Hostname: page-component-8448b6f56d-42gr6 Total loading time: 0 Render date: 2024-04-23T09:32:32.130Z Has data issue: false hasContentIssue false
  • English
  • Français

Director Connectedness: Monitoring Efficacy and Career Prospects

Published online by Cambridge University Press:  14 February 2018

Vincent J. Intintoli ,
Kathleen M. Kahle  and
Wanli Zhao
Get access Rights & Permissions [Opens in a new window]

Abstract

We examine a specific channel through which director connectedness may improve monitoring: financial reporting quality. We find that the connectedness of independent, non-co-opted audit committee members has a positive effect on financial reporting quality and accounting conservatism. The effect is not significant for non-audit committee or co-opted audit committee members. Our results are robust to tests designed to mitigate self-selection. Consistent with connected directors being valuable, the market reacts more negatively to the deaths of highly connected directors than to the deaths of less connected directors. Better connected directors also have better career prospects, suggesting they have greater incentives to monitor.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 1 , February 2018 , pp. 65 - 108
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank Jeffrey Coles (associate editor and referee) and Jarrad Harford (the editor) for their helpful suggestions. We also thank Renee Adams, Amir Barnea, David Becher, Alice Bonaimé, Luke DeVault, Ionnis Floros, Vladimir Gatchev, Samir Ghannam, Ivan Gloris, Daniel Greene, Sandy Klasa, Jayanthi Krishnan, Brandon Lockhart, Angie Low, David Mauer, Angela Morgan, Tom Omer, David Reeb, Matthew Serfling, Rick Sias, Johan Sulaeman, Jayanthi Sunder, Rong Wang, Mike Weisbach, Jack Wolf, Ryan Williams, Fei Xie, and Bernard Yeung; seminar participants at Clemson University, Iowa State University, Nanyang Technological University, and National University of Singapore; and conference participants at the 2015 American Accounting Association (AAA) annual meeting, the 2015 Financial Management Association (FMA) annual meeting, the 28th Australasian Finance and Banking Conference (AFBC), and the 2016 China International Conference in Finance (CICF) for useful comments. An earlier version of this paper was titled “Board Effectiveness and Board Connectedness.”

References

Abadie, A., and Imbens, G.. “Large Sample Properties of Matching Estimators for Average Treatment Effects.” Econometrica, 74 (2006), 235–267.CrossRefGoogle Scholar
Adams, R. B., and Ferreira, D.. “A Theory of Friendly Boards.” Journal of Finance, 62 (2007), 217–250.CrossRefGoogle Scholar
Ahmed, A. S., and Duellman, S.. “Managerial Overconfidence and Accounting Conservatism.” Journal of Accounting Research, 51 (2013), 1–30.CrossRefGoogle Scholar
Ai, C., and Norton, E.. “Interaction Terms in Logit and Probit Models.” Economics Letters, 80 (2003), 123–129.Google Scholar
Alam, Z.; Chen, M.; Ciccotello, C.; and Ryan, H.. “Does the Location of Directors Matter? Information Acquisition and Board Decisions.” Journal of Financial and Quantitative Analysis, 49 (2014), 131–164.CrossRefGoogle Scholar
Anderson, R. C.; Mansi, S.; and Reeb, D.. “Board Characteristics, Accounting Report Integrity, and the Cost of Debt.” Journal of Accounting and Economics, 37 (2004), 315–342.Google Scholar
Armstrong, C., and Larcker, D.. “Discussion of the Impact of the Options Backdating Scandal on Shareholders and Taxes and the Backdating of Stock Option Exercise Date.” Journal of Accounting and Economics, 47 (2009), 50–58.Google Scholar
Ashbaugh, H. A.; LaFond, R.; and Mayhew, B. W.. “Do Nonaudit Services Compromise Auditor Independence? Further Evidence.” Accounting Review, 78 (2003), 611–639.Google Scholar
