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Risk Management and Corporate Governance: the Importance of Independence and Financial Knowledge for the Board and the Audit Committee

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  • Georges Dionne
  • Thouraya Triki

Abstract

The new NYSE rules for corporate governance require the audit committee to discuss and review the firm's risk assessment and hedging strategies. They also put additional requirements for the composition and the financial knowledge of the directors sitting on the board and on the audit committee. In this paper, we investigate whether these new rules as well as those set by the Sarbanes Oxley act lead to hedging decisions that are of more benefit to shareholders. We construct a novel hand collected dataset that allows us to explore multiple definitions for the financially knowledgeable term present in this new regulation. We find that the requirements on the audit committee size and independence are beneficial to shareholders, although maintaining a majority of unrelated directors in the board and a director with an accounting background on the audit committee may not be necessary. Interestingly, financially educated directors seem to encourage corporate hedging while financially active directors and those with an accounting background play no active role in such policy. This evidence combined with the positive relation we report between hedging and the firm's performance suggests that shareholders are better off with financially educated directors on their boards and audit committees. Our empirical findings also show that having directors with a university education on the board is an important determinant of the hedging level. Indeed, our measure of risk management is found to be an increasing function of the percentage of directors holding a diploma superior to a bachelor degree. This result is the first direct evidence concerning the importance of university education for the board of directors.

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Bibliographic Info

Paper provided by CIRPEE in its series Cahiers de recherche with number 0515.

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Date of creation: 2005
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Handle: RePEc:lvl:lacicr:0515

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Keywords: Corporate governance; risk management; corporate hedging; financial knowledge; board independence; audit committee independence; board of directors; university education; empirical test; unrelated directors; NYSE rules; Sarbanes Oxley act; audit committee size; financially educated directors; financially active directors; firm performance;

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References

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Citations

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Cited by:
  1. J. David Cummins & Georges Dionne & Robert Gagné & Abdelhakim Nouira, 2006. "Efficiency of Insurance Firms with Endogenous Risk Management and Financial Intermediation Activities," Cahiers de recherche 06-06, HEC Montréal, Institut d'économie appliquée.
  2. Chang Dan & Hong Gu & Kuan Xu, 2005. "The Impact of Hedging on Stock Return and Firm Value: New Evidence from Canadian Oil and Gas Companies," Department of Economics at Dalhousie University working papers archive hedging, Dalhousie, Department of Economics.
  3. Gay, Gerald D. & Lin, Chen-Miao & Smith, Stephen D., 2011. "Corporate derivatives use and the cost of equity," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1491-1506, June.
  4. Dewally, Michaël & Shao, Yingying, 2013. "Financial derivatives, opacity, and crash risk: Evidence from large US banks," Journal of Financial Stability, Elsevier, vol. 9(4), pages 565-577.
  5. Berger, Allen N. & Kick, Thomas & Schaeck, Klaus, 2012. "Executive board composition and bank risk taking," Discussion Papers 03/2012, Deutsche Bundesbank, Research Centre.
  6. Monda, Barbara & Giorgino, Marco & Modolin, Ileana, 2013. "Rationales for Corporate Risk Management - A Critical Literature Review," MPRA Paper 45420, University Library of Munich, Germany.
  7. Murillo Campello & Chen Lin & Yue Ma & Hong Zou, 2010. "The Real and Financial Implications of Corporate Hedging," NBER Working Papers 16622, National Bureau of Economic Research, Inc.
  8. Kevin Aretz & Söhnke M. Bartram, 2010. "Corporate Hedging And Shareholder Value," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 33(4), pages 317-371, December.

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