In our paper, Director Ownership, Governance, and Performance, forthcoming in the Journal of Financial and Quantitative Analysis, we study the impact of SOX on the relationship between corporate governance and company performance. A significant part of SOX and other exchange requirements increase the role of independent board members. Given that prior academic research suggests there is no positive relationship between board independence and firm performance, the above regulatory efforts are especially notable.
We find a shift in the relationship between board independence and firm performance after 2002. Prior to 2002, we document a negative relationship between board independence and operating performance. After 2002, we find a positive relationship between independence and operating performance. We find this result is driven by firms that increase their number of independent directors. An event study provides independent evidence supportive of the above results – specifically, when a company goes from being non-compliant to being compliant with SOX’s board independence requirement, the market response is significantly positive. Why might SOX be related to this positive performance? SOX and the listing standards impose new responsibilities on firms’ directors, such as regular meetings of the independent directors, approval of director nominations by independent directors, and approval of CEO compensation by independent directors. As a consequence of these policies boards began including more independent directors, and, perhaps the independent directors became more engaged in the firm’s governance processes. For example, we find that firms with greater board independence (and stock ownership of board members) are less likely to engage in a value-destroying activity, namely, acquisitions.read more