Category Archives: Politics and Business

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

President Obama and the November Presidential Election

Dr. John Psarouthakis, Executive Editor of, Distinguished Visiting Fellow at the Institute of Advanced Studies in the Humanities, University of Edinburgh, Scotland, and Founder and former CEO, JPIndusries, Inc., a Fortune 500 industrial corporation

President Obama is going into history as the first African American elected to the presidency of USA. However, he might also go into history as a one term president because of the economy travails, and lack of leadership to bring the country together as he so eloquently stated of his belief of this country in his 2004 DNC keynote speech. Instead he has, in my opinion, become a polarizing force in the political spectrum of the country. He has missed the opportunity to be a Statesman. He has remained a traditional politician when the country needed a leader to unify the people and bring us out of a collapsing economy and two wars.

He has developed an atmosphere of uncertainty with his approach of decision making. Even the most important legislation of his administration to date, Health Care Law, he delegated the initiative to former Speaker Pelosi until it looked doubtful it will pass. He then got involved in what many called “Chicago politics” to pass the bill.

The voters in 2008 were “hungry” for a change. They did not demand of the candidates to spell out the change they promised. Here we are four years later and we continue to deal with old style politics.


Pres. Obama seems unable to get a firm grip on the tough issue-the economy. His ideological bent for ever bigger government has blocked his thinking on how this country’s economy has grown and how jobs are created in the private sector. When the 25 million people who are unemployed or cannot find full time work will they find a full time job? Does our president understand what is going on? Blaming others here or overseas does not really define the problem and therefore improvement of the economic situation is not anywhere near!

Technology is eliminating jobs

Tellers, phone operators, stock-brokers, stock-traders: These jobs are nearly extinct. Since 2007, the New York Stock Exchange has eliminated 1,000 jobs. And when was the last time you spoke to a travel agent? Nearly all of them have been displaced by technology and the Web. Librarians can’t find 36,000 results in 0.14 seconds, as Google can.

Doctors are under fire as well, from computer imaging that looks inside of us and from Computer Aided Diagnosis, which looks for patterns in X-rays to identify breast cancer and other diseases more cheaply and effectively than radiologists do. Other than barbers, no jobs are safe.

But be warned the USA economy is incredibly dynamic, and there is no quick fix for job creation when so much technology-driven job destruction is taking place. Fortunately, history shows that labor-saving machines haven’t decreased overall employment even when they have made certain jobs obsolete. Ultimately the economic growth created by new jobs always overwhelms the drag from jobs destroyed—if policy makers let it happen.


The inexperienced officials around the President have managed the crisis as an exercise in political maneuvering to position the President for the election in November.

Some believed that President Obama’s personality and intelligence alone would be enough to convince and appease the voters. Some claim that the administration has won society’s silent consent. However, the government’s problem is not so much the frustration or the reactions from the various sections of our society but the uncertainty that is now eroding our confidence in investing in our economy. It appears we are moving an ever bigger government and more of a well-fare state
The Obama administration seems ineffective, but that should hardly come as a surprise since President Obama had no prior executive experience of any kind! He has lost touch with a great part of the society and he looks more and more as a spent political force. But in politics surprises are the norm!

This brilliant person with extensive academic education – a graduate of Harvard Law School and editor of the School’s Law Review – and an unusually powerful speaker has shrunk and turned into an ordinary politician.

The fact is that Obama inherited a deep financial crisis; the worse since the Great Depression. However, it is also a fact that instead of focusing his attention on handling the crisis – and primarily focusing to create an environment for entrepreneurial investments in the private sector of our economy–forming new jobs – he lost valuable time and wasted many political resources on his health care reform bill, and trying to convince us all that the previous administration continues to be at fault. Well if the previous administration had done a better job most likely senator McCain would have been elected. President Obama was elected because he promised to change things for the better people believed and trusted him to do so. He has not succeeded yet.

For me, the most essential of Obama’s problems is that after almost four years as president, there are still few people who know what he is thinking, what he represents, and what he believes. Polls show that most Americans like him and trust him. But they don’t think that he is capable of fixing the economy.

The keys to this election are the economic issues, and primarily the unemployment figures, but also personal likeability is turning out to be a factor.

The Election, the Presidency and Foreign Policy

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 American presidency is designed to disappoint. Each candidate must promise things that are beyond his power to deliver. No candidate could expect to be elected by emphasizing how little power the office actually has and how voters should therefore expect little from him. So candidates promise great, transformative programs. What the winner actually can deliver depends upon what other institutions, nations and reality will allow him. Though the gap between promises and realities destroys immodest candidates, from the founding fathers’ point of view, it protects the republic. They distrusted government in general and the office of the president in particular.
Congress, the Supreme Court and the Federal Reserve Board all circumscribe the president’s power over domestic life. This and the authority of the states greatly limit the president’s power, just as the country’s founders intended. To achieve anything substantial, the president must create a coalition of political interests to shape decision-making in other branches of the government. Yet at the same time — and this is the main paradox of American political culture — the presidency is seen as a decisive institution and the person holding that office is seen as being of overriding importance.

