Abstract

We investigate the relation between audit committee co-option and financial reporting quality, where audit committee co-option is measured as the proportion of audit committee members who joined the board after the appointment of the current Chief Executive Officer (CEO). Because CEOs are often actively involved in the director nomination and selection process, we expect that higher levels of audit committee co-option will be associated with less effective monitoring, as evidenced by more financial statement misstatements and greater absolute discretionary accruals. Consistent with our expectations, we find a positive relation between audit committee co-option and misstatements as well as between audit committee co-option and absolute discretionary accruals. Consistent with prior work which documents the importance of accounting expertise on the audit committee, subsequent tests reveal that the adverse implications of audit committee co-option are mitigated when the audit committee chair is an accounting expert. Our findings should be of interest to regulators, investors, and other stakeholders because we provide new evidence about how potential CEO influence on director nominations and audit committee appointments impacts the effectiveness of monitoring by the audit committee.

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