SOX Generated Changes in Board Composition: Have

they Impacted Risk-Adjusted Returns

EXECUTIVE SUMMARY: This investigation examines the effect on risk-adjusted returns
for listed firms attributable to the Sarbanes-Oxley Act of 2002 and associated stock exchange
regulations. This analysis also advances the study of effects associated with the use of
independent directors, as it employs the difference-in-differences methodology to overcome
the endogeneity concerns which have consistently challenged the literature. This is
accomplished through examination of the effects on risk-adjusted returns associated with the
exogenously forced addition of independent directors to the boards of publicly listed firms.
The optimization of risk-adjusted returns is one potential area of board influence. This
optimization may be achieved via approval of capital allocations, as well as through their
efforts to advise and monitor the CEO. The results obtained reveal that there is a significant
negative relationship between firms that were compelled by law to change their boards and
their level of risk-adjusted returns, in comparison to firms that had pre-adopted similar
changes to their boards.

INRODUCTION: The aim of this study was to identify empirical evidence as to whether or
not the Sarbanes-Oxley Act of 2002 (SOX) and the concurrent New York and NASDAQ
Stock Exchanges listing requirement changes to board composition requirements contributed
to changes in the risk-adjusted returns to shareholders. This is a question of discovery, which
seeks to isolate the risk-adjusted return effects from the historic event of scandals and the
subsequent reactive laws and regulations through use of the difference-in-differences
methodology.
The central question of interest is whether the recent regulatory emphasis on increasing the
use of independent directors, on publicly listed corporate boards of directors and board
committees, has been an effective means of improving what is arguably the most important of
shareholder outcomes: their risk-adjusted returns. The importance of risk-adjusted returns
from the shareholders perspective is self-evident. The importance of risk-adjusted returns
from societys perspective is perhaps less obvious. Nonetheless, the wealth of a nation is
composed of the wealth of its citizens.
In the historical background section below, it is obvious that the monitoring and decision
optimization entrusted to boards has often failed. According to Hermalin and Weisbach
(2003), an explanation for the continued presence of multi-member boards is that each
member having other members to monitor them has remained important to retaining
shareholder trust. We therefore find ourselves, as a society, trying to find a way to make
boards work as intended for the benefit of shareholders; a goal valued for its influence on the
formation and allocation of capital.