Non-accounting Financial Expertise Research Articles

The effect of audit committee financial expertise on earnings management tactics in the post-SOX era

To restore investor confidence and promote the integrity of financial accounting information provided to investors, following the passage of the Sarbanes-Oxley Act (SOX), the SEC adopted two new rules for public firms in early 2003, requiring the disclosure of audit committee financial expertise (ACFE) per SOX 407 and the reconciliation of non-GAAP financial measures to those most comparable in GAAP (Regulation G) per SOX 401(b). Using quarterly filing data in the post-SOX era from March 2003 to December 2016, this study examines the impact of these requirements, with a focus on the effect of ACFE on the main earnings manipulation tactics used to just meet or beat analyst expectations (JUSTMBE). Our study investigates the effects of overall ACFE and its components on three key earnings management tactics, namely, discretionary accruals, real activities management, and non-GAAP financial disclosures. We observe that firms with a higher level of ACFE, particularly accounting and finance expertise, exhibit a lower propensity to JUSTMBE. Furthermore, we posit that two upward earnings manipulations, accrual-based and real activities management, are significantly mitigated by ACFE through a complementary effect of its accounting and supervisory expertise components. However, we identify a clear strategic shift in which non-GAAP financial disclosures with unexpected exclusions become a popular alternative tactic for managers to JUSTMBE under the increasing presence of ACFE. This study provides empirical evidence with implications for regulators to consider more rigorous intervention and regulation on non-GAAP disclosures and to refine the requirement of audit committee financial experts with an emphasis on the complement of accounting and non-accounting financial expertise to effectively curtail earnings manipulation.

Audit Committee Financial Expertise and Financial Reporting Timeliness

This study examines conceptually the relevance of the audit committee financial expertise to financial reporting timeliness of a firm. The methodology adopted in this study is library research whereby relevant and extant literature related to the audit committee financial expertise and financial reporting timeliness. Audit committee financial expertise was x-ray from the perspective of accounting financial expertise and the non-accounting financial expertise. Observations from the study highlights that the presence of accounting financial experts in an audit committee is an important element that mitigate reportorial challenges and motivates financial reporting timeliness. The study recommends that financial experts in the audit committee should be given more power to enable them discharge their duty effectively and efficiently, the definition of audit committee financial expertise should not relegate other relevant profession to the background, and the impact of the audit committee financial expertise on audit expectation gap should be considered when appointing members of the audit committee.
 
 Received: 3 February 2022 / Accepted: 23 February 2022 / Published: 5 March 2022

The Effects of Accounting Expertise of Board Committees on the Short- and Long-Term Consequences of Financial Restatements

Using financial restatements as the contextual setting, we examine whether the accounting expertise of board committees affects the consequences of financial reporting quality. We analyze both short-term consequences—stock market reactions surrounding restatement announcements, and long-term consequences—the incidence of Securities and Exchange Commission (SEC) Accounting and Auditing Enforcement Actions (AAERs), and CEO and CFO turnover after restatements. Our results show that the presence of audit committee members with accounting expertise moderates the consequences of restatements, resulting in less negative stock market reactions and a lower probability of CEO turnover. In contrast, the audit committee’s nonaccounting financial expertise increases the likelihood of AAERs. For the compensation committee, we find that accounting expertise reduces the probability of CEO turnover, while nonaccounting financial expertise exacerbates the negative stock returns around restatement announcements and increases the probability of AAER. In the post–Sarbanes–Oxley Act (SOX) period, restatements have resulted in less severe consequences as companies have increased their propensity to hire accounting experts on the board. Correspondingly, we document that the moderating effects of accounting expertise become less significant, in part because the moderating effects are offset by the changed investor expectations. Overall, our results suggest that accounting expertise of board committees helps mitigate the negative consequences of restatements.

