Small firms and the value of improvements in corporate governance mechanisms

Since 2002, many firms have been required to alter their board of directors and committees to increase management monitoring. Kinney and McDaniel (1989) and Chhaochharia and Grinstein (2007) provide empirical evidence suggesting that investments in corporate governance may differ based on firm size, and that underinvesting in monitoring may be more pronounced in smaller firms. To further test whether the benefits of recent changes in companies' governance mechanisms accrue to smaller firms that have underinvested in governance, we examine the stock market reaction to changes in board structure over the twenty-four months following the passage of the Sarbanes-Oxley Act We construct a new composite measure of board structure and regress buyand-hold abnormal returns on changes that occur in the Board Structure Index, finding that improvements incorporate governance quality result in economically significant abnormal returns accruing only to the smaller firms with weak initial board structures. (C) 2013 Elsevier Ltd. All rights reserved.