Associate professors Liu Xinming and Zheng Zhen from the Accounting Department of the Accounting Development Research Center/School of Management of Xiamen University collaborated with the team on a paper entitled "Multiple Directorships and Audit Committee Effectiveness: Evidence from Effort Allocation", which was published in the European Accounting Review.
01
introduction
Sarbanes-Oxley Act (SOX) greatly expanded the responsibility of the audit committee, not only improved the credibility of the company's financial statements, but also improved corporate governance by changing the incentive mechanism and competence of the board of directors, thus increasing the demand for high-quality audits. Previous studies have found that the main characteristics of the audit committee (such as independence, financial expertise, supervision function, etc.) have improved the audit quality, but they have not considered other specific characteristics that are not covered by SOX but may affect the effectiveness of the audit committee. The existing discussion on multiple directors mainly focuses on the level of independent directors, while Articles 301 and 407 of SOX restrict the qualifications of the audit committee, so multiple directors are more common among the directors of the audit committee. Because the audit committee is required to supervise the quality of corporate governance, and the directors of the audit committee play the dual roles of managing business operations and supervising the decisions of the board of directors, the empirical results of general independent directors may not be applicable to the directors of the audit committee. Therefore, this paper explores (1) how audit committee members who serve on audit committees of several companies allocate their energy; (2) Whether the unequal distribution of energy in the positions of directors of several audit committees affects the effectiveness of supervision by audit committees.
02
Multiple Directors and the Effectiveness of Audit Committee: From the Perspective of Company Size
Previous studies have shown that effective audit committees play an important role in restraining managers' opportunistic behavior. Because an effective audit committee needs more attention, time and energy, the directors of the audit committee who serve on multiple boards must decide how to allocate their limited energy among the directors. If the directors of the Audit Committee distribute their energy unequally according to the relative importance of a director position, the supervision efficiency of the Audit Committee will be different with the energy invested in each director position. Therefore, this paper studies how the directors of the Audit Committee who serve on multiple boards allocate their work energy to different board positions, and tests whether the inequality of work priorities among multiple boards will affect the effectiveness of the supervision of the Audit Committee.
Maintaining and improving the reputation of directors' labor market is a key factor for external directors. As a diligent management supervisor, it is attractive and valuable for directors, because a good reputation increases the human capital of directors and increases the possibility of obtaining new directorships. Because the size of the company currently employed is positively related to its popularity, prestige, salary and opportunities for other companies, larger companies will create stronger incentives for directors to invest more time and energy in supervising the management. Based on this reasoning, some scholars use company size to measure the relative importance of directors' positions. They found that when independent directors think that a director position is more important than other directors positions, the attendance rate of independent directors will increase and the company's performance will also improve.
Although the incentive opportunity based on the company size induces independent directors to give priority to their energy allocation, it is not clear whether this incentive measure will also affect the energy allocation decision of audit Committee directors. Unlike non-audit committee directors, audit committee directors are authorized to supervise the company's financial reporting process, supervise internal control and restrict opportunistic management reports. Considering that the directors of the audit committee play a dual and perhaps conflicting role in managing the operation of the company and supervising the decision-making of the board of directors, the empirical results on independent directors may or may not be applicable to the directors of the audit committee. Since SOX requires the audit committee to be responsible for the overall governance quality of the company, it is important to know how the directors of the audit committee allocate their energy to ensure the governance quality of each company. In the post-SOX period, the directors of the audit committee who have multiple directors' positions may have higher supervision effectiveness on larger companies, but they may not have significant influence.
03
Multiple Directors and the Effectiveness of Audit Committee: From the Perspective of Corporate Risk
After the promulgation of SOX, the litigation risk of audit committee directors is higher than that of other directors. Some evidences show that, compared with non-audit committee directors, audit committee directors have a higher degree of responsibility exposure after company misstatement. In class actions, directors of the audit committee are more likely to be listed as defendants than non-audit committee directors. In addition, the audit committee's responsibility in supervising the company's financial report and audit work has greatly increased in the post-SOX period, which leads to higher litigation risk of the audit committee. More importantly, independent boards with poor supervision records are punished by managing the labor market. There is evidence that, after the restatement of financial statements, the directors of the audit committee lost more other directorships than the non-audit committee directors. In addition, financial experts lose more directorships than non-financial experts in companies that restate declining income. Generally speaking, these studies emphasize the economic costs borne by directors of audit committees due to financial misstatement.
As the directors of the audit committee have stronger motivation to improve the earnings quality, so as to reduce the litigation risk and the resulting reputation loss, serving as directors in companies with different litigation risk levels may have different incentives for the directors of the audit committee to supervise the management. Specifically, if the directors of the audit committee can effectively reduce the risks of litigation and financial misstatement, the risk-based motivation may be the strongest. This demand-side perspective on the director market shows that the difference of risk-based motivation mechanism may be very important. Therefore, in the post-SOX period, the directors of the audit committee who hold multiple directorships may have higher supervision effectiveness on companies with higher risks.
04
Conclusion and enlightenment
This study discusses how the directors of the Audit Committee who serve on multiple boards distribute their energy, and whether the energy inequality in different directors' positions will affect the supervision effectiveness of the directors of the Audit Committee. Although the recent research of the audit committee shows that being a director may reduce the effectiveness of the audit committee's supervision, this paper studies whether the scale and risk of the company will have different motives, thus affecting the energy distribution among the directors of the audit committee, and how this energy distribution affects the quality of the company's financial report. Considering the competitive demand for time for the directors of the audit committee who hold multiple positions at the same time, the rational directors of the audit committee should put more energy into the places with high supervision efficiency.
Using the scale of the company, litigation risk and misrepresentation to measure the importance of the position of directors, this paper finds that after the implementation of SOX, the directors of the audit committee unequally allocate their energy to companies with different risk levels. Specifically, this paper finds that the more important a company with higher risk (rather than a larger company) is to the directors of the audit committee, the more energy they will devote to this company. Therefore, the higher the effectiveness of its supervision, the higher the audit fees, the choice of industry expert auditors and the higher the quality of financial reports. To sum up, this study emphasizes the importance of considering the risk motivation of individual directors when testing the effectiveness of audit supervision. This study also shows that audit committee directors will not distribute their energy evenly on all the boards where they are located. On the contrary, these talented audit committee directors tend to devote more energy to individual directors' positions to reduce the risk of litigation and misrepresentation, and the risk awareness of audit committee directors has a strong influence on their behavior. Therefore, the risk of litigation and misstatement of the company represents a new dimension of the supervision motivation of the directors of the audit Committee, which should be taken into account by researchers and shareholders in the relevant issues of the audit Committee.
The results of this paper are of great significance to regulators, board of directors, investors and others. First of all, although appointing high-quality auditors and determining appropriate audit fees are usually regarded as solutions to improve the quality of corporate financial reports, the results of this study show that these decisions may be affected by how the directors of the audit Committee allocate their energy when they serve on multiple boards. Secondly, the results of this paper suggest to disclose the number of multiple director positions held by each audit Committee director and the main supervision work performed by each audit Committee director. This information may be valuable to investors and regulators. Finally, future research can examine other aspects of multiple director positions (for example, the term of each director position, the status of each board of directors, and the punishment when supervision fails), which may also affect the effectiveness of the audit Committee.
