Only a few years ago, the mere mention of “corporate governance” was enough to put anyone to sleep. No hard-charging, cutting-edge corporate executive had time to be overly preoccupied with audit committee meetings, right? How times have changed as illustrated by the ongoing corporate scandals on Wall Street, which continue to ooze like a never-ending tube of toothpaste. In today's climate, a panel discussion on the Sarbanes-Oxley Act — which regulates the accounting industry and seeks to improve the disclosure practices of public companies — is virtually guaranteed to fill a room.

Although the corporate governance issue has no bearing on how the property markets will perform in the year ahead, mark my words: the full impact of Sarbanes-Oxley will be one of the big stories in commercial real estate in 2004 and beyond.

For starters, compliance is expensive and time-consuming. “I believe Sarbanes-Oxley will drive less-motivated public companies out of the public arena because this is just one new layer of pain that some companies may choose not to deal with,” says Dale Anne Reiss, global director of real estate, hospitality and construction for Ernst & Young. Reiss estimates the impact on real estate investment trusts (REITs) will be one to three cents per share (earnings per share).

Simply stated, a president of a Fortune 100 company told Reiss that the average annual cost to a public company for complying with Sarbanes-Oxley is $500,000. That figure doesn't take into account Section 404 of the Act, which requires companies to attest to the adequacy of their internal controls. The rule becomes effective in June.

“The cost [of compliance] is higher for smaller REITs because they are less likely to already have an internal audit staff, or well-documented systems of control,” says Reiss. That doesn't mean there will be a wave of public companies going private, but it's likely to spark more mergers. “As the burdens of being public become more difficult, mergers become a real natural.”

Whether REIT executives believe that Sarbanes-Oxley is an overreaction to corporate chicanery is irrelevant, Reiss says, because it's the law of the land. “The best thing that a company can do is to comply in spirit, not just in letter.”

In effect, audit committees are setting the plow deeper, according to Reiss. For example, quarterly audit committee meetings are twice as long as they used to be. In some cases, they last an entire day. What occurs at these meetings? Audit committee members pore over the books to find out why revenues are up or down from a previous quarter. They look for potential conflicts of interest across the board. “Every audit committee has a hotline so that a disgruntled employee can call and say, ‘I think a bad thing is happening,’ and the committee needs to be prepared to deal with such a situation,” says Reiss.

But is the spotlight on corporate governance a passing fad or something more permanent? “If people are put in prison based on violations of Sarbanes-Oxley,” says Reiss, “it will go for awhile.”