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  • Jennifer M Mueller-Phillips
    When Do Ineffective Audit Committee Members Experience...
    research summary posted August 30, 2016 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.03 Board/Audit Committee Tenure, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    When Do Ineffective Audit Committee Members Experience Turnover?
    Practical Implications:

     Preserving an image of effective monitoring can be just as important as preserving effective monitoring itself. AC-member ineffectiveness due to financial reporting increases the likelihood of AC turnover for both the AC-members who served during the events precipitating the financial reporting failure as well as the “tainted” AC-members (even if they were not serving as AC-members when the events precipitating the financial reporting failure occurred). This result shows that shareholders may take bold and visible actions to “clean house” when such financial reporting failures are revealed. Regarding individual characteristics, under normal circumstances characteristics of an AC-member’s potential ineffectiveness such as multiple board commitments may actually be seen as desirable by shareholders perhaps signaling the quality of the AC-member. However, when shareholder dissent increases these individual characteristics of an AC-member’s potential ineffectiveness increases the likelihood of turnover for that particular AC-members but does not “taint” the other AC-members. That is, characteristics once viewed as slightly positive for specific AC-members become negatives when shareholder dissent increases.

    Citation:

     Kachelmeier, S. J., S. J. Rasmussen, and J. J. Schmidt. 2016. When Do Ineffective Audit Committee Members Experience Turnover?. Contemporary Accounting Review 33 (1): 228-260.

    Keywords:
    Audit Committee, Audit Committee Turnover, Audit Committee Legitimacy Ineffective Governance, Shareholder Dissent, Institutional Theory
    Purpose of the Study:

     The study deepens our understanding of when and why ineffective audit committee members experience turnover and not just that it occurs. The authors broaden the traditional theories used to understand corporate governance to include institutional theory. This theory allows them to predict and observe that the image of effective monitoring can be as important as ensuring effective monitoring itself. Audit committee ineffectiveness is studied from both a broad perspective, financial reporting failures, as well as from a narrower perspective, individual AC-member characteristics. Their analysis focuses not only on the individual ineffective AC-member but also those AC-members “tainted by” (i.e. associated with) the ineffective AC-member. Additionally, the important influence of active shareholders and their dissent on AC-member turnover likelihood due to each type of ineffectiveness is studied.

    Design/Method/ Approach:

     Sample: Hand-collected database of effective, ineffective, and “tainted” AC members from S&P 1500 companies that require annual election of all directors in 2007. Source: Glass, Lewis, & Co proxy service voting recommendations (to infer AC-member effectiveness), Compustat, RiskMetrics, & Audit Analytics Model: Logistic regression with AC-member turnover regressed on ineffectiveness indicators (i.e. financial reporting failure or individual ineffectiveness characteristics) for individual AC-members, indicators if AC-member is “tainted” by another ineffective AC-member, interaction terms for level of shareholder dissent, and governance/company/board-characteristic controls

    Findings:
    • AC-member turnover is associated with financial reporting failures (i.e. main effect)
    • AC-member turnover is not associated with individual AC-member characteristics of ineffectiveness and is, in fact, slightly negative (i.e. main effect)
    • AC-member turnover is associated with shareholder dissent (i.e. main effect)
    • When proxies for shareholder dissent is interacted with financial reporting failure, the main effect loses significance, but the interactive effect is statistically positive.
    • When proxies for shareholder dissent is interacted with individual AC-member characteristics of ineffectiveness, the non-association becomes significantly positive.
    • New AC-members who serve with AC-members present during events that precipitated a financial reporting failure are “tainted” and are associated with increased turnover.
    • AC-members who serve with AC-members who have individual characteristics of ineffectiveness are not “tainted” and are not any more likely to face turnover.
    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Oversight, Board/Audit Committee Tenure
  • Jennifer M Mueller-Phillips
    Market Reactions to Departures of Audit Committee Directors
    research summary posted February 16, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.03 Board/Audit Committee Tenure 
    Title:
    Market Reactions to Departures of Audit Committee Directors
    Practical Implications:

    The evidence indicates that the market values the presence of audit committee financial experts who have previous accounting experience on the board and reacts negatively if such directors leave the company. Furthermore, the results indicate a negative stock market reaction when a short-tenured audit committee director leaves the board. Departures of audit committee members could be early warning signals for larger problems in the long run.

    For more information on this study, please contact Meghna Singhvi (Meghna.Singhvi@LMU.EDU)

    Citation:

    Singhvi, M., D.V. Rama and A. Barua. 2013. Market reactions to departures of audit committee directors. Accounting Horizons 27(1): 113-128

    Keywords:
    Audit committee turnover, audit committee resignations, expert directors, director-tenure.
    Purpose of the Study:

    Audit committee composition has received significant attention from legislators and regulators in recent years. In this study, the authors study investor’s reaction to audit committee director departures, conditional on directors’ attributes, namely, types of expertise, tenure and busy-ness (i.e., number of other board appointments). SOX’s requirements about audit committee expertise were initially controversial and the SEC had to change the proposed definitions related to “audit committee financial expert.” Some suggest that long-tenured board members provide better oversight because of firm-specific knowledge that is acquired with experience, while others argue that long tenured directors are less likely to provide adequate oversight over management.  Similarly, there are divergent arguments about audit committee directors serving on multiple boards. The authors argue that market reactions provide empirical evidence about market perceptions related to different types of audit committee director departures. 

