Do Compelling Director Stock Ownership Requirements Affect Audit Committee Monitoring of Financial Reporting?

• In Event: Audit Committee Expertise and Responsibilities

Abstract

We address whether director stock ownership requirements that compel audit committee members to acquire and hold shares in the firms on whose boards they participate improve financial reporting monitoring via decreasing the likelihood of financial statement misstatements. Corporate governance best practices encourage the use of DSORs to align directors’ incentives with shareholders’ interests. However, not all monitoring tasks are alike and stock ownership mechanisms having beneficial effects on monitoring of firm performance may not similarly improve monitoring of financial reporting. Using a sample of 714 firms that adopt DSORs from 1998 to 2013, we find compelling DSORs – those requiring a change in audit committee ownership behavior – are associated with decreased audit committee member stock sales post-adoption, with no similar effects on share purchases. We find a lower likelihood of financial statement misstatement in firm-years immediately following DSOR adoption, consistent with DSOR adoption affecting audit committee monitoring of financial reporting. Finally, we find that as average audit committee member ownership approaches the required level, both from below and from above up to five times the requirement, the likelihood of misstatement decreases. Said differently, average audit committee ownership that deviates from required levels, both on the downside and upside is associated with lower quality monitoring. Finally, when audit committee member ownership exceeds five times the requirement, monitoring again improves, indicative of long-term focus.

Authors

• Marcy Shepardson, Indiana University - Bloomington

• Amanda Bree Josefy, Indiana University - Bloomington

• Rani Hoitash, Bentley University