The Effects of Accounting Expertise of Board Committees on the Short- and Long-term Consequences of Financial Restatements

Using financial restatements as the contextual setting, we examine whether the accounting expertise of board committees affects the consequences of financial reporting quality. We analyze both short-term consequences—stock market reactions surrounding restatement announcements, and long-term consequences—the incidence of SEC Accounting and Auditing Enforcement Actions (AAERs), and CEO and CFO turnover after restatements. Our results show that the presence of audit committee members with accounting expertise moderates the consequences of restatements, resulting in less negative stock market reactions and a lower probability of CEO turnover. In contrast, the audit committee’s non-accounting financial expertise increases the likelihood of AAERs. For the compensation committee, we find that accounting expertise reduces the probability of CEO turnover, while non-accounting financial expertise exacerbates the negative stock returns around restatement announcements and increases the probability of AAER. In the post Sarbanes Oxley Act (SOX) period, restatements have resulted in less severe consequences while companies have increased their propensity to hire accounting experts. on the board. Correspondingly, we document that the moderating effects of accounting expertise become less significant, in part because the moderating effects are offset by the changed investor expectations. Overall, our results suggest that accounting expertise of board committees helps mitigate the negative consequences of restatements.

Audit Committee Financial Expertise and Financial Reporting Timeliness in Emerging Market: Does Audit Committee Chair Matter?

This study examines whether audit committee chair with financial expertise enhances the audit committee role in financial reporting quality in emerging market. We investigate this influence by employing the direct effect and moderating effect of audit committee chair with financial expertise on financial reporting timeliness. By using Omani data and the panel data method for two proxies for financial reporting timeliness, we find that audit committee chair with financial expertise enhances the timeliness of financial reporting through making the disclosure of annual reports timely. Further, we report evidence showing that both accounting and nonaccounting financial expertise on the audit committee have a positive and significant influence on the timeliness of financial reporting. We also document that the association between financial expertise and the timeliness of financial reporting is more pronounced when the chair of the audit committee has accounting expertise. This study is among the comprehensive evidence prove that audit committee chair with accounting expertise contributes to the quality of financial reporting in emerging market.

Audit Committee Financial Expertise and Financial Reporting Timeliness in Emerging Market: Does Audit Committee Chair Matter?

This study examines whether audit committee chair with financial expertise enhances the audit committee role in financial reporting quality in emerging market. We investigate this influence by employing the direct effect and moderating effect of audit committee chair with financial expertise on financial reporting timeliness. By using Omani data and the panel data method for two proxies for financial reporting timeliness, we find that audit committee chair with financial expertise enhances the timeliness of financial reporting through making the disclosure of annual reports timely. Further, we report evidence showing that both accounting and nonaccounting financial expertise on the audit committee have a positive and significant influence on the timeliness of financial reporting. We also document that the association between financial expertise and the timeliness of financial reporting is more pronounced when the chair of the audit committee has accounting expertise. This study is among the comprehensive evidence prove that audit committee chair with accounting expertise contributes to the quality of financial reporting in emerging market.

Audit committee financial expertise and earnings quality: A meta-analysis

Since the implementation of the Sarbanes–Oxley Act (SOX), a plethora of research has examined financial experts' monitoring on audit committees of financial reporting quality. However, the literature has found mixed evidence. This present study's objective is to reconcile through meta-analysis the results of 90 studies with 165,529firm-year observations concerning the relationship between audit committee financial expertise and earnings quality. The results show that audit committee financial expertise has a positive relationship with earnings quality and that accounting financial experts have a stronger relationship with earnings quality than non-accounting financial experts. Moreover, corporate governance systems, International Financial Reporting Standards (IFRS), and SOX moderate the relationship between audit committee financial expertise and earnings quality. Additional moderators of this relationship are different proxies of earnings quality and audit committee financial expertise, financial experts' independence and busyness, the external auditor's role, and publication quality. This study provides implications for regulators in terms of tightening the definition of audit committee financial expert and the need for at least two financial experts. Further, the study identifies opportunities for future research. Specifically, we provide suggestions for the improvement of financial experts' effectiveness and the expansion of existing research. We also highlight emerging research areas.

