The cost of regulatory compliance continues to inflate for Corporate America, according to a recent study, with some sectors, such as manufacturing, paying a much higher price than others.
The report, “The Impact of Regulatory Costs on Small Firms,” from the Small Business Administration, also found that small business spend a disproportionately higher percentage on compliance than mid-sized or large ones.
“Under any scenario the cost burden of regulations is rising,” says Mark Crain, co-author of the study, and a professor at Lafayette College. He notes that the cost of regulatory compliance has risen every time since the SBA first started tracking the statistic in the 1990s. The SBA study looks at the overall cost of federal regulations divided into four categories: economic; environmental; tax compliance; and occupational safety and health, and homeland security.
In total, the compliance cost for all federal regulations in 2008 was an estimated $1.75 trillion—an amount equal to 14 percent of the U.S. national income. The cost burden on businesses was pegged at about $970 billion. Individuals and state and local governments pay the balance. Those numbers are a 3 percent increase from the estimated $1.7 trillion cost (in 2009 dollars) on companies in 2004, the last year the SBA analyzed the data.
Beresford
“There's no doubt the cost of compliance is very high and going up,” says Dennis Beresford, an accounting professor at the University of Georgia who also served on the Financial Accounting Standards Board and sits on the boards of Fannie Mae, Kimberly Clarke, and Legg Mason.
The study, based on 2008 data, doesn't account for 2010 legislation such as the Dodd-Frank Act or healthcare reform. “These costs will rise tremendously as a result of the healthcare legislation and as a result of the new financial reform legislation,” Crain warns.
Crain
According to the study, the total costs broken down by regulation from highest to lowest are:
Economic (including price controls and trade laws): $1.23 trillion;
Environmental: $281 billion;
Tax: $160 billion; and
Occupational safety and health, and homeland security: $75 billion.
“There's no doubt the cost of compliance is very high and going up.”
—Dennis Beresford,
Professor of Accounting,
JM Tull School of Accounting
Taking into consideration all company sizes, sectors, and federal regulations, the study found that the cost burden on a typical U.S. firm is roughly $161,000. That averages out to $8,086 per employee per year, although specific cost burdens vary greatly for each individual company. “It really depends on the type of business as to what specific regulation or what areas they're going to be most concerned about,” Beresford says.
Broken down by company size, large firms (500 or more employees) carry a cost of $7,755 per employee annually, while medium-sized firms (20 to 499 employees) spend roughly $7,454 per employee.
Not surprisingly, small businesses feel the most pain for cost of compliance. For firms with fewer than 20 employees, the average cost is $10,585 per employee each year—at least 36 percent higher than in medium and large firms. Even more devils are in the details: Small firms pay more than four times as much as their larger brethren for environmental compliance, and three times as much for tax compliance.
Cost Distribution
Still, the study found that the “cost gap” between small and large firms actually shrank in the latter half of the 2000s, from a 45 percent gap in 2008 to only 36 percent in 2008. And when that gap is considered in each of the study's five major business sectors—manufacturing, wholesale and retail trade, healthcare, and “other”—the differences start to vary widely.
The manufacturing sector bears the highest total regulatory burden, with a compliance cost of $688,944 per manufacturing firm. The second most costly sector is the “other” category at $188,704 per firm.
Broken down by firm size, the burden on small firms is most dramatic for the manufacturing sector, where the estimated cost per employee for small firms is 110 percent higher than for mid-sized firms ($28,316 versus $13,504), and 125 percent higher than for large firms ($28,316 versus $12,586).
Small firms in the “other” category, meanwhile, pay 70 percent more in per capita compliance costs than mid-sized firms, and 83 percent more than large firms. In the healthcare sector, the numbers are 45 percent and 28 percent, respectively. Only in the services sector do small firms get anything near a fair deal compared to their larger rivals, paying 13 percent more per worker than mid-sized companies and 9 percent more than large ones.
The High Cost of Legalese
REGULATORY COST STATS
The following charts from the Small Business Administration show the division of regulatory compliance costs in terms of company size for 2008 (top) and 2005 (bottom):
Source: Small Business Administration.
Future compliance costs are only expected to rise, too, for reasons well beyond the sheer proliferation of laws governing companies. The language of legislation is “often very vague,” Crain says, and is getting worse. Simply interpreting the rules and hiring advisers to determine whether a company is in compliance with them now requires considerable investment and cost.
This is particularly for the Dodd-Frank Act, Beresford says. Right now companies are broadly familiar with what Dodd-Frank says, but don't know the specifics of how to implement its goals, “so they are managing business for the time being with a lot of question marks,” he says. “Just keeping track of all of the regulations that companies are responsible for and making sure that they do comply is a very formidable task these days.
McLaughlin
John McLaughlin, a senior managing director for LECG, questions the value in it all. Companies spend a lot of money to stay in compliance with regulations, “but is the company gaining a benefit for the fact that they're complying with these regulations?” he asks. “It's tough to measure that reward.”
According to McLaughlin, more companies try to do just that. He says they are putting in place “combined assurance” programs, integrating and aligning a company's multiple assurance functions to help reduce internal costs of regulations. While many companies have various risk-management activities, he adds, they haven't aggregated them into one enterprise-wide program that lets them see how each control relates to a particular regulation—with the goal of eliminating duplicate controls and simplifying the overall process.
“An emerging issue that you'll see within the next year or two is this issue of combined assurance as it relates to more a more effective enterprise risk-management program,” he says.
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