The effect of distracted audit committee members on earnings quality
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The effect of distracted audit committee members on earnings quality Susan Elkinawy1 · Joshua Spizman1 · Hai Tran1
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract In this paper, we examine the impact of distracting events to audit committee members on the firms’ earnings quality. Specifically, we focus on major events occurring simultaneously at other firms in which the audit committee members also serve as board members or CEOs. We find that during the years of major events, the number of board meetings at event firms significantly increases while there is no difference in board meetings at nonevent firms. During this period, distracted directors miss more board meetings at the nonevent firms than non-distracted directors. Consequently, firms with more distracted audit committee members have lower earnings quality. Our results indicate that director distractions, not director busyness, are associated with the decline in earnings quality. Notably, this decline in earnings quality at non-event firms is confined to the distraction years and audit committee members only. Our results have implications for shareholders and policy makers in assessing the tradeoffs between hiring experienced, qualified directors and the potential distractions that may result from their other commitments. Keywords Busy directors · Director attention · Distracted directors · Corporate governance · Earnings quality JEL Classification G30 · G34
* Joshua Spizman [email protected] Susan Elkinawy [email protected] Hai Tran [email protected] 1
Department of Finance, Loyola Marymount University, One LMU Drive, MS 8385, Los Angeles, CA 90045‑2657, USA
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1 Introduction In 2000, NiSource and Columbia Energy Group completed a merger creating a “superregional energy powerhouse stretching from the Gulf of Mexico to Chicago and New England” in a $6 billion transaction.1 In addition to serving as a director on the board of NiSource, Carolyn Woo served as a director on the board of AON Corporation, where she was also on the audit committee. During the same year, Carolyn Woo attended less than 75% of AON’s board meetings, the only year this happened in her 13 years of service on AON’s board. AON saw a decline in financial reporting quality overlapping this same time period. This anecdote raises an interesting research question: Is financial reporting quality affected when audit committee members are distracted due to a major event occurring at another firm they serve on? Whether shareholders benefit from owning firms whose directors sit on multiple boards of directors is an ongoing debate. On one hand, allowing directors to serve on multiple boards incentivizes them to provide effective monitoring, improve their reputational capital, and subsequently gain additional board seats (Fama 1980; Fama and Jensen 1983). In addition, Kaplan and Reishus (1990), Booth and Deli (1996), and Ferris et al. (2003) find evidence that directors who hold multiple directorships do no
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