The effect of the Sarbanes-Oxley Act of 2002 on corporate governance

The Sarbanes-Oxley Act of 2002 (SOX) introduced strict governance rules for public companies in the US to prevent diversion of resources by corporate insiders. Another governance mechanism that serves to align the interests of managers and directors of the firm with outside shareholders is ownership structure as discussed in Chapter 1. The equity structure of dual-class firms is characterized by multiple classes of shares with differential voting rights, which allows insiders to hold disproportionate dividend and voting rights. Dual-class status may serve as a protection from value-reducing takeovers and help the realization of growth options. At the same time, since managerial cash-flow rights have an incentive alignment effect, while voting control reduces the discipline of the market for corporate control, dual-class firms may protect large private benefits of insiders.;Chapter 2 evaluates the effect of SOX on incentive alignment between managers and shareholders. The value-increasing effect of managerial cash-flow rights is expected to be smaller in magnitude after SOX. Similarly, the negative effect of voting control should be less pronounced after SOX. Using dual-class firms, these effects can be separately estimated in a panel data model. Results indicate a smaller positive effect of cash-flow rights which is evidence that the governance provisions of SOX improve managerial incentive alignment.;Chapter 3 analyses differences in returns on inferior and superior shares of dual-class firms, which are expected to reflect reduced value of voting control after SOX. The market models in the event study methodology account for non-synchronous trading due to thin market in the superior shares. There is no evidence of improved performance of inferior shares vs. superior shares in the market's expectations around key SOX dates.;Insiders would value control less if SOX limits private benefits of control and may want to divest their holdings by recapitalizing into single-class. At the same time, if dual-class status is beneficial to outside shareholders, the new rules would reduce the cost in terms of diversion of resources. Chapter 4 empirically tests the effect of SOX on recapitalization decisions of dual-class firms into single-class by formulating a survival model. Results indicate that the propensity of firms to recapitalize into single class is significantly higher after the passage of the Act.