The past decade brought to the public’s attention record-breaking bankruptcy filings in the U.S. While many of these failures occurred in association with the downturn in the market, many did not. Some, for example, were the result of significant fraud.
Regardless of the causes of these substantial bankruptcies, and particularly in the wake of the Enron and WorldCom collapses in the early 2000s, a strong consensus emerged among policymakers and industry observers that existing management practices and government oversight were insufficient to promote a well-functioning and sound security market.
It is commonly understood that the separation of ownership and control leads to potential agency-related problems (see Berle and Means, 1932; Jensen, 1986; and Jensen and Meckling, 1976). These costs have persistently challenged market participants and regulators to engineer governance controls to mitigate any potential for managers to expropriate wealth from their stakeholders. Independent of government regulation, external market pressures have forced firms to develop internal and external governance measures to allow a firm’s stakeholders to more accurately monitor and measure its performance. However, the perceived lapse in these mechanisms led the U.S. Congress to pass the Sarbanes-Oxley Act of 2002. Among other requirements, the Sarbanes-Oxley Act demands firms to have audit committees comprised of independent directors and forces financial officers to certify that the firm’s financial statements are accurate. Moreover, the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board to oversee, regulate, inspect, and discipline accounting firms in their roles as auditors.
Corporate governance, as defined by Shleifer and Vishny (1997), refers to the ways in which investors ensure that they will receive maximum return on their investments. Fundamental components of an effective governance structure include managerial ownership, size and composition of the board of directors, CEO and directors’ compensation schemes, audit controls, and an external market for corporate control (Keasey and Wright, 1997). In general, effective governance controls agency conflicts between management and investors in two ways. First, the free-cash flow problem of a firm can be reduced through dividend policy, stock repurchases, capital structure decisions, and investment in long term projects. Second, the likelihood of management entrenchment can be reduced, thus strengthening shareholders’ rights.
The purpose of this paper is to investigate the impact of government regulation with respect to the Sarbanes-Oxley Act on the existing agency relation between corporate governance measures and dividend policy. Specifically, our research question is: Does the relation between dividend payout policies and various measures of governance and firm-specific characteristics change after the enactment of Sarbanes-Oxley? Empirical results show that prior to the Sarbanes-Oxley Act, shareholders’ rights, board size, and the proportion of outside directors are statistically significant factors in explaining a firm’s dividend policy. Following Sarbanes-Oxley, however, regulatory changes have structurally altered the impact that governance measures have in explaining dividend policies.
The paper is organized as follows. Section II reviews selected literature. Section III discusses and summarized the data and methodology, while Section IV presents the empirical findings and robustness tests. Section V provides concluding remarks.
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