After two years as chairman of the Public Company Accounting Oversight Board, William J. McDonough is feeling the heat. Corporate executives fume that the board's rules on testing internal financial controls -- required by Section 404 of the Sarbanes-Oxley Act -- are too costly and cumbersome. Auditors want McDonough to defend them more vigorously. McDonough, 71, joined the board in June, 2003, after a decade as president of the Federal Reserve Bank of New York. On July 15, he met with BusinessWeek editors. Here are excerpts.
You have said that in some cases, auditors went too far in applying 404. Are audit firms getting the message?
Auditors have to use judgment. They have a great deal of leeway. But in a litigious society, there's no question that some auditors may be protecting themselves by doing work that all of us might think objectively is excessive. That I want to see eliminated. The leadership of the firms agrees. But [auditors] have to be convinced that their leaders will not be pleased by excessive work.
Will companies spend less next year to comply with 404?
For a well-managed company where 404 was not that big a deal, costs will come down. Companies that really had to scramble may have an expensive second year because of investments in systems.
Auditors aren't private eyes, but aren't they supposed to detect fraud?
A good auditor most of the time should detect fraud. However, there could be cases in which, say, five people, all very brilliant, collude to steal money from shareholders and no auditor can catch them.
Many executives are complaining loudly that Sarbanes-Oxley went too far.
Sarbanes-Oxley should be interpreted by business leaders as the American people's condemnation of the behavior of the business community at large. [Those who believe in] the "few rotten eggs" scenario are misleading themselves. I'm really, really worried about business leaders not realizing that it is in their interest and that of our country to restore public confidence.
How important is reining in runaway CEO pay?
It's the single most important issue. When I was a kid, everyone was convinced you could become President, or head of First National Bank of Chicago. But now there's sort of a feeling that there are fat cats protecting themselves and "gee, my kid can't get into that group." That's a terrible message, but it is the message the average American is getting. Breaking the connection between the wealthy and the rest of us would be a great disservice. I tell business leaders: "You can't afford this rupture between yourself and the American people."
What do you say to CEOs who complain that reforms are discouraging them from taking risks?
It's wrong to blame it on Sarbanes-Oxley. The reason Congress passed [the law] was dissatisfaction with business leadership. If the attitude of the American people toward the business community doesn't come back in two or three years -- max -- we'll get a push toward more regulation.
What's your view on the global economy?
I don't have many short-term concerns. The U.S. economy is looking very good; Europe is disappointing; Japan is moving in fits and starts but is growing. My longer-term concern is with international flows of capital. Right now 6 1/2% of U.S. gross domestic product is financed by savings from elsewhere in the world. The sources of these funds are poor countries, mostly in Asia. In any reasonable model, rich countries should export capital to growing poor countries. If you have poor countries financing the consumption of rich countries -- that's not sustainable.