Disciplining Entrenched Managers Through Corporate Governance Reform : Implications for Risk-Taking Behavior

Prior studies find that entrenched managers destroy firm value by choosing lower risk negative NPV projects. In this paper, I argue that enhanced monitoring by boards and internal controls established following the passage of the Sarbanes-Oxley Act of 2002 and concurrent reforms to stock exchange rules (SOX) mitigated risk-related agency conflicts prevalent in entrenched firms. To capture managerial risk-taking decisions, I construct the risk measure based on variances and covariances of firm's operating segments. Using this measure, I examine changes in risk-taking and investment policies and performance in firms with entrenched management following SOX. I find that, by imposing an additional layer of discipline on managers, SOX increased managers' willingness to take on riskier, but more value-enhancing projects that were previously stifled in entrenched firms