to get that choice, and the beliefs he had about foreign policy — such as nation-building — were irrelevant. Obama thought he was going to rebuild the close relationship with the Europeans and build trust with the Arab world. The Europeans had many greater problems than their relationship with the United States, and the Islamic world’s objection to the United States was not amenable to Obama’s intentions. In the end, both of their presidencies resembled their campaign policies only incidentally. There was a connection, but for neither did the world go as expected.

The Question of Character

When Hillary Clinton was competing with Obama for the 2008 Democratic Party presidential nomination, she ran a television commercial depicting a 3 a.m. phone call to the White House about an unexpected foreign crisis. The claim Clinton was making was that Obama did not have the experience to answer the phone. Whether the charge was valid or not is the voter’s responsibility to answer. However, implicit in the ad was an important point, which was that the character of a candidate was more important than his policy position. When woken in the middle of the night by a crisis, policies are irrelevant. Character is everything.

I will make no serious effort to define character, but to me it comprises the ability to dissect a problem with extreme speed, to make a decision and live with it and to have principles (as opposed to policies) that cannot be violated but a cold-blooded will to do his duty in the face of those principles. For me, character is the competition within a leader who both wants power and wants something more. His precise position on the International Monetary Fund is not really relevant. His underlying sense of decency is, along with an understanding of how to use the power he achieved.

If this is vague and contradictory, it is not because I haven’t thought about it. Rather, of all of the political issues there are, the nature of character and how to recognize it is least clear. It is like love: inescapable when you encounter it, fragile over time, indispensable for a fully human life. Recognizing character in a leader would appear to me the fundamental responsibility of a voter.

The idea that you should vote for a leader based on his policy intentions is, I think, inherently flawed. Fortune moots the most deeply held policies and the finest leader may not reveal his intentions. Lincoln hid his intentions on slavery during the 1860 campaign. German Chancellor Angela Merkel never imagined the crisis she is facing when she ran for office. Intentions are hard to discern and rarely determine what will happen.

The issues that George W. Bush and Barack Obama had to deal with were not the ones they expected. Therefore, paying attention to their intentions told us little about what either would do. That was a matter of character, of facing the unexpected by reaching into his soul to find the strength and wisdom to do what must be done and abandon what he thought he would be doing. The grace and resolution with which a leader does this defines him.

I think that those who obsess over policies and ideologies are not wrong, but they will always be disappointed. They will always be let down by the candidate they supported — and the greater their initial excitement, the deeper their inevitable disappointment. It is necessary to realize that a leader of any sort cannot win through policy and ideology, and certainly not govern through them unless he is extraordinarily fortunate. Few are. Most leaders govern as they must, and identifying leaders who know what they must do is essential.

We study geopolitics, and geopolitics teaches that reality is frequently intractable, not only because of geography but because of the human condition, which is filled with fortune and misfortune, and rarely allows our lives to play out as we expect. The subjective expectation of what will happen and the objective reality in which we live are constantly at odds. Therefore, the tendency to vote for the candidate who appears to have deeper character, in the broadest sense of the term, would appear to me less frivolous than voting on the basis of ideology and policy. Both of those will and always do disappoint.

As to the question of who has the greatest character in this election, I have no greater expertise than any of my readers. There is no major in character at any university, nor a section on character in newspapers. The truth of democracy is that on this matter, none of us is wiser than any other.