Be Careful What You Regulate: Sarbanes-Oxley and Banks’ Growing Appetite for Risky Derivatives

• In Event: 051 - Regular Session. Economic Sociology. Law and Regulation in Economic Life

Abstract

In the wake of the Enron, Worldcom, and Tyco scandals in the early years of the new millennium, American policymakers passed the Sarbanes-Oxley Act to restrain corporate malfeasance and excessive risk-taking. Many commercial banks responded by appointing Chief Risk Officers to manage and control risk. Institutionalists have found that professionals tasked with regulatory compliance over-comply, expanding their own corporate roles by exaggerating likelihood of government sanction. We argue that Chief Risk Officers, trained to maximize risk-adjusted returns, took a different tack. While touting their capacity to comply with the law, these corporate officers brought their firms to the limits of the risk frontier as part of an effort to maximize shareholder value. In the process, the CROs transformed their roles from compliance officers to central actors in the shareholder value revolution. Two groups proved capable of preventing CROs from over-investing in risky derivatives: CEOs who held substantial equity in the firm and institutional investors who held large positions in the firm. We contribute to institutional theory by uncovering another path through which professions may use regulatory compliance to solidify their foothold in the firm. We also highlight the importance of internal power relations in determining corporate strategy.

Authors

• Kim Pernell-Gallagher, Harvard University

• Jiwook Jung, National University-Singapore

• Frank Dobbin, Harvard University