Auditing the Audit Committee: A Study of Shareholders' and Boards' Efforts to Hold Audit Committee Members Accountable

Abstract

Using information accompanying the audit committee (AC) member voting recommendations of a proxy advisory service, we examine the circumstances that condition when and why ineffective AC members experience subsequent turnover from the board of directors. We broadly classify the sources of ineffectiveness as (1) characteristics of individual AC members, such as overcommitment or questionable independence, and (2) financial reporting failures, such as restatements or material weaknesses in internal controls. We then estimate a model that conditions turnover reactions to these two general concerns on the corresponding degrees of shareholder dissent revealed in ratification voting. For the first category, we find that individual characteristics of ineffectiveness are associated with lower AC member turnover in the absence of shareholder dissent, but that the association becomes significantly positive as shareholder dissent increases. Conversely, financial reporting failures appear to exert a more systematic positive effect on turnover, even among “tainted” AC members who were not present when the event precipitating the reporting failure occurred. Together, these findings are consistent with an institutional-theoretic perspective that boards take remedial action only when circumstances present direct threats to the company’s image.