AAA Spark Meeting of Regions

Effective Board Monitoring over Earnings Reports and Forecasts: Evidence from CFO Outside Director Appointments

• In Event: Ethical Earnings Mangement, Earnings Report and Information Quality

Abstract

The manner in which boards are constructed to protect the public from misleading earnings reports and projections is an important public policy issue. While there is evidence that firms discipline managers after restatements and inaccurate earnings forecasts, there is little evidence as to how firms adjust their monitoring systems to prevent the recurrence of such events. In this paper, we posit that firms will appoint an outside director with the expertise and experience necessary to oversee the firm’s accounting system. Consistent with this theory, we find that firms are more likely to appoint an outside director with CFO experience to the board when they have recently restated earnings and when they have higher prior management forecast error. We also find that the appointment of a CFO to the board is followed by a lower likelihood of restatement and more accurate management forecast. Our results suggest that firms voluntarily adjust their board structure in response to accounting failures by appointing outside directors with CFO experience. Thus, we provide insight into the types of expertise firms consider to be most important in protecting the public from misleading earnings reports and projections, how board composition influences the ability to monitor the accounting system, and how firms voluntarily react to signs of weaknesses in their governance systems.

Authors

• Seungmin Chee, Korea University

• Steven Roy Matsunaga, University of Oregon

• Shan Wang, Loyola Marymount University