A new study co-authored by Terry finance professors Jeff Netter and Jim Linck and former doctoral student Tina Yang finds that the landmark Sarbanes-Oxley Act of 2002 — as well as related rule changes at 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 54 percent.
"Post Sarbanes-Oxley, the demand for directors is up and the supply is down because the job is harder," says Netter. "So what do you find? Pay is up — way up."
The Sarbanes-Oxley Act was passed with near unanimous congressional approval following scandals that brought down companies such as Enron and WorldCom. In conjunction with changes imposed by NYSE and Nasdaq, the act sought to enhance corporate governance by promoting board independence and imposing greater responsibility and accountability on board members.
In their paper, the authors label Sarbanes-Oxley "the most dramatic change to securities laws regulating corporate governance since the Great Depression." Previous laws set disclosure requirements, they explain, but Sarbanes-Oxley sets specific rules for how corporations should be governed.
To gauge the impact of the law, the researchers examined data on more than 8,000 firms of various sizes from 1989-2005. Median pay per director rose from $52,495 in 2001 to $80,646 in 2004, an increase of more than 50 percent. Data also showed that higher costs of director pay are disproportionately borne by small firms; they paid $3.19 in director fees per $1,000 of net sales in 2004, which is 81 cents per $1,000 more than they paid in 2001. Large firms, on the other hand, paid 32 cents in director fees per $1,000 of net sales, a mere seven cents more than in 2001.
Director workload also increased in the aftermath of SOX. Audit committees met roughly twice as often, from an average of 2.6 meetings per year for small firms in 2001 to 5.1 meetings per year in 2004. Audit committees of large firms met 4.5 times per year in 2001 versus 8.2 times in 2004.
Under Sarbanes-Oxley, corporate directors now face more legal liability for corporate malfeasance, and their director and officer insurance premiums have increased sharply as a consequence. In a sample of firms incorporated in New York, D&O premiums rose from a median of $143,000 in 2001 to $360,000 in 2004, an increase of 152 percent. For a sample of S&P 500 firms, D&O 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 must work harder post-SOX and are much more accountable," says Linck. "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 weren't caused by SOX alone. The legislation coincided with a large drop in stock prices, the start of a recession, and a series of corporate scandals. Sarbanes-Oxley coincided with rule changes at the NYSE and Nasdaq. But the authors see SOX as a turning point, and their data supports the idea that firms are making substantial changes in response to it.
The researchers say the question of whether Sarbanes-Oxley has improved corporate performance or reduced malfeasance is beyond the scope of their study. Data suggests that more companies went private after Sarbanes-Oxley and more went dark, meaning they filed paperwork with the SEC that allows them to function as a private company. The authors note that foreign companies appear to be shifting their fundraising from the U.S. 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," says Linck. "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."
Sam Fahmy (BS '97) is a science writer in the UGA News Service.