    Design/Method/ Approach:

    The data are from the years 2005-2008. This paper studies the cumulative abnormal return around the seven days surrounding the Form 8-K filing related to the departure of audit committee directors. The authors focus on single audit committee director departures and delete firms with (a) more than one audit committee director resignation and (b) other contemporaneous news. The final sample comprises of 107 audit committee director departures with available data for the analysis. 

    Findings:
    • The authors find that there is a negative market reaction when an audit committee financial expert who has an accounting background departs from the audit committee.
    • The authors find that there is a negative market reaction when a short-tenured (0-3years) audit committee director departs from the audit committee.
    • The market reaction does not differ between directors with and without multiple board memberships.
    Category:
    Governance
    Sub-category:
    Board/Audit Committee Composition, Board/Audit Committee Tenure
  • Jennifer M Mueller-Phillips
    Corporate Governance Research in Accounting and Auditing:...
    research summary posted October 27, 2014 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.03 Board/Audit Committee Tenure, 13.04 Board/Audit Committee Compensation, 13.05 Board/Audit Committee Oversight, 13.06 Board/Audit Committee Processes 
    Title:
    Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions
    Practical Implications:

    First, the weight of evidence suggests that weak governance is associated with an increased likelihood of adverse financial reporting outcomes (in particular, fraud and restatements). Thus, perhaps the most fundamental practice implication is that the governance research findings to date are, on an overall basis, consistent with the focus on improved corporate governance (e.g., board independence, audit committee expertise) found in SOX and related regulatory reforms.

    Second, since the board and the audit committee are primary mechanisms for the internal monitoring of top management’s financial reporting behavior, and given that the CEO and/or CFO is involved in 89 percent of all public company accounting frauds (Beasley et al. 2010), external auditors need to very carefully examine corporate governance characteristics and processes in assessing the control environment.

    Third, research finds that auditor changes/dismissals are less problematic in the presence of good governance. That is, in the presence of good governance, the auditor change/dismissal may be justified by poor auditor performance or excessive fees. Since regulators do not have the resources to examine all auditor changes, even if limited to dismissals, regulators might want to consider the client firm’s governance characteristics when deciding whether to investigate an auditor dismissal.

    Fourth, research indicates that external auditors assess risk higher and plan more audit hours for firms with weak governance. However, whether auditors adequately adjust for weak governance has not been examined. In other words, adjustments of risk assessments and audit hours occur, but is there enough adjustment in light of the higher risk?

    Fifth, strong governance and strong auditing appear to be complements rather than substitutes—stronger boards and audit committees are associated with stronger auditing. Therefore, monitoring (both internal monitoring by the board and audit committee, and external monitoring by the auditor) is likely to be especially weak in firms with weak governance, for the quality of auditing is likely to be lower in the presence of weak governance.

    Sixth, a number of studies have demonstrated the importance of audit committee accounting expertise, as well as auditing expertise and industry expertise. Firms should strive to appoint audit committee members with specific accounting and auditing expertise given their apparently greater effectiveness and the positive stock market reaction to the appointment of accounting experts.

    Seventh, a growing line of research indicates that audit committee compensation methods can influence audit committee members’ judgments, and audit committee compensation methods are associated with the risk of restatement and with the handling of auditor adjustments. We encourage auditors, analysts, and shareholders to be cognizant of the potential risks involved if audit committee members are compensated primarily with short-term, incentive-based pay.

    Eighth, some audit committees appear to take their monitoring roles seriously, while others appear to be primarily ceremonial in nature. Auditors are in a unique position to evaluate the effectiveness of the audit committee process. Auditors should explicitly evaluate the effectiveness of the audit committee’s processes, and adjust their risk assessments, budgeted hours, and the nature, extent, and timing of audit testing, especially if effective audit committee processes seem to be attenuated by the intervention of a dominant CEO.

    Finally, given the severe reputational damage experienced by directors, especially audit committee members, in cases of financial reporting failures, and given the difficulty of monitoring a large entity on a part-time basis, audit committees might want to consider retaining permanent staff or consultants to the audit committee.

    For more information on this study, please contact Dana Hermanson.

    Citation:

    Carcello J. V., D. R. Hermanson, and Z. Ye. 2011. Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions. Auditing: A Journal of Practice & Theory 30 (3): 1-31. 

    Keywords:
    Corporate governance; board; audit committee; literature review.
    Purpose of the Study:

    Over the past two decades, the corporate governance literature in accounting and auditing has grown rapidly. We review this literature, primarily focusing on corporate board and audit committee issues.

    Design/Method/ Approach:

    We discuss 12 recent literature review or meta-analysis papers and summarize selected results (i.e., clusters of papers with new and interesting results) from recent empirical research papers, after reviewing the findings of over 250 studies. 

    Findings:

    We discuss the major insights from this literature and the practice implications of these findings. In addition, we identify a number of opportunities for future research. In particular, we make suggestions for: (1) improved research paradigms in corporate governance, (2) extensions of existing research, and (3) new or emerging lines of research.

    Category:
    Governance
    Sub-category:
    Board/Audit Committee Compensation, Board/Audit Committee Composition, Board/Audit Committee Oversight, Board/Audit Committee Processes, Board/Audit Committee Tenure

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