Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

Posts

  • Jennifer M Mueller-Phillips
    The Effectiveness of SOX Regulation: An Interview Study of...
    research summary posted April 15, 2014 by Jennifer M Mueller-Phillips, tagged 01.0 Standard Setting, 01.05 Impact of SOX, 07.0 Internal Control, 07.05 Impact of 404 on Fees and Financial Reporting Quality, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    The Effectiveness of SOX Regulation: An Interview Study of Corporate Directors
    Practical Implications:

    A large majority of the directors interviewed for the purpose of this study maintained that, costs aside, SOX had positively impacted the quality of financial reporting. This can be supported by the decline in major frauds since the passage of the Act. On the downside, several directors also noted that SOX had negatively impacted corporate risk taking. Overall, corporate directors were by and large supportive of the SOX regulation. This conclusion runs counter to the typical opposition that corporate America has to any additional regulation.

    For more information on this study, please contact Jeffrey R. Cohen.
     

    Citation:

    Cohen, J. R., C. Hayes, G. Krishnamoorthy, G. S. Monroe, and A. M. Wright. 2013. The Effectiveness of SOX Regulation: An Interview Study of Corporate Directors. Behavioral Research in Accounting 25 (1).

    Keywords:
    audit process; corporate governance; qualitative research; risk management; Sarbanes-Oxley Act.
    Purpose of the Study:

    The Sarbanes-Oxley Act (SOX) was enacted in July 2002 in response to a number of significant financial reporting failures. This legislation significantly expanded the authority and responsibilities of the audit committee and board in overseeing financial reporting and internal controls. This study was conducted to provide insights into the effectiveness of SOX regulation from the perspective of corporate directors. By examining these director’s experiences of the impact of SOX, the authors aimed to discover how public corporations have responded to the legislation. Specifically, this study attempts to analyze the effectiveness of SOX with respect to achieving high-quality financial reporting.

    Design/Method/ Approach:

    The authors interviewed 22 experienced public company directors in 4 cities: Boston, Los Angeles, Chicago, and New York. The directors were chosen with a view to capture a cross-section of corporate governance experience, industries, and company size. The interviews were conducted over a 5 week period in 2007 just before the financial crisis of late 2007. The interviews varied in length from 30 to 60 minutes. All interviews were conducted by a single person in the offices of the participants, with the exception of one interview that was conducted by telephone. The interviews were guided by a pre-determined set of interview questions based on Cohen et al (2010), with additional questions added regarding SOX provisions and other SOX-related academic literature.

    Findings:
    • Directors have experienced enhanced expertise, attitude, process, and power and authority of the audit committee.
    • Post-SOX internal scope, level of responsibility, and status of internal audit functions have seen substantial improvement.
    • Compliance with SOX has led to greater empowerment of the audit committee.
    • CEO/CFO certification has increased CEO ownership of the integrity of financial disclosure and has been pushed down through the organization.
    • Management is still actively involved in the decision management process, including such matters as the appointment of the auditor.  
       
    Category:
    Corporate Matters, Internal Control, Standard Setting
    Sub-category:
    Audit Committee Effectiveness, Impact of 404 on Fees and Financial Reporting Quality, Impact of SOX
  • Jennifer M Mueller-Phillips
    The effects of disclosure type and audit committee expertise...
    research summary posted October 20, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.07 Internal auditor role and involvement in controls and reporting, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior, 14.11 Audit Committee Effectiveness 
    Title:
    The effects of disclosure type and audit committee expertise on Chief Audit Executives’ tolerance for financial misstatements.
    Practical Implications:

    The results suggest that internal auditors contribute to decreased reliability of disclosed amounts. It appears that the incentives of external auditors and internal auditors are closely aligned on this issue. In general, both of these parties seem to feel less responsibility for disclosed, relative to recognized amounts. The results indicate that financial reporting location has significant effects on internal auditors’ decisions to correct misstatements. Specifically, internal auditors are more willing to waive disclosed misstatements relative to recognized misstatements. Contrary to expectations, the results do not indicate that increased audit committee expertise and associated increases in audit committee members’ perceived powers cause internal auditors to be less willing to waive misstatements.

    Citation:

    Norman, C. S., J. M. Rose, and I. S. Suh. 2011. The effects of disclosure type and audit committee expertise on Chief Audit Executives’ tolerance for financial misstatements. Accounting, Organizations & Society 36 (2): 102-108.

