Expertise Rents from Insider Trading for Financial Experts on Audit Committees

Abstract

Sarbanes Oxley Act (SOX) Section 407 requires firms to disclose if there is a financial expert serving on their audit committees. The extant literature has largely documented SOX 407 benefits, ranging from controlling earning management to reducing internal control weaknesses. Our paper investigates whether there is a cost associated with SOX 407. Using a sample of executive and director transactions from 2003 to 2007, we test whether financial experts obtain information rents or expertise rents on stock purchases. Information rent is earned due to access to superior information, whereas expertise rent is earned due to superior processing skill of the same information. We first find that audit committee members obtain significantly higher abnormal returns than other independent board members. This suggests that audit committee members, including both financial and non-financial experts, earn information rent due to their access to privileged information in audit committees. We then find that financial experts on audit committees obtain higher abnormal returns than non-financial experts on audit committees. Because financial experts and non-financial experts have access to the same information in audit committees, our finding suggests that audit committee financial experts earn additional rents due to their financial expertise. The existence of such expertise rents indicates that there is a cost associated with SOX 407.