To ensure that audit committees provide sufficient oversight over the auditing process and quality of financial reporting, legislators have imposed stricter requirements on the independence of audit committee members. Although many audit committees appear to be “fully” independent, anecdotal evidence suggests that CEOs often appoint directors from their social networks. Based on a 2004 to 2008 sample of U.S.-listed companies after the Sarbanes-Oxley Act, we find that these social ties have a negative effect on variables that proxy for oversight quality. In particular, we find that firms whose audit committees have “friendship” ties to the CEO purchase fewer audit services and engage more in earnings management. Auditors are also less likely to issue going-concern opinions or to report internal control weaknesses when friendship ties are present. On the other hand, social ties formed through “advice networks” do not seem to hamper the quality of audit committee oversight.
Data Availability: All data are publicly available from sources identified in the text.
Various regulatory governance initiatives have strived for board diversity, as diversity stimulates creativity, encourages discussion, and enlarges the board's knowledge base. However, increased diversity results in superior decision-making only when the board is free from conflicts and acts as a cohesive group. In this paper, we extend existing corporate governance research by introducing faultline theory to the board of directors (Lau and Murnighan 1998). The idea is to show how a board's diversity structure can give rise to the formation of subgroups along faultlines. The resulting subgroup formation may, in turn, reduce board effectiveness. Using a sample of U.S.-listed firms between 2008 and 2012, results suggest that boards with strong faultlines are associated with lower firm performance, lower CEO turnover-performance sensitivity, and higher abnormal CEO compensation. Understanding potential unintended consequences of board diversity could be of interest to regulators and companies that plan to appoint new directors to the board.
JEL Classifications: G30; G38; D70; M41.
SUMMARY: In this paper we examine whether there is auditor differentiation through industry specialization and audit methodology in judging the adequacy of mitigating management actions as implemented by financially distressed companies. Using a sample of U.S. companies from manufacturing industries (SIC 20–39) that went bankrupt between 1999–2002, we find evidence that specialist auditors are more likely to issue a going-concern opinion for soon-to-be bankrupt companies when management undertakes strategic turnaround initiatives, relative to non-specialist auditors. Interestingly, and counter to our expectations, we find that audit firms that use a business risk audit methodology are less likely to issue a going-concern opinion for a firm that subsequently goes bankrupt if the client has undertaken operating initiatives to mitigate financial distress. Finally, we also find very strong evidence that all auditors, irrespective of type, are less likely to issue a going-concern opinion for clients that subsequently go bankrupt when the client has plans to raise cash in the short term.
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