AAA Spark Meeting of Regions

Audit Committee Tenure, Financial Reporting Quality, and Perceived Auditor Independence

• In Event: Audit Committees Attributes' and Characteristics of the Audit, including pricing

Abstract

How audit committee (AC) tenure affects corporate governance is a long-debated topic. Several mechanisms of the social capital theory explain how directors’ effectiveness varies over the course of their tenure. Based on this theory, I argue that AC tenure has a nonlinear effect on AC governance. Specifically, I examine whether there exhibits an inverted U-shaped relationship between AC tenure and a firm’s financial reporting quality and perceived external auditor independence. Using a pooled sample from the post-Sarbanes-Oxley Act (SOX) period, I find that average AC tenure has an inverted U-shaped relation with financial reporting quality proxied by earnings management, and perceived auditor independence proxied by firm’s purchase of NAS from its external auditor. I also find that a tenure period between 7 to 9 years is the optimal period during which AC oversight minimizes a firm’s earnings management behaviors. Overall, the results of my study are consistent with the social capital theory which suggests that knowledge and social capital accumulated by AC directors during their service on the board improve AC governance to an optimal level, following which, entrenchment and familiarity take place and AC governance declines.

Author

• Lin Wang, Florida Atlantic University