Constraints in the Foreign Policy Arena

The president has somewhat more authority in foreign policy, but only marginally so. He is trapped by public opinion, congressional intrusion, and above all, by the realities of geopolitics. Thus, while during his 2000 presidential campaign George W. Bush argued vehemently against nation-building, once in office, he did just that (with precisely the consequences he had warned of on the campaign trail). And regardless of how he modeled his foreign policy during his first campaign, the 9/11 attacks defined his presidency.
Similarly, Barack Obama campaigned on a promise to redefine America’s relationship with both Europe and the Islamic world. Neither happened. It has been widely and properly noted how little Obama’s foreign policy in action has differed from George W. Bush’s. It was not that Obama didn’t intend to have a different foreign policy, but simply that what the president wants and what actually happens are very different things.
The power often ascribed to the U.S. presidency is overblown. But even so, people — including leaders — all over the world still take that power very seriously. They want to believe that someone is in control of what is happening. The thought that no one can control something as vast and complex as a country or the world is a frightening thought. Conspiracy theories offer this comfort, too, since they assume that while evil may govern the world, at least the world is governed. There is, of course, an alternative viewpoint, namely that while no one actually is in charge, the world is still predictable as long as you understand the impersonal forces guiding it. This is an uncomfortable and unacceptable notion to those who would make a difference in the world. For such people, the presidential race — like political disputes the world over — is of great significance.
Ultimately, the president does not have the power to transform U.S. foreign policy. Instead, American interests, the structure of the world and the limits of power determine foreign policy.
In the broadest sense, current U.S. foreign policy has been in place for about a century. During that period, the United States has sought to balance and rebalance the international system to contain potential threats in the Eastern Hemisphere, which has been torn by wars. The Western Hemisphere in general, and North America in particular, has not. No president could afford to risk allowing conflict to come to North America.
At one level, presidents do count: The strategy they pursue keeping the Western Hemisphere conflict-free matters. During World War I, the United States intervened after the Germans began to threaten Atlantic sea-lanes and just weeks after the fall of the czar. At this point in the war, the European system seemed about to become unbalanced, with the Germans coming to dominate it. In World War II, the United States followed a similar strategy, allowing the system in both Europe and Asia to become unbalanced before intervening. This was called isolationism, but that is a simplistic description of the strategy of relying on the balance of power to correct itself and only intervening as a last resort.
During the Cold War, the United States adopted the reverse strategy of actively maintaining the balance of power in the Eastern Hemisphere via a process of continual intervention. It should be remembered that American deaths in the Cold War were just under 100,000 (including Vietnam, Korea and lesser conflicts) versus about 116,000 U.S. deaths in World War I, showing that far from being cold, the Cold War was a violent struggle.
The decision to maintain active balancing was a response to a perceived policy failure in World War II. The argument was that prior intervention would have prevented the collapse of the European balance, perhaps blocked Japanese adventurism, and ultimately resulted in fewer deaths than the 400,000 the United States suffered in that conflict. A consensus emerged from World War II that an “internationalist” stance of active balancing was superior to allowing nature to take its course in the hope that the system would balance itself. The Cold War was fought on this strategy.

The Cold War Consensus Breaks

Between 1948 and the Vietnam War, the consensus held. During the Vietnam era, however, a viewpoint emerged in the Democratic Party that the strategy of active balancing actually destabilized the Eastern Hemisphere, causing unnecessary conflict and thereby alienating other countries. This viewpoint maintained that active balancing increased the likelihood of conflict, caused anti-American coalitions to form, and most important, overstated the risk of an unbalanced system and the consequences of imbalance. Vietnam was held up as an example of excessive balancing.
The counterargument was that while active balancing might generate some conflicts, World War I and World War II showed the consequences of allowing the balance of power to take its course. This viewpoint maintained that failing to engage in active and even violent balancing with the Soviet Union would increase the possibility of conflict on the worst terms possible for the United States. Thus, even in the case of Vietnam, active balancing prevented worse outcomes. The argument between those who want the international system to balance itself and the argument of those who want the United States to actively manage the balance has raged ever since George McGovern ran against Richard Nixon in 1972.
If we carefully examine Obama’s statements during the 2008 campaign and his efforts once in office, we see that he has tried to move U.S. foreign policy away from active balancing in favor of allowing regional balances of power to maintain themselves. He did not move suddenly into this policy, as many of his supporters expected he would. Instead, he eased into it, simultaneously increasing U.S. efforts in Afghanistan while disengaging in other areas to the extent that the U.S. political system and global processes would allow.
Obama’s efforts to transition away from active balancing of the system have been seen in Europe, where he has made little attempt to stabilize the economic situation, and in the Far East, where apart from limited military repositioning there have been few changes. Syria also highlights his movement toward the strategy of relying on regional balances. The survival of Syrian President Bashar al Assad’s regime would unbalance the region, creating a significant Iranian sphere of influence. Obama’s strategy has been not to intervene beyond providing limited covert support to the opposition, but rather to allow the regional balance to deal with the problem. Obama has expected the Saudis and Turks to block the Iranians by undermining al Assad, not because the United States asks them to do so but because it is in their interest to do so.
Obama’s perspective draws on that of the critics of the Cold War strategy of active balancing, who maintained that without a major Eurasian power threatening hemispheric hegemony, U.S. intervention is more likely to generate anti-American coalitions and precisely the kind of threat the United States feared when it decided to actively balance. In other words, Obama does not believe that the lessons learned from World War I and World War II apply to the current global system, and that as in Syria, the global power should leave managing the regional balance to local powers.

