Board monitoring, firm risk, and external regulation

Abstract

We examine the relationship between board monitoring and firm characteristics using a broad sample of firms over the 8 year period from 1996 to 2003. We find that board independence and monitoring is negatively related to firm risk in the absence of external regulation. In addition, we find that external regulatory and political pressures affect the level of board monitoring, especially after the increased focus on board composition by the stock exchanges beginning in 1999 and the passage of the 2002 Sarbanes–Oxley Act. We find that the sensitivity of the negative relationship between board monitoring and firm risk decreases in the post 1999 period suggesting that firms have increased board monitoring in response to external regulations. We also find that these external regulations have had an asymmetrical impact on high-risk firm. In our empirical analysis we also control for other factors that affect board monitoring and find that firms in which the CEO has longer tenure and greater equity ownership have less board monitoring activity and that there is a negative relationship between the level of board monitoring and the level of shareholder rights.