Independent Directors and Dividend Payouts in the Post Sarbanes-Oxley Era

• In Event: Breakfast and Research Forum
  In Roundtable Session: Table 9: Boards of Directors and Audit Committees

Abstract

The manner in which publicly traded companies’ management teams handle their firm’s free cash flows (FCF) has been an issue for many decades since it is difficult to determine whether these management teams work for their own benefit or for that of their shareholders. Recent financial scandals have heightened mistrust of management. This mistrust, in turn, may have increased the pressure to reduce the portion of FCF left under management’s control. Boards of directors control dividend payout decisions, thus determining the portion of FCF available to corporate management. This article examines whether the 2002 legal response to corporate financial reporting scandals, which came in the form of many new initiatives and requirements on all firms, was relevant to dividend payouts. This question is investigated by noting that the impact of these new requirements differed between firms. Some firms had already introduced the use of independent directors and fully independent committees prior to their being made compulsory in 2002. This article examines whether these ‘pre-adopters’ experienced less change in their dividend payout policies than those firms that were forced to change their board composition and committee structures.
This investigation examines the effect on dividend payouts for listed firms attributable to the Sarbanes-Oxley Act of 2002 and concurrent changes in stock exchange regulations that compelled increased use of independent directors and fully independent committees. This analysis also advances the study of effects associated with the use of independent directors while employing the difference-in-differences methodology to overcome the endogeneity concerns that have consistently challenged prior governance studies. That is accomplished by examination of the effects on dividend payouts associated with the exogenously forced addition of independent directors to the boards of publicly listed firms. The results obtained reveal that there is a significant positive relationship between firms that were compelled by law to change their boards and increases in average changes in dividend payouts and percentage changes in dividends paid, when compared to firms that had pre-adopted the Sarbanes-Oxley corporate board composition requirements. These findings imply that these board composition changes lead to decisions that increased dividend payouts in total and in percentage terms.

Authors

• Timothy G Coville, St. John's University

• Gary Kleinman, Montclair State University