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

Abstract

This paper investigates whether the NYSE and Sarbanes Oxley Act requirements for the independence and the financial knowledge of directors sitting on the board and the audit committee improve corporate hedging decisions. Our original hand collected dataset allows multiple definitions for financial knowledge. We show that financially educated directors encourage corporate hedging while financially active directors and those with an accounting background play no active role in such policy. This evidence combined with the positive relation we report between the firm’s hedging ratio and its performance suggests that shareholders are better off with financially educated directors on their boards and audit committees. Finally, we provide the first direct evidence showing that university education of directors is an important determinant of the hedging activity.

Keywords: Corporate governance, risk management, Sarbanes Oxley act, university education