We examine whether firms utilize governance systems and increased monitoring mechanisms when information asymmetry and managerial discretion are limited. Given that such monitoring is costly, we expect regulated firms to use less monitoring if regulation substitutes for governance. Using data from initial public offerings, we document that regulated firms have greater proportions of monitoring directors and larger boards as well as use similar amounts of equity-based compensation as non-regulated firms. Further, regulated and unregulated firms are analogous in terms of observed trade-offs between traditional monitoring mechanisms and insider ownership. Finally, regulated firms appear to decrease monitoring following a period of deregulation. These findings support the hypothesis that regulation and governance are complements and are consistent with the notion that regulators pressure firms to adopt effective monitoring structures.

We develop a model to predict expected or normal director compensation. Based on this, we then calculate whether directors of corporate boards are over- or undercompensated. On average, we find greater evidence of over- rather than undercompensation. For companies that overpay, the average excess compensation is greater than $60,000 per director, while directors that are underpaid receive about $33,000 less than predicted. Excess compensation declines over our sample period, which may be consistent with increased director workloads as well as increased scrutiny. We also find that overcompensated directors exacerbate agency problems and lead to reduced CEO turnover sensitivity to performance and a decrease in CEO pay-for-performance sensitivity. Thus, director excess compensation may be a sign of board entrenchment where overcompensated directors are not necessarily focused on protecting shareholder interests.

The board independence requirements enacted in conjunction with the Sarbanes Oxley Act of 2002 (SOX) provided motivation for firms that were already compliant with the regulations to alter their board structure. We consider actual board changes made by compliant firms and how such changes affect the monitoring efficiency of the boards. We find that the majority of compliant firms (approximately 56%) add independent directors following SOX. However, we find a nontrivial number of firms (approximately 26%) actually decrease the number of independent directors to move closer to the stated 50% requirement. For firms that decrease independence, the CEO turnover performance sensitivity significantly decreases following SOX. We also find that large board independence changes seem to be most detrimental to the monitoring function of the board. Our results highlight that SOX may have had unintended consequences.