The Mitigating Effect of Audit Committee Financial Expertise on the Voluntary Adoption of Clawback Policies

Clawback policies are compensation recovery policies that provide companies with the ability to recoup incentive-based compensation in the event of a financial fraud. We investigate whether the mandatory clawback provision in the Dodd-Frank Act is necessary or whether existing provisions under the Sarbanes-Oxley Act (SOX) are sufficient in inducing problematic firms to voluntarily adopt clawbacks. Specifically, we examine the relation between financial expertise on audit committees and voluntary adoption of clawback policies in the pre-Dodd-Frank period, separating audit committee financial expertise into accounting- and non-accounting financial expertise and classifying clawbacks into fraud-based- and non-fraud based clawbacks. While firms with restatement history are more likely to adopt fraud-based clawbacks due to SOX Section 304, the financial expertise on audit committees has a mitigating effect on the voluntary adoption of clawback policies. Greater accounting financial expertise is more likely to result in voluntary adoption of fraud-based clawbacks for firms without prior restatements. On the contrary, accounting and non-financial expertise are less likely to result in the voluntary adoption of fraud-based clawbacks for firms with prior restatements. Consistent with the signaling hypothesis, this suggests that accounting experts are more in favor of adopting fraud-based clawbacks when they are not associated with any previous accounting scandals, whereas both accounting experts and non-financial experts are against adopting fraud-based clawbacks when they could be implicated by prior financial frauds. Since non-fraud based clawbacks do not serve as signals, neither accounting- nor non-accounting financial expertise is related to the adoption of non-fraud based clawbacks. Our results suggest that the mandatory clawback requirement in Dodd-Frank can eliminate the mitigating effect of audit committee financial expertise on the voluntary adoption of clawback policies.

Audit committee accounting expertise, CEO power, and audit pricing

The Sarbanes–Oxley Act of 2002 (SOX) mandates that all listed firms disclose whether they have a financial expert on the audit committee, highlighting the committee’s expertise. However, some argue that non-accounting financial experts, compared to accounting financial experts, are not sufficient to ensure audit committee effectiveness because the former lack accounting knowledge. Accounting experts on audit committees may require higher audit efforts, while auditors may assess audit committees with accounting financial experts as effective, decreasing audit efforts. This paper first inspects the effect of audit committee accounting expertise on audit fees as a proxy for audit efforts, and then investigates whether the effect is moderated by powerful CEOs. Using post-SOX period data, our results show that, on average, firms with accounting experts on audit committees are more likely to pay higher audit fees, and the effect is less pronounced when a powerful CEO manages a firm.

Earnings conservatism and audit committee financial expertise

Using an Australian sample of 494 firm-year observations, this study finds that accounting financial expertise is the primary type of expertise that influences earnings conservatism, rather than nonaccounting financial expertise. The association between accounting financial expertise and conservatism holds only when the accounting financial expert(s) on audit committees is (are) independent. Overall, results suggest that audit committee accounting financial expertise is important in recognising the asymmetrical timeliness of losses. Findings provide a better understanding of the dynamics between audit committee financial expertise and earnings conservatism and demonstrate the importance of accounting financial expertise in improving financial reporting quality.

Audit committee financial expertise and properties of analyst earnings forecasts

An important role of financial accounting information is to aid financial statement users in forming expectations about the firm's future earnings. Prior research finds that accounting financial expertise of the audit committee is associated with higher financial reporting quality. We extend this literature by examining the association between audit committee financial expertise and analysts' ability to anticipate future earnings. We find a significant association between accounting financial expertise on the audit committee and analyst earnings forecasts that are more accurate and less dispersed. In contrast, we do not find a significant association between non-accounting financial expertise (i.e., supervisory expertise) and forecast accuracy or forecast dispersion. These findings contribute to our understanding of the benefits of accounting expertise in audit committees by demonstrating an association between accounting financial expertise and improvements in analyst earnings forecasts.

