Abstract

http://ssrn.com/abstract=2054966
 


 



CEO Power, Internal Control Quality, and Audit Committee Effectiveness in Substance vs. in Form


Ling Lei Lisic


George Mason University

Terry L. Neal


University of Tennessee

Ivy Zhang


University of Minnesota - Twin Cities

Yan Zhang


State University of New York at Binghamton - School of Management

September 2014


Abstract:     
During the past decade, new regulations have been adopted in an attempt to improve audit committee effectiveness. Prior research has generally provided evidence in support of these regulations and suggests that a more independent and expert audit committee is more effective. We posit that CEO power reduces or even eliminates the improvements in audit committee effectiveness resulting from independent and financially expert committee members. Thus, CEO power may result in an audit committee that appears effective in form but is not in substance. We construct a composite index for CEO power by combining ten CEO characteristics and employ the incidence of internal control weaknesses as a proxy for audit committee monitoring quality. Since all of the firms in our sample have completely independent audit committees, we use financial expertise to examine the impact of CEO power on audit committee effectiveness. We find that, when CEO power is low, audit committee financial expertise is negatively associated with the incidence of internal control weaknesses. However, as CEO power increases, this association monotonically weakens. When CEO power reaches a sufficiently high level, this association is no longer negative. The moderating effect of CEO power on audit committee effectiveness in reducing internal control weaknesses is more prominent when the CEO extracts more rents from the firm through insider trading. Our results are not driven by the CEO’s involvement in director selection. Our paper suggests that more expert audit committees in form do not automatically translate into more effective monitoring. Rather, the substantive monitoring effectiveness of audit committees is contingent on CEO power.

Number of Pages in PDF File: 63

Keywords: CEO power, Audit committee, Internal control

JEL Classification: M41, M42

working papers series


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Date posted: May 9, 2012 ; Last revised: September 3, 2014

Suggested Citation

Lisic, Ling Lei and Neal, Terry L. and Zhang, Ivy and Zhang, Yan, CEO Power, Internal Control Quality, and Audit Committee Effectiveness in Substance vs. in Form (September 2014). Available at SSRN: http://ssrn.com/abstract=2054966 or http://dx.doi.org/10.2139/ssrn.2054966

Contact Information

Ling Lei Lisic
George Mason University ( email )
Fairfax, VA 22030
United States
Terry L. Neal (Contact Author)
University of Tennessee ( email )
639 Stokely Management Center
Knoxville, TN 37996-0560
United States
865-974-2664 (Phone)
865-974-4631 (Fax)
Ivy Zhang
University of Minnesota - Twin Cities ( email )
19th Avenue South
Minneapolis, MN 55455
United States
Yan Zhang
State University of New York at Binghamton - School of Management ( email )
P.O. Box 6015
Binghamton, NY 13902-6015
United States
607-777-6195 (Phone)
607-777-4422 (Fax)
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