Risk Management and Corporate Governance: The Importance of Independence and Financial Knowledge

Abstract

This paper provides an independent assessment of the effects of the New York Stock Exchange (NYSE) and the Sarbanes Oxley act (SOX) requirements of independence and financial literacy on the use of derivatives for hedging purposes. Our original hand collected database on directors' university education and financial experience allows multiple definitions of financial knowledge. We show that financially educated directors encourage the use of derivatives as opposed to directors with only financial experience or accounting background. We also find evidence that shareholders are better off with financially qualified board and audit committee members. Specifically, we provide the first direct evidence showing that graduate education of the board including the CEO is an important determinant of the hedging activity using derivatives.

Keywords: Risk management, hedging using derivatives, SOX and NYSE regulations, university education of directors, firm performance

JEL Classification: G18, G30