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Consequences of Financial Reporting Failure for Outside Directors: Evidence from Accounting Restatements and Audit Committee Members

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  • SURAJ SRINIVASAN
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    Abstract

    I use a sample of 409 companies that restated their earnings from 1997 to 2001 to examine penalties for outside directors, particularly audit committee members, when their companies experience accounting restatements. Penalties from lawsuits and Securities and Exchange Commission (SEC) actions are limited. However, directors experience significant labor market penalties. In the three years after the restatement, director turnover is 48% for firms that restate earnings downward, 33% for a performance-matched sample, 28% for firms that restate upward, and only 18% for technical restatement firms. For firms that overstate earnings, the likelihood of director departure increases in restatement severity, particularly for audit committee directors. In addition, directors of these firms are no longer present in 25% of their positions on other boards. This loss is greater for audit committee members and for more severe restatements. A matched-sample analysis confirms this result. Overall, the evidence is consistent with outside directors, especially audit committee members, bearing reputational costs for financial reporting failure. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2005.

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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal Journal of Accounting Research.

    Volume (Year): 43 (2005)
    Issue (Month): 2 (05)
    Pages: 291-334

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    Handle: RePEc:bla:joares:v:43:y:2005:i:2:p:291-334

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    Cited by:
    1. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    2. Cohen, Jeffrey & Ding, Yuan & Lesage, Cedric & Stolowy, Hervé, 2008. "The role of managers’ behavior in corporate fraud," Les Cahiers de Recherche 900, HEC Paris.
    3. Aditi Gupta & David Otley & Steven Young, 2008. "Does superior firm performance lead to higher quality outside directorships?," Accounting, Auditing & Accountability Journal, Emerald Group Publishing, vol. 21(7), pages 907-932, September.
    4. Armstrong, Christopher S. & Guay, Wayne R. & Weber, Joseph P., 2010. "The role of information and financial reporting in corporate governance and debt contracting," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 179-234, December.
    5. Sharad Asthana & Steven Balsam, 2010. "The impact of changes in firm performance and risk on director turnover," Review of Accounting and Finance, Emerald Group Publishing, vol. 9(3), pages 244-263, August.
    6. Kevin W. Hee, 2011. "Changes in the predictive ability of earnings around earnings restatements," Review of Accounting and Finance, Emerald Group Publishing, vol. 10(2), pages 155-175, June.
    7. Udi Hoitash, 2011. "Should Independent Board Members with Social Ties to Management Disqualify Themselves from Serving on the Board?," Journal of Business Ethics, Springer, vol. 99(3), pages 399-423, March.
    8. Jo-Ellen Pozner, 2008. "Stigma and Settling Up: An Integrated Approach to the Consequences of Organizational Misconduct for Organizational Elites," Journal of Business Ethics, Springer, vol. 80(1), pages 141-150, June.
    9. Del Guercio, Diane & Seery, Laura & Woidtke, Tracie, 2008. "Do boards pay attention when institutional investor activists "just vote no"?," Journal of Financial Economics, Elsevier, vol. 90(1), pages 84-103, October.
    10. Wagner, Alexander F., 2011. "Board independence and competence," Journal of Financial Intermediation, Elsevier, vol. 20(1), pages 71-93, January.
    11. Hunton, James E. & Rose, Jacob M., 2008. "Can directors' self-interests influence accounting choices?," Accounting, Organizations and Society, Elsevier, vol. 33(7-8), pages 783-800.
    12. Li, Chan & Sun, Lili & Ettredge, Michael, 2010. "Financial executive qualifications, financial executive turnover, and adverse SOX 404 opinions," Journal of Accounting and Economics, Elsevier, vol. 50(1), pages 93-110, May.
    13. Sofia Larmou & Nikos Vafeas, 2010. "The relation between board size and firm performance in firms with a history of poor operating performance," Journal of Management and Governance, Springer, vol. 14(1), pages 61-85, February.
    14. Wang, Hongxia & Davidson III, Wallace N. & Wang, Xiaoxin, 2010. "The Sarbanes-Oxley Act and CEO tenure, turnover, and risk aversion," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(3), pages 367-376, August.
    15. Shamsul Nahar Abdullah & Nor Zalina Mohamad Yusof & Mohamad Naimi Mohamad Nor, 2010. "Financial restatements and corporate governance among Malaysian listed companies," Managerial Auditing Journal, Emerald Group Publishing, vol. 25(6), pages 526-552, July.
    16. Dimitropoulos, Panagiotis E. & Asteriou, Dimitrios, 2010. "The effect of board composition on the informativeness and quality of annual earnings: Empirical evidence from Greece," Research in International Business and Finance, Elsevier, vol. 24(2), pages 190-205, June.
    17. Adams, Renée B. & Ferreira, Daniel, 2008. "Do directors perform for pay?," Journal of Accounting and Economics, Elsevier, vol. 46(1), pages 154-171, September.
    18. Engel, Ellen & Hayes, Rachel M. & Wang, Xue, 2010. "Audit committee compensation and the demand for monitoring of the financial reporting process," Journal of Accounting and Economics, Elsevier, vol. 49(1-2), pages 136-154, February.
    19. Afshad J. Irani & Le (Emily) Xu, 2011. "Do stealth restatements convey material information?," Accounting Research Journal, Emerald Group Publishing, vol. 24(1), pages 5-22, July.

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