Barnea, A., and Guedj, I.. “Director Networks.” Working Paper, HEC Montreal and Bates White, LLC (2014).Google Scholar
Basu, S.“The Conservatism Principle and the Asymmetric Timeliness of Earnings.” Journal of Accounting and Economics, 24 (1997), 3–37.Google Scholar
Bates, T. W.; Becher, D. A.; and Wilson, J. I.. “Performance-Based Turnover on Corporate Boards.” Working Paper, Arizona State University, Drexel University, and Indiana University. Available at http://ssrn.com/abstract=2654375 (2017).Google Scholar
Beatty, A.; Weber, J.; and Yu, J. J.. “Conservatism and Debt.” Journal of Accounting and Economics, 45 (2008), 154–174.Google Scholar
Bebchuk, L.; Cohen, A.; and Ferrell, A.. “What Matters in Corporate Governance?” Review of Financial Studies, 22 (2009), 783–827.Google Scholar
Bédard, J.; Chtourou, S. M.; and Courteau, L.. “The Effect of Audit Committee Expertise, Independence, and Activity on Aggressive Earnings Management.” Auditing: A Journal of Practice & Theory, 23 (2004), 15–37.Google Scholar
Belliveau, M. A.; O’Reilly, C. A.; and Wade, J. B.. “Social Capital at the Top: Effects of Social Similarity and Status on CEO Compensation.” Academy of Management Journal, 39 (1996), 1568–1593.Google Scholar
Bhagat, S., and Black, B. S.. “The Uncertain Relationship between Board Composition and Firm Performance.” Business Lawyer, 54 (1999), 921–963.Google Scholar
Bizjak, J. M.; Lemmon, M. L.; and Whitby, R. J.. “Option Backdating and Board Interlocks.” Review of Financial Studies, 22 (2009), 4821–4847.CrossRefGoogle Scholar
Bonacich, P.“Factoring and Weighting Approaches to Status Scores and Clique Identification.” Journal of Mathematical Sociology, 2 (1972), 113–120.Google Scholar
Brown, R.; Gao, N.; Lee, E.; and Stathopoulos, K.. “What Are Friends for? CEO Networks, Pay and Corporate Governance.” In Corporate Governance: Recent Developments and New Trends, Boubaker, S., Nguyen, B. D., and Nguyen, D. K., eds. Berlin, Germany: Springer Berlin Heidelberg (2012), 287–307.Google Scholar
Carcello, J.; Neal, T.; Palmrose, Z. V.; and Scholz, S.. “CEO Involvement in Selecting Board Members, Audit Committee Effectiveness, and Restatements.” Contemporary Accounting Research, 28 (2011), 396–430.CrossRefGoogle Scholar
Cashman, G. D.; Gillan, S. L.; and Whitby, R. J.. “Expertise, Connections, and the Labor Market for Corporate Directors.” Working Paper, Texas Tech University, University of Georgia, and Utah State University (2010).Google Scholar
Chemmanur, T., and Paeglis, I.. “Management Quality, Certification, and Initial Public Offering.” Journal of Financial Economics, 76 (2005), 331–368.Google Scholar
Chidambaran, N. K.; Kedia, S.; and Prabhala, N. R.. “CEO-Director Connections and Corporate Fraud.” Working Paper, Fordham University, Rutgers Business School, and University of Maryland. Available at http://ssrn.com/abstract=2023030 (2012).Google Scholar
Chiu, P.-C.; Teoh, S. H.; and Tian, F.. “Board Interlocks and Earnings Management Contagion.” Accounting Review, 88 (2013), 915–944.CrossRefGoogle Scholar
Cohen, A., and Wang, C. C. Y.. “How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment.” Journal of Financial Economics, 110 (2013), 627–641.Google Scholar
Cohen, L.; Frazzini, A.; and Malloy, C.. “Hiring Cheerleaders: Board Appointments of ‘Independent’ Directors.” Management Science, 58 (2012), 1039–1058.Google Scholar
Coles, J. L.; Daniel, N. D.; and Naveen, L.. “Co-Opted Boards.” Review of Financial Studies, 27 (2014), 1751–1796.Google Scholar
Coles, J. L., and Hoi, C. K.. “New Evidence on the Market for Directors: Board Membership and Pennsylvania Senate Bill 1310.” Journal of Finance, 58 (2003), 197–230.Google Scholar
