The Impact of SOX and SEC Investigation on Corporate Governance of Option Backdating Firms

Abstract

We investigate the exogenous impacts of the Sarbanes and Oxley (SOX) regulations and the SEC’s investigations on stock-option backdating firms’ corporate governance characteristics in three periods – pre-SOX, post-SOX, and the SEC’s investigation. Our logistic estimates show that backdating firms are associated with weaker board and committee corporate governance measures including less independent and less diligent board and compensation committee, fewer subcommittees and no fixed granted date in the pre-SOX period. Backdating firms are no longer associated with weaker board-level summary governance measures but they are still significantly associated with weaker committee-level governance measures in the post-SOX period. The SEC’s investigations prompt backdating firms to strengthen their governance mechanisms by replacing Founder-CEOs. The investigations also result in other changes in backdating firms’ governance mechanism. It appears that SEC’s investigations have a great impact on backdating firms’ governance practice. Additionally, we find that backdating firms are associated with higher CEO stock-option compensation.

Keywords: options backdating, corporate governance, CEO compensation

JEL Classification: C13, C2, G18, G28