    Keywords:
    audit committee expertise, misstatements, Chief Audit Executives, audit committee, financial executives
    Purpose of the Study:

    External audit partners are more willing to waive misstatement corrections for disclosed than for recognized amounts. This willingness to allow misstatements may increase management’s incentives to manipulate disclosed amounts and increase the levels of error and bias in disclosed information. While external auditors are more willing to waive disclosed amounts, relative to recognized amounts, internal auditors may require management to adjust misstatements regardless of their reporting locations. If internal auditors do not tolerate misstatements that are disclosed, this will increase the reliability (i.e., decrease the random error and bias) of disclosed amounts and decrease the likelihood of management manipulation of disclosed amounts. As a result, the impact to practice of external auditors’ willingness to waive misstated disclosures could be mitigated or even eliminated by internal audit oversight.

    The authors examine Chief Audit Executives’ and deputy Chief Audit Executives’ decisions to require adjustments of misstatements that are either recognized or disclosed. Chief Audit Executives (CAEs) may require equivalent adjustments for recognized and disclosed amounts, and act to counter the actions of management and external auditors. Understanding the decision processes of CAEs will help to inform regulators and standard setters of the underlying factors that drive financial statement reliability.

    Design/Method/ Approach:

    The participants are 73 Chief Audit Executives (CAEs) and deputy CAEs. CAEs and deputy CAEs are the ultimate decision makers in internal audit. None of these participants are from outsourced internal audit departments. The average number of years of internal audit experience is 13.71. The study was completed on paper and provided to participants in sealed envelopes by one of the study’s authors. All participants completed the materials in their professional offices under controlled conditions in the presence of one of the authors. The evidence was gathered prior to 2011.

    Findings:

    The results of this study indicate that reporting location has a significant effect on internal auditors’ decisions. Specifically, CAEs and their deputies require lesser amounts of misstatement correction of disclosed amounts relative to recognized amounts. While increased audit committee expertise increases audit committee members’ perceived power over management, the authors do not find that CAEs require greater misstatement corrections when the audit committee has more financial expertise, relative to less expertise. It appears that internal auditors may not have enough concern about disclosed misstatements to warrant a decision to exercise the power they derive from audit committee expertise. The results suggest that internal auditors, like external auditors and managers, act to decrease the perceived and actual reliability of disclosed information. Further, increasing the power of the internal audit function does not mitigate this problem. The authors find reason for serious concerns about the accuracy of disclosed amounts, relative to recognized amounts.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Earnings Targets & Management Behavior, Internal auditor role and involvement in controls and reporting
  • The Auditing Section
    The Effects of Trust and Management Incentives on Audit...
    research summary posted May 7, 2012 by The Auditing Section, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    The Effects of Trust and Management Incentives on Audit Committee Judgments
    Practical Implications:

    The results of this study suggest that the judgments of more trusting audit committee members are largely insensitive to indicators of management’s incentives to manage earnings. It appears that high levels of dispositional trust among members of the board of directors can have serious consequences, and high trust is common among audit committee members.  To overcome this possible concern, boards of directors and audit committees may consider training audit committee members to recognize the relationships between incentives and the likelihood of management deception in order to improve audit committee judgment. 

    Citation:

    Rose, A.M., J.M. Rose, and M. Dibben. 2010. The effects of trust and management incentives on audit committee judgments. Behavioral Research in Accounting 22(2): 87-103.

    Keywords:
    Audit committee; management incentives; trust
    Purpose of the Study:

    Audit committee members are entrusted with substantial authority to enhance corporate governance, including overseeing the audit process, hiring and firing auditors, and resolving auditor and management disputes.  However, prior research suggests that audit committee members do not consistently view management’s incentives to be threats to management credibility.  The authors propose that audit committee members’ disposition to trust plays a critical role in their interpretation of management incentives and associated judgments.  Below are two objectives that the authors address in their study: 

    • Examine how dispositional trust influences audit committee members’ decisions to support the auditor when management has incentives to manage earnings.
    • Examine how dispositional trust influences audit committee members’ assessment of management credibility and likelihood of deception when management has incentives to manage earnings. 
    Design/Method/ Approach:

    The authors collected their evidence using a simulated task completed by experienced, independent, and currently-serving audit committee members.  Participants were asked to act as audit committee members and make a subjective judgment about auditor- proposed adjustments.  Participants were assigned to an environment of either higher or lower levels of management incentive to manipulate earnings based on proximity to EPS.  The research evidence is collected in the mid-2000s time period (post SOX).

