Increased Disclosure Requirements and Corporate Governance Decisions

In the paper, Increased Disclosure Requirements and Corporate Governance Decisions: Evidence from Chief Financial Officers in the Pre- and Post-Sarbanes Oxley Periods, which is forthcoming the Journal of Accounting Research, I examine how the new internal control disclosure requirements mandated by SOX affect annual corporate governance decisions regarding CFOs. The “disclosure of type” hypothesis argues that increased disclosures on internal controls mitigate information asymmetry between the board and the CFO by credibly disclosing the quality of firms’ internal controls, thus distinguishing good CFOs from bad ones. As a result, it predicts lower pay and higher turnover for low-quality CFOs.

My empirical analyses employ a difference-in-difference research design to examine changes in annual corporate governance decisions from the pre-SOX period to the post-SOX period for CFOs relative to other non-CEO, non-COO executive officers. I obtain two main empirical findings. First, while average levels of CFO salary, bonus, and total compensation for the full sample do not change over the sample period, there is a significant increase in the levels of CFO salary, bonus, and total compensation in the post-SOX period compared to the pre-SOX period for firms with strong internal controls, and a significant decrease in those areas for firms with weak internal controls. Second, while the results show significant increases in CFO turnover rates from the pre-SOX period to the post-SOX period in all firms, additional analyses that restrict the sample to forced turnovers find significant increases in CFO turnover rates only in firms with weak internal controls.

Collectively, these significantly different patterns in CFO compensation and turnover changes between firms with strong internal controls and those with weak internal controls are consistent with the “disclosure of type” hypothesis, supporting the notion that mandated increases in disclosure reduce information asymmetry in the executive labor market.

The full paper is available for download here.