CEO Power and SEC Prompted Restatements

Abstract

We rely on governance theory summarized in Adams, Hermalin, and Weisbach (2010) and Bushman (2009) which suggests that corporate governance characteristics may be endogenous. This differs from past research that links governance to fraud (i.e., Farber 2005) and assumes corporate governance is exogenous. According to Weisbach et al. 2010, the exogenous parameters explaining corporate governance relate to management (CEO) power characteristics negotiated by management with the board of directors. Consistent with their theory, we first find that firms with restatements prompted by the SEC tend to have strong CEOs. Second, we find that firms prompted by the SEC to restate, take actions to decrease CEO power through the termination of strong CEOs and the separation of the CEO and chairman roles. Ours is the first study to provide insight into the significance of regulatory (SEC) monitoring as opposed to other more voluntary monitors such as the board of directors or auditor. Our results suggest that the SEC provides a valuable monitoring function because it not only identifies misstatements that might otherwise go unrestated, but also its monitoring function is associated with improved governance.