A new University of Georgia study finds that the landmark Sarbanes-Oxley Act of 2002 and related rule changes of the major stock exchanges have dramatically altered the makeup of corporate boards, making them larger and more independent. The legislation also had the unintended effect of increasing director pay by more than 50 percent.
"Post Sarbanes-Oxley, the demand for directors by firms is up and the supply is down because the job is harder," said study co-author Jeff Netter, a finance professor and chair holder in UGA's Terry College of Business. "So what do you find? Pay is up - pay is way up."
The Sarbanes-Oxley Act (SOX) was passed with near unanimous Congressional approval following the corporate scandals that brought down companies such as Enron and WorldCom. Among other things, the act and changes imposed by the New York Stock Exchange and NASDAQ sought to enhance corporate governance by promoting board independence and imposing greater responsibility and accountability on board members.
In their paper, which is available online at http://ssrn.com/abstract=902665, Netter, associate professor James Linck and former doctoral student Tina Yang (now at Clemson University) call Sarbanes-Oxley "the most dramatic change to securities laws regulating corporate governance since the Great Depression." Previous laws set disclosure requirements, they explain, but SOX sets specific rules for how corporations should be governed.
To gauge the impact of the law on corporate boards, the researchers examined data on more than 8,000 firms of various sizes between 1989 and 2005. Among other things, they found that median pay per director rose from $52,495 in 2001 to $80,646 in 2004, an increase of more than 50 percent.
The researchers also find that the higher costs of director pay are disproportionately borne by small companies. Small firms paid $3.19 in director fees per $1,000 of net sales in 2004, which is $.81 more than they paid in 2001. Large firms, on the other hand, paid $.32 in director fees per $1,000 of net sales, seven cents more than they paid in 2001.
Director workload also increased post-SOX. The researchers found that audit committees met roughly twice as often after the law was implemented, from an average of 2.6 meetings per year for small firmsin 2001 to 5.1 meetings per year in 2004. Audit committees of large firms met and average of 4.5 times per year in 2001 and 8.2 times in 2004.
Under SOX, directors now face more legal liability for corporate malfeasance, and their director and officer (DandO) insurance premiums have increased sharply as a consequence. In a sample of firms incorporated in New York, DandO premiums rose from a median of $143,000 in 2001 to $360,000 in 2004, an increase of 152 percent. For a sample of SandP 500 firms, DandO premiums rose from $826,000 in 2001 to $3.0 million in 2004, an increase of more than 264 percent.
"Members of the audit committee really have to work harder post-SOX and are much more accountable," Linck said. "Some firms even pay additional fees to members of the audit committee, which was rare before SOX."
Linck and Netter acknowledge that the changes in director pay and board makeup following SOX aren't caused by the legislation alone. They note that SOX coincided with a large drop in stock prices, the start of a recession and a series of corporate scandals. SOX coincided with rule changes at the NYSE and NASDAQ. But they call SOX a turning point, and said their data supports the idea that firms are making substantial changes in response to it.
The researchers also said the question of whether SOX has improved corporate performance or reduced malfeasance is beyond the scope of their study. A possible consequence of SOX may be that firms change their behavior in some ways to avoid it. They point out that data suggest that more companies went private post-SOX and more went dark, meaning that they filed paperwork with the Securities and Exchange Commission that allows them to function as a private company. They also note that foreign companies appear to be shifting their fundraising from the United States to other nations.
"As recently as 2000, nine out of every 10 dollars raised by foreign companies through equity offerings were raised in New York instead of London or Luxembourg," Linck said. "However, the reverse is true by 2005. That's a pretty major shift in terms of where firms are going public, and a lot of people argue that it's because it has become so expensive to be public in the U.S."