    Findings:
    • The authors find that less trusting audit committee members are more likely to support the external auditor than are more trusting audit committee members when management has incentives to manage earnings.
    • The authors find that less trusting audit committee members are more likely to perceive that management is not credible and more likely to perceive that management is being deceptive than are more trusting audit committee members when management has incentives to manage earnings.
    • The authors find that less trusting audit committee members are more likely to perceive that management’s incentives to manage earnings result in potential deception by management, and less trusting audit committee members increase their support for the auditor because of concerns about management deception. 
    Category:
    Governance, Corporate Matters
    Sub-category:
    Board/Audit Committee Oversight, Audit Committee Effectiveness
    Home:
    home button
  • Jennifer M Mueller-Phillips
    The Efficacy of Shareholder Voting in Staggered and...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards: The Case of Audit Committee Elections
    Practical Implications:

     This study contributes to the accounting landscape in many different ways. First, the results suggest that, through voting and differentiating between AC and non-AC directors, shareholders can influence the AC’s oversight over financial reporting. Second, the study complements previous research on similar topics by showing that dissatisfaction with AC members is also associated with subsequent turnover of accounting financial experts and that low auditor ratification and AC votes are both associated with a reduction in auditor-provided tax services. Finally, the results show that going forward all studies examining the efficacy of shareholder votes should separately consider staggered and non-staggered boards.

    Citation:

     Gal-Or, R., Hoitash, R., and Hoitash U. 2016. The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards: The Case of Audit Committee Elections. Auditing: A Journal of Practice and Theory 35 (2): 73-95.

    Keywords:
    staggered boards, director elections, audit committee, and proxy advisors
    Purpose of the Study:

    Previous accounting research provides evidence that certain characteristics of audit committees (ACs) are associated with improved effectiveness, finding that features such as size, independence, and member expertise all contribute to the quality and effectiveness of the audit committee. Research on the influence of shareholders on audit committee effectiveness is scarce, so this paper examines whether shareholders voting on audit committee members and the frequency of those elections (staggered versus non-staggered) can influence the effectiveness of the audit committee. Because of the way shareholder votes are cast, the votes in director elections provide an important mechanism to monitor and discipline directors.

                Despite the majority of directors standing for election every year, a significant number of firms have staggered boards, in which only a fraction of members face election every year. Under the staggered board regime, shareholders can typically voice their opinion on any given director only once every three years, making it conceivably possible that directors on staggered boards who do not face election following poor performance will be insulated from the scrutiny of shareholder votes. This could lead to a decrease in accountability, responsiveness, and the overall efficacy of shareholder votes. This paper separates itself from others because prior research has not considered the issue of diminished efficacy of shareholder voting and has not examined whether the effectiveness of shareholder votes is similar across staggered and non-staggered boards. 

    Design/Method/ Approach:

    The authors used cross-sectional time-series data spanning the years 2004 to 2010. The final sample contains over 18,296 director elections taking place in more than 6,786 firm-year observations. The authors also use several measures to test the reaction of ACs to low shareholder approval rates separately for non-staggered and staggered ACs. 

    Findings:
    • The authors find that most AC members serve on non-staggered boards, which typically have higher shareholder votes than staggered boards.
    • The authors find that, consistent with former research, firms with non-staggered boards perform better than those with staggered boards and are more likely to have majority voting rather than plurality voting.
    • The authors find that companies do not necessarily respond to low votes by indiscriminately replacing AC members; instead, they remove and replace financial accounting experts on the AC when shareholders express dissatisfaction with the AC. This appears to only be the case in non-staggered boards; staggered boards do not react to low votes in the same manner.
    • The authors find that low shareholder support is associated with an improvement in the composition and diligence of the AC; however, these associations are prominent only in non-staggered firms.
    • The authors’ findings suggest that dissatisfaction with the AC and the auditor expressed through low votes is associated with a decrease in the tax NAS ratio.
    • The authors’ findings suggest that low shareholder votes in firms with non-staggered boards are associated with changes to the composition and diligence of the AC, changes to the relationship with the auditor and gradual changes to financial reporting quality. 
    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Oversight
  • Jennifer M Mueller-Phillips
    The influence of director stock ownership and board...
    research summary posted September 16, 2015 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.04 Board/Audit Committee Compensation, 14.0 Corporate Matters, 14.01 Earnings Management, 14.11 Audit Committee Effectiveness 
    Title:
    The influence of director stock ownership and board discussion transparency on financial reporting quality.
    Practical Implications:

    Understanding why stock ownership can bias directors’ objectivity, and examining how board discussion transparency can yield differential effects for stock-owning and non-stock-owning directors makes it possible to anticipate the effects of increased board transparency on earnings management and directors’ decisions. The notion of increased board discussion transparency is valid in the current environment in which shareholders are pushing for “constituency board seats” because information leaks surrounding board discussions likely will result when constituent directors report back to their shareholder groups. Hence, if controversial boardroom discussions are eventually divulged to the public, the findings suggest that directors’ judgments and decisions will be influenced by knowledge of increased board transparency.

    Citation:

    Rose, J. M., C. R. Mazza, C. S. Norman, and A. M. Rose. 2013. The influence of director stock ownership and board discussion transparency on financial reporting quality. Accounting, Organizations & Society 38 (5): 397-405.

    Keywords:
    stock ownership, board of directors, transparency in organizations, earnings management, corporate governance quality
    Purpose of the Study:

    Stock ownership requirements for directors have become commonplace, and institutional investors can pressure corporate boards to rely wholly or partly on stock based forms of pay for board service. Consistent with the underlying principles of agency theory, the usual justification for stock ownership requirements is for directors to have “skin in the game,” thus aligning their personal interests with those of company shareholders. Recent archival studies strongly favor board stock ownership requirements and indicate that firms with ownership requirements exhibit better performance the year after implementing the requirements. Existing literature often equates director stock ownership with improved financial performance and improved corporate governance. On the other hand, improved firm performance associated with stock ownership could arise from a narrow focus on short-term earnings. Support for this potential alternative explanation is provided by extant archival studies indicating that managers often become myopic when paid with stock options and stock grants. In addition, recent experimental findings suggest that director stock ownership can harm objectivity and lead to biased financial reporting.

    The current study examines whether stock ownership will induce directors to go along with management’s aggressive revenue recognition in light of pressure from the Chief Audit Executive (CAE) to take a more conservative approach. In particular, the authors examine whether the effects of board stock ownership are dependent upon board discussion transparency.

    Design/Method/ Approach:

    The current study involves a 2 X 2 between-participant randomized experiment. The experiment was computerized and administered via the Internet. The authors contacted current and former CEOs and board chairs to request the participation of board members. 72 directors completed all of the response items and correctly answered manipulation check items. Of the 72 directors who are included in the final sample, there were 58 (81%) male and 14 (19%) female directors. This data was collected prior to July 2013.

    Findings:

    The authors find that stock ownership can affect directors’ independence and objectivity as well. They conclude that independence requirements resulting from SOX and adopted by the NYSE and NASDAQ focusing on board member affiliation are threatened by directors’ ownership of stock in the companies for which they serve. The authors suggest that the temptation of stock-owning directors to engage in myopic behavior that could boost the company’s stock price can be mitigated by increasing the transparency of board discussions. In examining the effects of transparency of board discussions on the likelihood of directors agreeing with management’s aggressive reporting attempts, the authors find competing effects, depending on whether directors own or do not own stock. Specifically, directors who own stock were less likely to agree with management’s aggressive reporting when board discussions were more transparent, compared to less transparent. Yet, there were no benefits of increased transparency for directors who did own stock, and directors who did not own stock were more likely to support earnings management attempts than were stock owning directors when transparency was high.

    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Oversight, Earnings Management
  • Jennifer M Mueller-Phillips
    The Interplay of Management Incentives and Audit Committee...
    research summary posted November 15, 2016 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.05 Board/Audit Committee Oversight, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    The Interplay of Management Incentives and Audit Committee Communication on Auditor Judgment
    Practical Implications:

    This study indicates that increasing the frequency of informal communication between the audit committee and the audit team can positively impact reporting quality, but auditors need to be sensitized to how management may exhibit undue influence and its potential to undermine audit committee effectiveness. From a practical standpoint, this study indicates that failing to consider specific expectations communicated by the audit committee can have severe consequences.

