Board Structure and Monitoring

In the paper, Board Structure and Monitoring: New Evidence from CEO Turnover, which was recently made publicly available on SSRN, we provide new evidence on the potential benefits of SOX and ensuing new exchange listing rules and the effectiveness of monitoring by independent directors. Although many researchers, regulators and investors believe that increasing the representation of independent directors on corporate boards can improve quality of board oversight, empirical evidence has been mixed and inconclusive. Recent research even raises doubt about the effectiveness of independent directors in monitoring CEOs.

Using the change in NYSE and Nasdaq listing rules following the passage of the Sarbanes-Oxley Act as a source of exogenous variation, we provide the first statistically convincing evidence on a causal relation between board (committee) independence and the sensitivity of forced CEO turnover to firm performance. Specifically, we find that firms that after SOX moved to a majority of independent directors or to a fully independent nominating committee experience increased sensitivity of forced CEO turnover to performance. This evidence suggests that quality of board monitoring is positively related to board independence and nominating committee independence and the causation goes from board structure to quality of board monitoring.

Consistent with the increase in turnover-performance sensitivity representing more effective monitoring, we find that forced CEO turnovers are followed by improvements in both stock performance and operating performance in firms that are forced to adopt majority independent boards or fully independent nominating committees. Plots of cumulative abnormal stock returns and change in ROA around forced CEO turnovers in these firms show that these firms in general experience a smaller decline in firm performance prior to CEO turnover and a quicker recovery thereafter in the post-SOX period than they do in the pre-SOX period.

Lastly, when we compare turnover announcement period abnormal stock return in the pre- and post-SOX period, we find no evidence that the more prompt firing in the post-SOX period significantly increases the chances of making type I errors. Since the increase in sensitivity of forced CEO turnover to firm performance should in general lead to stronger incentives to CEOs, the lack of evidence of premature firing suggests that the increase in sensitivity appears to be indicative of more effective monitoring.

The full paper is available for download here.