Romney and Active Balancing

Romney takes the view that active balancing is necessary. In the case of Syria, Romney would argue that by letting the system address the problem, Obama has permitted Iran to probe and retreat without consequences and failed to offer a genuine solution to the core issue. That core issue is that the U.S. withdrawal from Iraq left a vacuum that Iran — or chaos — has filled, and that in due course the situation will become so threatening or unstable that the United States will have to intervene. To remedy this, Romney called during his visit to Israel for a decisive solution to the Iran problem, not just for Iran’s containment.
Romney also disagrees with Obama’s view that there is no significant Eurasian hegemon to worry about. Romney has cited the re-emergence of Russia as a potential threat to American interests that requires U.S. action on a substantial scale. He would also argue that should the United States determine that China represented a threat, the current degree of force being used to balance it would be insufficient. For Romney, the lessons of World Wars I and II and the Cold War mesh. Allowing the balance of power to take its own course only delays American intervention and raises the ultimate price. To him, the Cold War ended as it did because of active balancing by the United States, including war when necessary. Without active balancing, Romney would argue, the Cold War’s outcome might have been different and the price for the United States certainly would have been higher.
I also get the sense that Romney is less sensitive to global opinion than Obama. Romney would note that Obama has failed to sway global opinion in any decisive way despite great expectations around the world for an Obama presidency. In Romney’s view, this is because satisfying the wishes of the world would be impossible, since they are contradictory. For example, prior to World War II, world opinion outside the Axis powers resented the United States for not intervening. But during the Cold War and the jihadist wars, world opinion resented the United States for intervening. For Romney, global resentment cannot be a guide for U.S. foreign policy. Where Obama would argue that anti-American sentiment fuels terrorism and anti-American coalitions, Romney would argue that ideology and interest, not sentiment, cause any given country to object to the leading world power. Attempting to appease sentiment would thus divert U.S. policy from a realistic course.

Campaign Rhetoric vs. Reality

I have tried to flesh out the kinds of argument each would make if they were not caught in a political campaign, where their goal is not setting out a coherent foreign policy but simply embarrassing the other and winning votes. While nothing suggests this is an ineffective course for a presidential candidate, it forces us to look for actions and hints to determine their actual positions. Based on such actions and hints, I would argue that their disagreement on foreign policy boils down to relying on regional balances versus active balancing.
But I would not necessarily say that this is the choice the country faces. As I have argued from the outset, the American presidency is institutionally weak despite its enormous prestige. It is limited constitutionally, politically and ultimately by the actions of others. Had Japan not attacked the United States, it is unclear that Franklin Roosevelt would have had the freedom to do what he did. Had al Qaeda not attacked on 9/11, I suspect that George W. Bush’s presidency would have been dramatically different.
The world shapes U.S. foreign policy. The more active the world, the fewer choices presidents have and the smaller those choices are. Obama has sought to create a space where the United States can disengage from active balancing. Doing so falls within his constitutional powers, and thus far has been politically possible, too. But whether the international system would allow him to continue along this path should he be re-elected is open to question. Jimmy Carter had a similar vision, but the Iranian Revolution and the Soviet invasion of Afghanistan wrecked it. George W. Bush saw his opposition to nation-building wrecked by 9/11, and had his presidency crushed under the weight of the main thing he wanted to avoid.
Presidents make history, but not on their own terms. They are constrained and harried on all sides by reality. In selecting a president, it is important to remember that candidates will say what they need to say to be elected, but even when they say what they mean, they will not necessarily be able to pursue their goals. The choice to do so simply isn’t up to them. There are two fairly clear foreign policy outlooks in this election. The degree to which the winner matters, however, is unclear, though knowing the inclinations of presidential candidates regardless of their ability to pursue them has some value.
In the end, though, the U.S. presidency was designed to limit the president’s ability to rule. He can at most guide, and frequently he cannot even do that. Putting the presidency in perspective allows us to keep our debates in perspective as well.