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    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 
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    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