Coles, J. L.; Wang, A. Y.; and Zhu, C.. “Director Network and CEO Turnover.” Working Paper, University of Utah, Auburn University, and New York University (2015).Google Scholar
Dechow, P. M., and Dichev, I. D.. “The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors.” Accounting Review, 77 (2002), 35–59.CrossRefGoogle Scholar
Dechow, P. M.; Ge, W.; Larson, C. R.; and Sloan, R. G.. “Predicting Material Accounting Misstatements.” Contemporary Accounting Research, 28 (2011), 17–82.CrossRefGoogle Scholar
Dechow, P. M.; Ge, W.; and Schrand, C.. “Understanding Earnings Quality: A Review of the Proxies, Their Determinants and Their Consequences.” Journal of Accounting and Economics, 50 (2010), 344–401.CrossRefGoogle Scholar
DeFond, M. L.; Hann, R. N.; and Hu, X.. “Does the Market Value Financial Expertise on Audit Committees of Boards of Directors?” Journal of Accounting Research, 43 (2005), 153–193.Google Scholar
Denis, D. K.; Lee, J.; and Lee, K. J.. “Director Connections, Board Appointments, and Director Reputation.” Working Paper, University of Pittsburgh, University of Florida, and U.S. Securities and Exchange Commission (2014).Google Scholar
Dhaliwal, D. S.; Naiker, V.; and Navissi, F.. “Audit Committee Financial Expertise, Corporate Governance and Accruals Quality: An Empirical Analysis.” Working Paper, University of Arizona, The University of Melbourne, and Monash University. Available at http://ssrn.com/abstract=906690 (2006).Google Scholar
Dhaliwal, D. S.; Naiker, V.; and Navissi, F.. “The Association between Accruals Quality and the Characteristics of Accounting Experts and Mix of Expertise on Audit Committees.” Contemporary Accounting Research, 27 (2010), 787–827.Google Scholar
Doyle, J.; Ge, W.; and McVay, S.. “Determinants of Weaknesses in Internal Control over Financial Reporting.” Journal of Accounting and Economics, 44 (2007), 193–223.CrossRefGoogle Scholar
Dyck, I. J. A.; Morse, A.; and Zingales, L.. “Who Blows the Whistle on Corporate Fraud?” Journal of Finance, 65 (2010), 2213–2253.Google Scholar
El-Khatib, R.; Fogel, K.; and Jandik, T.. “CEO Network Centrality and Merger Performance.” Journal of Financial Economics, 116 (2015), 349–382.Google Scholar
Engelberg, J.; Gao, P.; and Parsons, C. A.. “Friends with Money.” Journal of Financial Economics, 103 (2012), 169–188.CrossRefGoogle Scholar
Engelberg, J.; Gao, P.; and Parsons, C. A.. “The Price of a CEO’s Rolodex.” Review of Financial Studies, 26 (2013), 79–114.Google Scholar
Fahlenbrach, R.; Low, A.; and Stulz, R.. “Do Independent Director Departures Predict Future Bad Events?” Review of Financial Studies, 30 (2017), 2313–2358.CrossRefGoogle Scholar
Fama, E. F.“Agency Problems and the Theory of the Firm.” Journal of Political Economy, 88 (1980), 288–307.Google Scholar
Fama, E. F., and French, K. R.. “Industry Costs of Equity.” Journal of Financial Economics, 43 (1997), 153–193.Google Scholar
Fama, E. F., and Jensen, M. C.. “Separation of Ownership and Control.” Journal of Law and Economics, 26 (1983), 301–325.Google Scholar
Ferreira, M., and Laux, P.. “Corporate Boards and SEOs: The Effect of Certification and Monitoring.” Journal of Financial and Quantitative Analysis, 51 (2016), 899–927.Google Scholar
Fich, E. M., and Shivdasani, A.. “Are Busy Boards Effective Monitors?” Journal of Finance, 61 (2006), 689–724.CrossRefGoogle Scholar
Fich, E. M., and Shivdasani, A.. “Financial Fraud, Director Reputation, and Shareholder Wealth.” Journal of Financial Economics, 86 (2007), 306–336.CrossRefGoogle Scholar
Fracassi, C.“Corporate Finance Policies and Social Networks.” Management Science, 63 (2017), 2420–2438.Google Scholar
Fracassi, C., and Tate, G.. “External Networking and Internal Firm Governance.” Journal of Finance, 67 (2012), 153–194.Google Scholar
