CEO Involvement in Selecting Board Members, Audit Committee Effectiveness, and Restatements

Abstract:     
Research finds independent audit committees and audit committee financial experts are generally effective in monitoring the financial reporting and auditing processes. However, not all audit committees that appear in form to be independent are in fact actually independent, and not all financial experts with similar backgrounds and credentials are equally effective. CEO involvement in the board selection process can affect whether an audit committee substantively functions as an independent one. We use financial statement restatements to examine whether the benefits of having an independent and expert audit committee are diminished, or even eliminated, when the CEO is involved in the selection of board members. Our results provide some evidence that the monitoring benefits of having an independent and expert audit committee are only maintained when the CEO is not formally involved in selecting board members, although our proxy for CEO involvement in the director selection process is likely subject to some measurement error. Further, we find that these results appear to be driven by the more severe restatements, including misstatements in conjunction with fraudulent financial reporting. In addition, we find that our results continue to apply in the post-SOX period, a period where we have a more exact measure of CEO involvement in the director selection process. Finally, we find that the stock market’s negative reaction to a restatement is mitigated only when the audit committee is independent and the CEO was not involved in selecting board members.

Number of Pages in PDF File: 54

Keywords: CEO Involvement, Board Selection, Audit Committee, Restatements

JEL Classification: G30, M41

working papers series