| The overall objective of this thesis is to advance the understanding of the economic consequences of the Sarbanes-Oxley Act of 2002 (SOX) by examining its impact on managerial incentives and shareholder wealth. Specifically, the study investigates (a) whether the market reaction to SOX is a function of corporate governance strength and the extent of firms' agency costs in the pre-SOX period and (b) whether the market reaction to SOX reflects its effect on executive compensation structure and investment opportunity sets.; The premise of this study is that the net benefit to shareholders from imposing stronger corporate governance requirements depends on how effective corporate governance was in the pre-SOX period. That is, strengthening inadequate corporate governance is beneficial to shareholders, but imposing too much governance on firms with adequate corporate governance is costly to shareholders.; Specifically, I examine three sets of hypotheses. First, SOX will be of greater net cost to firms with adequate corporate governance despite weak and of greater net benefit to firms with inadequate corporate governance despite strong. Second, the better the CEO compensation is tied to the change of the shareholders' wealth, the more adverse the consequences of SOX if it results in managers becoming overly risk averse after SOX. Last, the decrease in investment opportunity sets due to SOX stipulations for firms with adequate pre-SOX corporate governance would be value-decreasing to shareholders in such firms. Following Core et al. [1999], I use long-term firm performance (relative to industry) as the proxy for the adequacy of pre-SOX corporate governance and use Gompers' index as a measure of the strength or level of pre-SOX corporate governance.; The results suggest that the market reaction to SOX is a function of the adequacy rather than the strength or the level of pre-SOX corporate governance. For firms with adequate pre-SOX corporate governance, the higher the incentive ratio, the lower is the market reaction to SOX. For firms with inadequate pre-SOX corporate governance, the higher the incentive ratio, the higher is the market reaction to SOX. Finally, I document significant declines in investment opportunity only for firms with adequate pre-SOX corporate governance (despite apparently being weak). Sensitivity tests indicate that these firms have smaller magnitudes of discretionary accruals and higher cash flow predictability of such discretionary accruals. In the post-SOX period, they are also associated with significant declines in sales, return-on-assets, price-earning ratio for these firms. These results are consistent with the market reaction to the events leading up to the implementation of SOX. |