    Citation:

    Brown, J. O. and V. K. Popova. 2016. The Interplay of Management Incentives and Audit Committee Communication on Auditor Judgment.  Behavioral Research in Accounting 28 (1): 27-40.

    Keywords:
    audit committee communication, management incentives, competing preferences, source credibility and auditor judgment
    Purpose of the Study:

    Over the past two decades, the audit committee has evolved from a passive observer to a critical player in ensuring quality financial reporting. Just recently, the PCAOB approved Auditing Standard No. 16 to enhance communication between the external auditor and the audit committee in order to better facilitate the audit committee’s oversight role and improve financial reporting quality. However, despite this reform, auditors continue to harp on the importance of management’s role in corporate governance and its ability to exhibit significant influence during the audit. Consequently, the purpose of this study is to examine the interplay of management and the audit committee on auditor judgment, and whether auditor’s sensitivity to a characteristic of management, its incentive to influence the auditor, moderates the effectiveness of additional oversight by the audit committee. It is also important to examine whether auditors are effectively integrating expressed expectations voiced by the audit committee, in light of the recent passage of AS No. 16.

    Design/Method/ Approach:

    The authors administered a 2 x 2 between-subjects experiment that required audit seniors to evaluate management’s estimate for obsolete inventory. The auditors either were or were not given additional communication from the audit committee of its expectations. Management’s incentives to influence the auditor were also manipulated by varying the perceived propensity to manage earnings.  

    Findings:
    • The authors find that management’s incentives to influence the auditor not only affect the persuasiveness of management-provided information but also spill over to impact the potential benefit of additional audit committee communication on auditor judgments.
    • The authors find that when management’s incentives were lower, additional audit committee communication had no effect on auditor judgments, and auditors documented more items consistent with management’s aggressive reporting preference.
    • The authors find that when management’s incentives were higher, the additional communication of the audit committee had a significant and positive impact on auditors’ evidence evaluation and judgments, as auditors were less supportive of management’s aggressive estimate and also documented a greater proportion of evidence items consistent with the audit committee’s expressed expectations. 
    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Oversight
  • Jennifer M Mueller-Phillips
    The Role of Firm Status in Appointments of Accounting...
    research summary posted June 7, 2014 by Jennifer M Mueller-Phillips, tagged 04.0 Independence and Ethics, 04.08 Impact of SEC Rules Changes/SarbOx, 13.0 Governance, 13.02 Board/Financial Experts, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    The Role of Firm Status in Appointments of Accounting Financial Experts to Audit Committees
    Practical Implications:

    The primary contribution of this study is finding that status-related concerns can prevent firms from appointing AFEs to their boards. This result has clear implications for regulators, as firms without AFEs are more likely to encounter accounting reporting problems. Specifically, recent regulation changes by the SEC to introduce a more broad definition of “financial expert” may damage the improvement of financial reporting that was intended by SOX. This research is consistent with previous findings that directors’ concerns for firm status and their own welfare can negatively affect accounting reporting quality. 

    Citation:

    Erkens, D. H., and S. E. Bonner. 2013. The Role of Firm Status in Appointments of Accounting Financial Experts to Audit Committees. The Accounting Review 88 (1): 107–136.

    Keywords:
    accounting financial experts; audit committees; director status; firm status
    Purpose of the Study:

    Since 1999 regulators have exerted pressure on firms to appoint accounting financial experts (AFE) to their audit committees in an attempt to improve the monitoring of financial reporting. Despite prior research showing more positive financial reporting outcomes, firms have been reluctant to appoint these experts. This study examines the effect of firm status on some firms’ reluctance to appoint AFEs to their audit committees. The authors propose that higher status firms may be more reluctant to appoint AFEs, which could potentially result in more financial reporting problems. 

