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    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 
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    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