Corporate Governance Responses to Director Rule Changes

This paper explains the governance changes induced by the director rules under the Sarbanes-Oxley Act and stock exchange rule changes. The paper uses the law change as a natural experiment to test how firms adjust the choice and magnitude of governance tools given a “floor level” of monitoring from independent directors.


In 2002, U.S. stock exchanges and the Sarbanes-Oxley Act established minimum standards for director independence. The laws induced changes in firm agency controls is studied on a two new datasets (The Director Database and Equilar Executive Compensation) with a much larger range of firm size than previous studies. Firms most treated by the director rules increase leverage and decrease CEO stock ownership. This suggests that leverage complements and CEO ownership substitutes for outside director supervision. The average treated firm also increased interlocking directorships, the number of other boards its directors serve. The rules failed to reduce CEO misbehavior like excess compensation, heavy use of incentive-compensation, or low turnover. Additionally, treated firms do not outperform the market. These results are more consistent with governance optimization than either managerial entrenchment or compliance cost explanations.

Keywords: Independent directors; Governance; Sarbanes-Oxley Act; Executive compensation; Agency costs; Managerial entrenchment
JEL: G18, G30, G34, G38