Do Audit Committee Members with Tarnished Reputations Learn from their Mistakes?

• In Event: Audit Committees

Abstract

Audit committee performance is judged by the audit quality of the firm. When the firm fails to report accurate financial information (e.g., misstatements), audit committee members suffer reputational damage as ineffective monitors. However, experiencing a failure in governance over financial reporting can also provide directors an opportunity to understand the underlying structure and circumstances that led to ineffective (and even problematic) governance, and thus serve as a catalyst to learn and improve monitoring effectiveness. Consistent with this notion, we find that audit committee members who have experienced governance failures (i.e., restatement) in the past are positively associated with a higher likelihood of a similar governance failure. Moreover, we find evidence that the audit committee member’s expertise mitigates this positive association between past and future failures, suggesting that financial and accounting expertise can be a prerequisite for audit committee members to internalize the mistake and improve their monitoring effectiveness. This mitigating effect is more pronounced when the expertise and experience belongs to the audit committee chair who has more authority to make changes to the audit process. Our findings suggest that audit committee members can “learn from their mistakes” under the right conditions and provide an alternative view that not every director with a tarnished reputation is of lower quality.

Authors

• Youngki Jang, University of Nebraska-Omaha

• Joonil Lee, Kyunghee University

• Peter SH Oh, McGill University

• Patrick Woong Ryu, University of Georgia