Corporate Governance Principal-Agent Problem: The Equity Cost of Independent Directors

25 Pages Posted: 22 Jul 2014 Last revised: 11 Jun 2015

See all articles by Sebastien Gay

Sebastien Gay

The University of Chicago

Chris Denning

University of Chicago

Date Written: October 17, 2014

Abstract

The classic question in corporate governance is how to manage the conflicts-of-interest that arise from fundamental principal-agent problems. One of the most popular methods of solving the problem is by separating ownership and management. Since 2002, the Sarbanes-Oxley Act has set new standards for board composition by using independent directors, especially for audit committees. This article analyzes the impact of board composition, related to a majority of independent directors, on returns. For this purpose we construct a panel dataset of 2919 stocks over a 10 year period. We find that a majority of independent directors on the board has an overall negative effect on stock returns. We also use our panel data set to show the consequences of the Sarbanes-Oxley Act on the defense or offense mechanisms that companies might pursue over their lifespan.

Keywords: Corporate Governance, Independent Directors, Board of Directors, Monitoring Effect, Signaling Effect; Advising Effect, Takeovers

JEL Classification: G14, G38, J33, L14

Suggested Citation

Gay, Sebastien and Denning, Chris, Corporate Governance Principal-Agent Problem: The Equity Cost of Independent Directors (October 17, 2014). Available at SSRN: https://ssrn.com/abstract=2468942 or http://dx.doi.org/10.2139/ssrn.2468942

Sebastien Gay (Contact Author)

The University of Chicago ( email )

Department of Economics
1126 East 59th Street
Chicago, IL 60637
United States
773-834-0887 (Phone)

HOME PAGE: http://www.sebastiengay.com

Chris Denning

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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