Do Director Networks Matter for Financial Reporting Quality? Evidence from Restatements

Abstract

This study examines the effect of board of director connectedness on financial reporting quality, specifically the misstatement of annual financial statements. Because restatements are costly, it is important to understand whether firms with well-connected directors benefit from better access to the information exchanged through the director network. We examine multiple dimensions of connectedness and find that, after controlling for operating performance and corporate governance characteristics, firms with well-connected directors are less likely to misstate their annual financial statements, even in the presence of a board connection with another misstating firm. In particular, our results indicate that the negative effect on financial reporting quality of board interlocks to misstating firms can be offset by connections to other well-connected directors, by the speed at which directors can access information and by having directors who increase the likelihood of receiving more complete information through the boardroom network. We conduct several tests to address alternative explanations, as well as hold board composition constant to control for endogeneity, and find similar results. Our findings suggest that corporate boards with better-networked directors are less likely to adopt reporting practices that reduce financial reporting quality.