Freeman, L. C.“A Set of Measures of Centrality Based on Betweenness.” Sociometry, 40 (1977), 35–41.Google Scholar
Gilson, S.“Bankruptcy, Boards, Banks, and Blockholders: Evidence on Changes in Corporate Ownership and Control When a Firms Default.” Journal of Financial Economics, 27 (1990), 355–387.Google Scholar
Givoly, D., and Hayn, C.. “The Changing Time-Series Properties of Earnings, Cash Flows and Accruals: Has Financial Reporting Become More Conservative?” Journal of Accounting and Economics, 29 (2000), 287–320.Google Scholar
Gompers, P. A.; Ishii, J. L.; and Metrick, A.. “Corporate Governance and Equity Prices.” Quarterly Journal of Economics, 11 (2003), 107–155.Google Scholar
Gormley, T. A., and Matsa, D. A.. “Common Errors: How To (and Not To) Control for Unobserved Heterogeneity.” Review of Financial Studies, 27 (2014), 617–661.Google Scholar
Greene, W. H.“The Behaviour of the Maximum Likelihood Estimator of Limited Dependent Variable Models in the Presence of Fixed Effects.” Econometrics Journal, 7 (2004), 98–119.Google Scholar
Greene, W. H.“Testing Hypotheses about Interaction Terms in Nonlinear Models.” Economic Letters, 107 (2010), 291–296.Google Scholar
Harford, J.“Takeover Bids and Target Directors’ Incentives: The Impact of a Bid on Directors’ Wealth and Board Seats.” Journal of Financial Economics, 69 (2003), 51–83.Google Scholar
Harford, J., and Schonlau, R.. “Does the Director Labor Market Offer Ex Post Settling-Up for CEOs? The Case of Acquisitions.” Journal of Financial Economics, 110 (2013), 18–36.Google Scholar
He, J., and Huang, Z.. “Board Informal Hierarchy and Firm Financial Performance: Exploring a Tacit Structure Guiding Boardroom Interactions.” Academy of Management Journal, 54 (2011), 1119–1139.Google Scholar
Healy, P. M.“The Effect of Bonus Schemes on Accounting Decisions.” Journal of Accounting and Economics, 7 (1985), 85–107.Google Scholar
Hermalin, B. E., and Weisbach, M. S.. “Endogenously Chosen Boards of Directors and Their Monitoring of the CEO.” American Economic Review, 88 (1998), 96–118.Google Scholar
Holthausen, R., and Watts, R.. “The Relevance of Value Relevance Literature for Financial Accounting Standard Setting.” Journal of Accounting and Economics, 31 (2001), 3–75.Google Scholar
Hooghiemstra, R., and van Manen, J.. “The Independence Paradox: (Im)possibilities Facing Non-Executive Directors in the Netherlands.” Corporate Governance: An International Review, 12 (2004), 314–324.Google Scholar
Hribar, P., and Nichols, D. C.. “The Use of Unsigned Earnings Quality Measures in Tests of Earnings Management.” Journal of Accounting Research, 45 (2007), 1017–1053.Google Scholar
Hwang, B. H., and Kim, S.. “It Pays to Have Friends.” Journal of Financial Economics, 93 (2009), 138–158.Google Scholar
Jones, J.“Earnings Management during Import Relief Investigations.” Journal of Accounting Research, 29 (1991), 193–228.CrossRefGoogle Scholar
Karpoff, J.; Koester, A.; Lee, D. S.; and Martin, G. S.. “Proxies and Databases in Financial Misconduct Research.” Accounting Review, 92 (2017), 129–163.Google Scholar
Khan, M., and Watts, R. L.. “Estimation and Empirical Properties of a Firm-Year Measure of Accounting Conservatism.” Journal of Accounting and Economics, 48 (2009), 132–150.Google Scholar
Khanna, V.; Kim, E. H.; and Lu, Y.. “CEO Connectedness and Corporate Fraud.” Journal of Finance, 70 (2015), 1203–1252.Google Scholar
Kim, I., and Skinner, D. J.. “Measuring Securities Litigation Risk.” Journal of Accounting and Economics, 53 (2012), 290–310.Google Scholar
Klein, A.“Audit Committee, Board of Director Characteristics, and Earnings Management.” Journal of Accounting and Economics, 33 (2002), 375–400.Google Scholar
Knyazeva, A.; Knyazeva, D.; and Masulis, R. W.. “The Supply of Corporate Directors and Board Independence.” Review of Financial Studies, 26 (2013), 1561–1605.Google Scholar