Tax Planning and Financial Expertise in the Audit Committee

Specialized knowledge allows expert directors to provide valuable advice while simultaneously monitoring managers. We investigate the advising and monitoring roles of corporate directors by examining the relation between firm tax planning and the level of financial expertise on the audit committee. Consistent with the advising function, we find that firms whose audit committees have high levels of accounting expertise are associated with higher levels of tax planning. Consistent with the monitoring function, we find that firms with higher levels of accounting expertise on the audit committee are associated with a lower likelihood of engaging in risky tax planning. Despite controlling for CEO compensation, we find that the strength of corporate governance is associated with an overall reduction in both tax planning and risky tax planning. In contrast, we find evidence that firms with higher levels of non-accounting financial expertise on the audit committee exhibit a significantly higher likelihood of engaging in risky tax planning.

Audit Committee Expertise and Financial Analysts’ and Investors’ Ability to Anticipate Future Earnings

One of the important attributes of high quality accounting information is its ability to aid financial statement users in forming expectations about the firm’s future earnings. Prior research finds that accounting financial expertise of the audit committee is associated with higher financial reporting quality. We extend the literature by examining the association between audit committee expertise and security analysts’ and investors’ ability to anticipate future earnings. We find that analyst earnings forecasts of firms with an audit committee member with accounting financial expertise are more accurate and less dispersed. These associations tend to be stronger in weaker governance firms. We also find that audit committee expertise is associated with a more informative stock price for firms weaker governance. We do not find a significant association between non-accounting financial expertise and attributes of analysts’ forecasts or earnings informativeness. These findings contribute to our understanding of the role of accounting expertise in audit committees.

Do Auditors Price Audit Committee's Expertise? The Case of Accounting versus Nonaccounting Financial Experts

The issue of whether audit pricing reflects the effectiveness of the audit committee is of fundamental interest to auditors, managers, and others. Auditors are expected to price the effectiveness of the audit committee because it relates to the control risk and thus, the overall audit risk. This study examines the relation between audit fees and a key determinant of the audit committee's effectiveness—that is, the financial expertise of the audit committee. Though the Sarbanes-Oxley Act mandates the disclosure of a financial expert, the Securities and Exchange Commission (SEC) broadly defined experts to include accounting or nonaccounting financial experts. Does audit pricing differentiate between accounting and nonaccounting financial expertise? For a sample of Standard & Poor's (S&P) 500 firms for the years 2000 through 2002, we find that after controlling for several board and audit committee characteristics and firm characteristics, audit pricing is negatively related to accounting financial expertise. However, this finding is conditional upon the strength of the overall governance structure. We do not find a significant relation between audit fees and accounting financial expertise for observations with weak governance structure. Overall, our evidence is consistent with the SEC's initial narrow definition to include only the accounting financial experts. The lack of a significant relationship between nonaccounting financial expertise and audit fees suggests that auditors perceive that only accounting financial expertise contributes to audit committee's effectiveness.

Audit Committee Financial Expertise, Competing Corporate Governance Mechanisms, and Earnings Management

A prime objective of the Sarbanes-Oxley Act and recent changes to stock exchange listing standards is to improve the quality of financial reporting. We examine the associations between audit committee financial expertise and alternate corporate governance mechanisms and earnings management. We find that both accounting and certain types of non-accounting financial expertise reduce earnings management for firms with weak alternate corporate governance mechanisms, but that independent audit committee members with financial expertise are most effective in mitigating earnings management. Importantly we find that alternate corporate governance mechanisms are an effective substitute for audit committee financial expertise in constraining earnings management. Finally, we find either no association or a positive association between financial expertise and real earnings management. Our results suggest that alternate governance approaches are equally effective in improving the quality of financial reporting, and that firms should have the flexibility to design the particular set of governance mechanisms that best fit their unique situations.

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

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.