    Design/Method/ Approach:

    The sample selected consists of 875 firms and 3,590 firm-year observations that are included in the S&P 1500 index from 1999 to 2008. Firms included in the sample have board member biographical information and board composition data available in the RiskMetrics or BoardEx databases and cannot have previously appointed an AFE to the audit committee. This data, combined with an aggregate measure of firm and director status is used to test the following hypotheses:

    1. The average status of appointed AFEs is less than the average status of sitting directors.
    2. Director status is positively related to firm status
    3. The difference in status of appointed AFEs and sitting directors is larger for higher status firms than it is for lower status firms.
    4. The probability that a firm will appoint an AFE to its audit committee in a given year is negatively related to the status of the firm.
    Findings:
    • Higher status firms were reluctant to appoint AFEs to their audit committees because typical AFEs are of lower director status than typical directors. 
    • The gap between the status of AFEs and sitting directors was larger for higher status firms. 
    • Directors’ personal incentives related to appointing higher status directors outweigh the concerns about damaging firm status.
    • Firms that have directors who serve on other boards with AFEs, have corporations nearby with AFEs, or have an auditor with a significant fraction of clients that have AFEs are more likely to appoint AFEs to their audit committees.
    • Firms with complex accounting or past accounting problems are also more likely to appoint AFEs. 
    Category:
    Corporate Matters, Governance, Independence & Ethics
    Sub-category:
    Audit Committee Effectiveness, Board/Financial Experts, Impact of SEC Rules Changes/SarBox
    Home:

    home button

  • Jennifer M Mueller-Phillips
    Voluntary Adoption of More Stringent Governance Policy on...
    research summary posted November 12, 2014 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    Voluntary Adoption of More Stringent Governance Policy on Audit Committees: Theory and Empirical Evidence
    Practical Implications:

    The findings in this study have important policy and practical implications. First, the study provides empirical evidence that firms have incentives to adopt more stringent governance mechanisms voluntarily if doing so is beneficial. The OSC Policy to exempt smaller issues is both effective and efficient in that it encourages the voluntary adoption and it avoids imposing unnecessary compliance costs associated with a one-size-fits-all mandatory compliance policy. Second, the findings in this study provide strong evidence that adopting more stringent audit committees can generate tangible economic benefits in the form of increased firm valuation, lower cost of capital, and improved investment efficiency. It appears that managers in some TSX listed firms may have overlooked these benefits and did not adopt the more stringent audit committee voluntarily before the mandatory adoption date. Finally, the findings in this study provide corroborating evidence that fully independent and financially literature audit committees are more effective than the less stringent ones in monitoring firm investments and in enhancing the quality of accounting information, as implied in our findings. Investors and policy makers should advocate the adoption of more stringent audit committees.

    For more information on this study, please contact either Feng Chen or Yue Li.

    Citation:

    Chen, F., and Y. Li. 2013. Voluntary Adoption of More Stringent Governance Policy on Audit Committees: Theory and Empirical Evidence. The Accounting Review 88 (6): 1939-1969.

    Keywords:
    Independent audit committees; corporate governance; voluntary compliance; investment efficiency; firm valuation; cost of capital
    Purpose of the Study:

    The Ontario Securities Commission (OSC) issued Multilateral Instrument 52-110 (MI 52-110) policy in June 2003. This policy, which became effective on January 1, 2004, requires securities issuers listed in the Toronto Stock Exchange (TSX) to set up an audit committee with at least three independent and financially literate board members. One unique feature of this policy is that it exempts small issuers such as companies listed on the TSX Venture Exchange in favor of voluntary compliance by these firms due to concerns about compliance costs. . The policy only requires small issuers to disclose whether they have an audit committee, the names of its members, and whether the members are independent.

    The OSC’s policy on audit committees is unique in that it allows TSX Venture-listed firms to adopt a more stringent governance mechanism voluntarily. This policy creates a desirable regulatory setting to investigate the costs and benefits associated with voluntary adoption of a more stringent audit committee.  Within this Canadian regulatory setting, we examine the following research questions: (1) What economic factors would affect TSX Venture firms’ decisions to adopt the more stringent audit committee voluntarily? (2) What are the likely economic benefits from adopting more stringent audit committees by TSX Venture firms and from mandatory compliance by TSX listed firms? 

    Design/Method/ Approach:

    The researchers first develop a parsimonious analytical model to analyze controlling shareholders’ (or management) incentives to adopt the more stringent audit committee policy voluntarily. The model provides interesting and intuitive predictions. First, firms with low compliance costs will be more likely to adopt the more stringent audit committee voluntarily. Second, firms with high future financing needs will also be more likely to adopt the more stringent audit committee voluntarily. Finally, the adoption of the more stringent audit committee will lead to higher firm valuation due to improvement in investment efficiency.           