Kothari, S. P.; Leone, A. J.; and Wasley, C. E.. “Performance Matched Discretionary Accrual Measures.” Journal of Accounting and Economics, 39 (2005), 163–197.Google Scholar
Krishnan, G. V., and Visvanathan, G.. “Does the SOX Definition of an Accounting Expert Matter? The Association between Audit Committee Directors’ Accounting Expertise and Accounting Conservatism.” Contemporary Accounting Research, 25 (2008), 827–858.CrossRefGoogle Scholar
Krishnan, J.; Wen, Y.; and Zhao, W.. “Legal Expertise on Corporate Audit Committees and Financial Reporting Quality.” Accounting Review, 86 (2011), 2099–2130.Google Scholar
Larcker, D. F.; So, E. C.; and Wang, C. C. Y.. “Boardroom Centrality and Firm Performance.” Journal of Accounting and Economics, 55 (2013), 225–250.Google Scholar
Liu, Y.“Outside Options and CEO Turnover: The Network Effect.” Journal of Corporate Finance, 28 (2014), 201–217.CrossRefGoogle Scholar
Morse, A.; Nanda, V.; and Seru, A.. “Are Incentive Contracts Rigged by Powerful CEOs?” Journal of Finance, 66 (2011), 1779–1821.Google Scholar
Newman, M. E. J.“The Structure and Function of Complex Networks.” SIAM Review, 45 (2003), 167–256.Google Scholar
Nguyen, B. D.“Does the Rolodex Matter? Corporate Elite’s Small World and the Effectiveness of Boards of Directors.” Management Science, 58 (2012), 236–252.Google Scholar
Omer, T. C.; Shelley, M. K.; and Tice, F. M.. “Do Director Networks Matter for Financial Reporting Quality? Evidence from Restatements.” Working Paper, University of Nebraska at Lincoln and University of Colorado at Boulder. Available at http://ssrn.com/abstract=2379151 (2016).Google Scholar
PricewaterhouseCoopers. “Achieving Excellence: The Audit Committee’s Role in Deterring Fraud,” Audit Committee Excellence Series. Available at http://www.corporatecomplianceinsights.com/wp-content/uploads/2015/12/ACES-Audit-Committees-Role-in-Deterring-Fraud.pdf(2015).Google Scholar
Proctor, C. H., and Loomis, C. P.. “Analysis of Sociometric Data.” In Research Methods in Social Relations with Special Reference to Prejudice, Vol. 2, Jahoda, M., Deutsch, M., and Cook, S. W., eds. New York, NY: Dryden (1951), 561–585.Google Scholar
Raheja, C. G.“Determinants of Board Size and Composition: A Theory of Corporate Boards.” Journal of Financial and Quantitative Analysis, 40 (2005), 283–306.CrossRefGoogle Scholar
Sabidussi, G.“The Centrality Index of a Graph.” Psychometrika, 31 (1966), 581–603.Google Scholar
Shivdasani, A., and Yermack, D.. “CEO Involvement in the Selection of New Board Members: An Empirical Analysis.” Journal of Finance, 54 (1999), 1829–1853.Google Scholar
Shleifer, A., and Vishny, R. W.. “A Survey of Corporate Governance.” Journal of Finance, 52 (1997), 737–783.Google Scholar
Srinivasan, S.“Consequences of Financial Reporting Failure for Outside Directors: Evidence from Accounting Restatements and Audit Committee Members.” Journal of Accounting Research, 43 (2005), 291–334.Google Scholar
Teoh, S.; Welch, I.; and Wong, T.. “Earnings Management and the Subsequent Market Performance of Initial Public Offerings.” Journal of Finance, 53 (1998), 1935–1974.Google Scholar
Wang, C.; Xie, F.; and Zhu, M.. “Industry Expertise of Independent Directors and Board Monitoring.” Journal of Financial and Quantitative Analysis, 50 (2015), 929–962.Google Scholar
Watts, R.“Conservatism in Accounting, Part I: Explanations and Implications.” Accounting Horizons, 17 (2003), 207–221.Google Scholar
Xie, H.“The Mispricing of Abnormal Accruals.” Accounting Review, 76 (2001), 357–373.Google Scholar
Yermack, D.“Remuneration, Retention, and Reputation Incentives for Outside Directors.” Journal of Finance, 59 (2004), 2281–2308.Google Scholar