Perception of Auditor Independence, Audit Committee Characteristics, and Auditor Provision of Tax Services

The Sarbanes-Oxley Act (SOX) greatly expanded audit committees’ oversight responsibilities by requiring that they pre-approve all non prohibited non-audit services (NAS), effectively making them “the gatekeepers” of auditor independence. Motivated by the SOX requirement and the controversy over the potential independence-impairing nature of tax NAS, we examine factors that are associated with audit committees’ decisions to approve tax NAS purchases for the years 2004 through 2007. We find that accounting financial experts are less likely to approve the purchase of any tax NAS than other audit committee members and, when they do, they approve lower levels relative to audit fees, suggesting that they are sensitive to the perceived threats to auditor independence at least in appearance. We find no such relation with non-accounting financial experts. We also find that audit committee members that hold multiple directorships approve lower levels of tax fees relative to audit fees than non busy members, possibly because they are concerned with the potential negative effects on their reputational capital if they approve high levels. Overall, our results suggest that audit committees make decisions consistent with concerns about independence impairment in appearance, as requested by the SEC.

Audit Committee Financial Expertise and Misappropriation of Assets

Our study extends prior literature that examines the relation between the incidence of misappropriation of assets and the effectiveness of the audit committees (Mustafa and Meier, 2006; Chapple et al., 2007). Mustafa and Meier (2006) find that the percentage of independent members and the average tenure of audit committee members significantly reduce occurrences of misappropriation of assets in publicly held companies in the United States. Chapple et al. (2007) find, also, that the proportion of independent directors on the audit committee is inversely related to occurrences of misappropriation of assets in Australian companies. While both studies draw attention to independence of audit committee members, there is no direct empirical evidence to support that the financial expertise of audit committee members will reduce the occurrences of misappropriation of assets in publicly held companies. Following Zhang et al. (2007), we classify audit committee financial expertise into two groups: accounting financial experts and non-accounting financial experts. Our study contributes to the ongoing debate surrounding the definition of a financial expert under SOX and his/her role in reducing occurrences of financial fraud (DeFond et al., 2005; Carcello et al., 2006; Dhaliwal et al., 2006; Krishnamet and Visvanathan, 2007).

Determinants of Audit Committee Diligence

The number of audit committee meetings is the only publicly available quantitative signal about the diligence of audit committees, and private sector bodies and Securities and Exchange Commission (SEC) officials have emphasized the need for frequent meetings of the audit committee. Prior research indicates that the number of audit committee meetings is associated with many “good” outcomes related to financial reporting, but there is little empirical evidence related to the determinants of audit committee diligence. In this paper we examine the association between firm characteristics and the number of audit committee meetings as a proxy for audit committee diligence. Our sample includes 319 firms from the S&P SmallCap600 with a December 31, 2003 fiscal year-end. We find that there are more audit committee meetings in firms that (1) are larger, (2) have high outsider block-holdings, (3) are in litigious industries, or (4) have more board meetings. The number of audit committee meetings increases with audit committee size. There is a significant positive relationship between the proportion of accounting experts and the number of meetings, but there is no such association between the proportion of nonaccounting financial experts and the number of meetings; these results also provide some context to the controversy surrounding the SEC's attempts to define “audit committee financial expert.”

Do Auditors Price Audit Committee's Expertise? The Case of Accounting Vs. Non-Accounting Financial Experts

The issue of whether audit pricing reflects the risk of corporate governance failure is of fundamental interest to auditors, managers, and others. Auditors are expected to price corporate governance risk because it relates to the control risk and thus, the overall audit risk. This study examines the relation between audit fees and a key aspect of effective governance, i.e., the expertise of the audit committee. Though the Sarbanes-Oxley Act mandates the disclosure of a financial expert, the SEC defined experts broadly to include accounting or non-accounting financial experts. Does audit pricing differentiate between accounting and non-accounting financial expertise? For a sample of S&P 500 firms for the years 2000 through 2002, we find that after controlling for several board and audit committee characteristics and firm characteristics, audit pricing is negatively related to accounting financial expertise. However, this finding is conditional upon the strength of the overall governance structure, i.e., in weak boards the presence of audit committee financial expertise may not be effective in mitigating control risk. Overall, our evidence is consistent with the SEC's initial narrow definition to include only accounting financial experts that is valued by the auditors. The lack of a significant relationship between non-accounting financial expertise and audit fees suggests that auditors perceive only accounting financial expertise contributes to increased monitoring by the audit committee and thus, mitigates the risk of governance failure.