    They then test the predictions of the model empirically by using archival data from a sample of 376 firms listed on the TSX Venture Exchange during the 2003-2004 period. They also analyzed whether the adoption of the more stringent audit committee would lower the cost of capital and improve the investment efficiency for both the TSX Venture firms and TSX listed firms. 

    Findings:
    • Consistent with the predictions of the model, the researchers find that compliance costs negatively affect the TSX Venture firms’ decisions to adopt the more stringent audit committee policy voluntarily.
    • They also find that firms that adopted the more stringent audit committees voluntarily were more likely to raise capitals and to migrate to the Toronto Stock Exchanges during the three year period immediately following the adoption decision.
    • The study also finds that companies that adopted the audit committee policy voluntarily experienced a high firm valuation measured in Tobin's Q, lower costs of capital, improved investment efficiency after the voluntary adoption.
    • Finally, the study finds that TSX listed firms also experienced increased firm valuation, lower cost of capital, and improved investment efficiency immediately following the mandatory adoption of more stringent audit committees.
    Category:
    Corporate Matters, Governance
    Sub-category:
    Audit Committee Effectiveness, Board/Audit Committee Composition
  • 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
    Who’s Really in Charge? Audit Committee versus CFO Power a...
    research summary posted March 1, 2015 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations, 14.0 Corporate Matters, 14.11 Audit Committee Effectiveness 
    Title:
    Who’s Really in Charge? Audit Committee versus CFO Power and Audit Fees
    Practical Implications:

    The results demonstrate the importance of, and tension between, CFO and audit committee power in audit fee negotiations. Our findings suggest CFOs often continue to exert significant influence over audit fees even though contractual responsibility for compensating external auditors resides with the audit committee. These results highlight the importance for auditors to identify the more powerful party when negotiating audit fees with their clients.

    In addition, this study has significant implications for investors who believe current regulations separate management from audit fee negotiations. These regulations may give investors a false sense of security if they assume the audit committee always limits managerial influence during audit fee negotiations.

    For more information on this study, please contact Elaine Mauldin.

    Citation:

    Beck, M. J. and E. Mauldin, 2014. Who’s really in charge? Audit committee versus CFO power and audit fees. The Accounting Review 89 (6): 2057-2085.

    Keywords:
    audit fees, audit committee, CFO, recession
    Purpose of the Study:

    Sarbanes-Oxley (SOX) intended to restore and improve investor confidence in financial reporting by charging audit committees with direct responsibility for determining external audit fees. However, some auditors report that management continues to control the external auditor relationship, even though the audit committee, by law, has contractual responsibility. Thus, current regulations may give investors a false sense of security if they assume the audit committee always limits managerial influence during audit fee negotiations.

    We compare chief financial officer (CFO) and audit committee influence on audit fees to provide insight into the effectiveness of mandating contractual responsibility for audit fees to the audit committee. We examine changes in fees during the recent financial crisis and economic recession as this time period creates a natural experiment that allows us to better isolate and identify the influence of audit committee and CFOs on audit fees. We expect CFOs with greater power, relative to the audit committee, will negotiate fee reductions during the recession because cutting audit fees directly improves net income and reduced audit fees could result in less audit effort and allow management more earnings management opportunities. On the other hand, we expect audit committees with greater power, relative to the CFO, will not negotiate fee reductions during the recession because they more likely support the auditor’s and shareholders’ desire for higher fees to combat higher audit risks

    Design/Method/ Approach:

    We utilize a sample of firms from 2006-2009 and utilize OLS regressions to examine the effects that audit committee and CFO power have on audit fees during the recession. We utilize tenure of the audit committee and CFO to proxy for power as longer tenure increases firm-specific expert knowledge necessary for effective bargaining and the ability to develop networks of key stakeholders, enabling individuals to form coalitions in support of their bargaining position.

    Findings:
    • We find that during the recession audit fees declined by 4 percent on average 
    • We find smaller fee reductions when audit committee power is greater than CFO power and larger fee reductions when CFO power is greater than CFO power
    • We find when the audit committee is sufficiently more powerful than the CFO, audit fee reductions during the recession disappeared
    Category:
    Corporate Matters, Engagement Management
    Sub-category:
    Audit Committee Effectiveness, Audit Fee Decisions

Filter by Type

Filter by Tag