Abstract

This paper examines the interactions between governance mechanisms and performance for US small cap firms over the period from 2000 to 2004. We perform analyses accounting for both simultaneity between the variables and a sample selection bias that may be related to the venue of listing firm's stock. The results demonstrate significant interactions between board independence, firm leverage, CEO ownership, and pay-performance sensitivity. With regard to the impact of governance mechanisms on corporate performance, leverage significantly reduces firm value while strong pay-performance compensation links are beneficial to corporate performance. We also find a weak association between board independence and firm performance. The results do not show a significant relationship between CEO ownership and performance. Another finding is that the passage of the Sarbanes-Oxley Act considerably increases the market value of small cap firms with a rate of return of around 15%, suggesting that the benefits of improved transparency outweigh their potential costs. The results are also consistent with the contention that CEOs may lack the power or will to remove insiders from the boards when firms are required to comply with independence standards.