The Effects of Professional and Social Ties between the CEO and Audit Committee on Investors’ Judgments of Audit Committee Effectiveness

• In Event: Investor Perceptions

Abstract

Despite regulations that mandate audit committees must be independent of management, the CEO may still influence the audit committee through members who have prior connections with the CEO. These connections can take the form of either social ties (e.g., belonging to the same country club) or professional ties (e.g., having worked together or served on boards together). This study examines whether knowledge of such ties affect investors’ assessments of audit committee independence, competence, and effectiveness. The results of an experiment with 170 nonprofessional investors indicate that investors who were informed that there were no professional or social ties between management and the audit committee viewed the audit committee as more independent than in all other conditions. We also find that audit committees with no ties are viewed as more effective than in all other conditions, while those committees with professional ties are viewed as more effective than those with social ties. There is no difference in perceived effectiveness based on whether the professional ties are in the same industry or in other industries. Finally, the results also indicate that independence mediates the relationship between ties and effectiveness and that competence, while significant in the overall model, does not mediate the relationship. In all, the results support our expectations that investors consider the existence of ties between the CEO and audit committee members when making assessments about the quality of the audit committee.

Authors

• Jeffrey R Cohen, Boston College

• Lisa Milici Gaynor, University of South Florida

• Ganesh Krishnamoorthy, Northeastern University

• Arnold Wright, Northeastern University