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The Effects and Unintended Consequences of the Sarbanes-Oxley Act on the Supply and Demand for Directors

By Harvard Law School Program on Corporate Governance

(Editor?s Note: This post comes to us from James S. Linck and Jeffry M. Netter of the University of Georgia and Tina Yang of Clemson University.)

In our forthcoming Review of Financial Studies paper The Effects and Unintended Consequences of the Sarbanes-Oxley Act on the Supply and Demand for Directors, we examine the effects of SOX and contemporary reforms on the structure and makeup of corporate boards and directors.

We examine the effects of SOX using a simple framework of demand and supply for directors. Specifically, demand for directors increased due to various mandates on board composition and workload. The supply of directors decreased due to the increased workload and risks of being a director. While we cannot directly trace out the shifts of the curves, we examine the magnitude of the changes caused by these demand and supply shifts on the number and pay of directors (price and quantity). Both demand and supply shifts would increase the price of directors (pay) ? indeed, director pay does rise dramatically. While the shifts have opposite effects on quantity, some of SOX?s requirements often necessitate that the quantity of directors increases; thus, we expect that the demand effect will dominate. In fact we find that boards are larger post SOX.

We construct several different samples for our empirical analysis to provide sufficient breadth and depth to identify important time series and cross-sectional impacts. For example, we study the boards of more than 8,000 firms from 1989 to 2005, providing broad-sample evidence on the impact of SOX and contemporary changes on the major exchanges. We complement our broad-sample evidence with more detailed analysis of smaller subsamples. The breadth and depth of our sample allow for a comprehensive analysis of board-related costs, and the extent to which the costs of these regulatory mandates are uniform across firms.

Our results suggest that SOX dramatically affected corporate boards, their activities, and their costs. Median pay per director rose by more than $38,000 from 2001 to 2004, an increase of more than 50%. By comparison, CEO pay increased by just 24% over the same time period. The per director pay increase, coupled with the fact that firms also have more outside directors, drove a substantial increase in total director fees paid by firms. Our results also suggest that changes in director pay especially fall on smaller firms, a fact that was exacerbated by SOX given the dramatic post-SOX rise in director compensation. For example, small firms paid $3.19 in director fees per $1,000 of net sales in 2004, which is $0.84 more than they paid in 2001 and $1.21 more than in 1998. In contrast, large firms paid $0.32 in director fees per $1,000 of net sales in 2004, seven cents more than they paid in 2001 and ten cents more than in 1998. Further, the proportion of equity to cash pay rose significantly post SOX. Board committees meet more often post SOX and Director and Officer (D&O) insurance premiums doubled. Directors post SOX are more likely to be lawyers/consultants, financial experts and retired executives, and less likely to be current executives. Lastly, post-SOX boards are larger and more independent.

The full paper is available for download here.

Full post as published by The Harvard Law School Corporate Governance Blog on November 13, 2008 (boomark / email).