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Does the Market Value Financial Expertise on Audit Committees of Boards of Directors?

45 Pages Posted: 11 Feb 2004  

Mark L. DeFond

University of Southern California - Leventhal School of Accounting

Rebecca N. Hann

University of Maryland - Robert H. Smith School of Business

Xuesong Hu

University of Oregon - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: January 2004

Abstract

We examine 3-day cumulative abnormal returns (CARs) around the announcement of 850 newly appointed outside board members assigned to audit committees during 1993-2002, a period prior to the implementation of the Sarbanes-Oxley Act (SOX). Motivated by the SOX requirement that public companies disclose whether they have a financial expert on their audit committee, we test whether the market reacts favorably to the appointment of directors with financial expertise to the audit committee. In addition, because it is controversial whether SOX should define financial experts narrowly to include primarily accounting financial experts (as initially proposed), or more broadly to include non-accounting financial experts (as ultimately passed), we separately examine appointments of each type of expert.

We find significantly positive CARs around the appointment of accounting financial experts to the audit committee, but not around the appointment of non-accounting financial experts or directors without financial expertise. In addition, CARs are only positive when the newly appointed outside directors are independent (as opposed to affiliated), and when the appointing firms have relatively strong corporate governance prior to appointing the new directors. All of our findings hold in a multivariate test that includes several control variables, and are robust to several sensitivity tests.

Our findings are consistent with accounting financial expertise on audit committees improving corporate governance, but only when both the expert and appointing firm possess characteristics that facilitate the effective use of the accounting expertise. Thus, our findings suggest that while appointing financial experts to the audit committee may improve corporate governance, their ability to do so is contextual.

Keywords: Sarbanes-Oxley, Audit Committee, Financial Expert, Corporate Governance, Boards of Directors

JEL Classification: M41, M49, G34, G14, G18, K22

Suggested Citation

DeFond, Mark L. and Hann, Rebecca N. and Hu, Xuesong, Does the Market Value Financial Expertise on Audit Committees of Boards of Directors? (January 2004). Available at SSRN: https://ssrn.com/abstract=498822 or http://dx.doi.org/10.2139/ssrn.498822

Mark DeFond

University of Southern California - Leventhal School of Accounting ( email )

Accounting Building, Room 206
Los Angeles, CA 90089-0441
United States
213-740-5016 (Phone)
213-747-2815 (Fax)

Rebecca N. Hann (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

Xuesong Hu

University of Oregon - Department of Accounting ( email )

Lundquist College of Business
1208 University of Oregon
Eugene, OR 97403
United States

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