The Sarbanes-Oxley Act (SOX) and related stock listing requirements now require boards of publicly traded companies to have a majority of outside, independent directors to provide a counterbalance to the power of management on the board. SOX also mandated the existence of three board committees, audit, nominating, and compensation which had to be comprised solely of independent directors.
Using a sample of 335 firms and 3,675 observations from the S&P 500 from 1999 to 2009, I use panel Poisson regressions in pre-SOX (1999-2003) and post-SOX (2004-2009) periods to test the effect of SOX structural changes at the board and committee levels on governance practices as measured by the Entrenchment Index. I first consider the direct relationships, suggesting positive relationships between the mandated requirements of board independence, the presence of audit, nominating and compensation committees, and the independence of these committees on governance practices supporting shareholder value at the board level in the pre- and post-SOX periods. In the pre-SOX period I find significant relationships between board independence and governance practices as well as significant relationships between the existence of audit, nominating, and compensation committees and governance practices; however, they were not in the direction hypothesized. I find no significant relationships in the post-SOX period.
I then create a new construct, board independence power (comprised of dimensions of structure/prestige, ownership and expertise) to measure the latent power of the independent members of the board. I validate the construct quantitatively through a factor analysis and interviews with board members and lawyers specializing in corporate governance.
I hypothesize that board independence power positively moderates the relationship between the SOX structural changes and selected governance practices supporting shareholder value at the board level. In the pre and post-SOX periods, board independence structure/prestige power significantly moderates the relationship between the existence of the mandated committees and selected governance practices supporting shareholder value when they were lagged for one and two time periods.
Results of this study demonstrate that the SOX structural changes by themselves have not led to better governance practices by boards. This is important given the organizational attention, energy and cost necessary to fulfill the SOX requirements
