The Effects of Professional and Social Ties Between the CEO and Audit Committee on Investor Decision Making

• In Event: Corporate Governance, CFOs, and Audit Committees

Abstract

Despite regulations that mandate that audit committees must be independent of management, the CEO may still influence the audit committee through audit committee members having 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 and ultimately, their investment decisions. The results of an experiment with 263 informed, nonprofessional investors indicate that investors who were told that there were no professional or social ties between management and the audit committee viewed the audit committee as more independent and effective than when social ties or profession ties were present. Further, audit committees with professional ties are viewed as more independent and effective than those with social ties. Finally, investors made more favorable investment decisions when there were no ties between the audit committee members and the CEO than when there were either profession or social ties. Results also indicate that independence, but not competence, mediates the relationship between ties and effectiveness. 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 audit committee and when making investment decisions.

Authors

• Jeffrey R Cohen, Boston College

• Lisa Milici Gaynor, University of South Florida

• Ganesh Krishnamoorthy, Northeastern University

• Arnold Wright, Northeastern University