Does the SOX Definition of an Accounting Expert Matter? The Association between Audit Committee Directors' Accounting Expertise and Accounting Conservatism*

Abstract

The Sarbanes-Oxley Act (SOX) (U.S. Congress 2002) mandates the disclosure of whether the audit committee includes a financial expert. ' However, the operationalization of who is a financial expert was and still is a controversial issue (Plitch and Ceron 2003). Some have argued that effective audit committee members are those who have general management experience rather than those who have an accounting or financial background (Olson 1999). The Securities and Exchange Commission (SEC) initially proposed a narrow definition to include only accounting financial experts — that is, directors with experience as a certified public accountant (CPA), auditor, chief financial officer (CFO), controller, or chief accounting officer. Subsequently, the SEC defined financial expert broadly to include nonaccounting financial experts, such as directors with experience as a chief executive officer (CEO) or president (SEC 2003).2 Was the SEC correct in defining financial experts to include both accounting and nonaccounting experts? Do accounting financial experts enhance the quality of financial reporting more than nonaccounting financial experts? These are important questions because the primary objective of SOX was to restore credibility to the U.S. financial reporting system, which was tarnished by several high-profile accounting scandals. Because the audit committee is the ultimate monitor of the financial reporting process, the audit committee's financial expertise is a key determinant of its effectiveness (Treadway 1987). We contribute to this debate by separately examining the association between the audit committee's accounting financial expertise and nonaccounting financial expertise and several attributes of financial reporting quality.