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Journal ArticleDOI

The Audit Committee: Management Watchdog or Personal Friend of the CEO?

TL;DR: This article found that firms whose audit committees have "friendship" ties to the CEO purchase fewer audit services and engage more in earnings management, and that auditors are also less likely to issue going-concern opinions or to report internal control weaknesses when friendship ties are present.
Abstract: To ensure that audit committees provide sufficient oversight over the auditing process and quality of financial reporting, legislators have imposed stricter requirements on the independence of audit committee members. Although many audit committees appear to be “fully” independent, anecdotal evidence suggests that CEOs often appoint directors from their social networks. Based on a 2004 to 2008 sample of U.S.-listed companies after the Sarbanes-Oxley Act we find that these social ties have a negative effect on variables that proxy for oversight quality. In particular, we find that firms whose audit committees have “friendship” ties to the CEO purchase fewer audit services and engage more in earnings management. Auditors are also less likely to issue going-concern opinions or to report internal control weaknesses when friendship ties are present. On the other hand, social ties formed through “advice networks” do not seem to hamper the quality of audit committee oversight.
Citations
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01 Jan 2006
TL;DR: This paper investigated the extent to which interpersonal ties, network characteristics, and people's personal characteristics (e.g., gender) affect the nature of reciprocal relationships and found that giving support is strongly associated with getting it.
Abstract: Reciprocity - doing for others if they have done for you - is a key way people mobilize resources to deal with daily life and seize opportunities. In principle, reciprocity (the Golden Rule) is a universal norm. In practice, it is variable. Personal networks rarely operate as solidarities and as such, people cannot count on all the members of their networks to provide help all the time. Rather, social support comes uncertainly from a variety of ties in networks. This paper uses survey research to understand the variable and contingent nature of reciprocity and inquires about the kinds of resources exchanged between people. We investigate the extent to which interpersonal ties, network characteristics, and people's personal characteristics (e.g., gender) affect the nature of reciprocal relationships. The evidence is extraordinarily clear on one subject - giving support is strongly associated with getting it. Analyses show that getting support from network members is the key to East Yorkers reciprocating - usually in kind but sometimes with other forms of support.

245 citations

Journal ArticleDOI
TL;DR: In this paper, the authors conceptualize a model based on the premise of boards as groups of individuals obtaining, processing and sharing information and explain how variation in information processing demands at the director, board and firm level may challenge effective monitoring.
Abstract: In this review, we challenge the idea that directors are well positioned to be effective monitors of management. Moving beyond the logic of incentives and ability, we conceptualize a model based on the premise of boards as groups of individuals obtaining, processing and sharing information and explain how variation in information-processing demands at the director, board and firm level may challenge effective monitoring. We draw on multiple theoretical perspectives to identify these barriers to effective board monitoring. Our goal in reviewing these barriers is to help us take stock of existing research in corporate governance and to better explain board behavior beyond traditional agency and resource dependency accounts. We also aim to uncover gaps in the conceptual and empirical research and suggest areas of fruitful future research.

197 citations


Cites background from "The Audit Committee: Management Wat..."

  • ...Bruynseels and Cardinaels (2014) Empirical Individual 3 Social connections with CEO may hamper the functioning of the audit committee....

    [...]

Journal ArticleDOI
TL;DR: Wang et al. as mentioned in this paper identify connected auditors as those who attended the same university as the executives of their clients and find that connected audrators are more likely to issue favorable audit opinions, especially for financially distressed clients.
Abstract: We identify connected auditors as those who attended the same university as the executives of their clients. Using manually collected data from China, we find that connected auditors are more likely to issue favorable audit opinions, especially for financially distressed clients. Moreover, companies audited by connected auditors report significantly higher discretionary accruals, are more likely to subsequently restate earnings downward, and have lower earnings response coefficients. Lastly, connected auditors earn higher audit fees. Collectively, our evidence suggests the impairment of audit quality when auditors and client executives have school ties and the presence of social reciprocity derived from school ties.

182 citations

Journal ArticleDOI
TL;DR: In this paper, the authors explore how narcissistic CEOs address two powerful and conflicting needs: the need for acclaim and the need to dominate others by employing lower-status, younger and less experienced top management team members who will be more deferential to and dependent on them.
Abstract: We explore how narcissistic CEOs address two powerful and conflicting needs: the need for acclaim and the need to dominate others. We argue that narcissistic CEOs address their need for acclaim by pursuing celebrity in the media and affiliating with high-status board members, and they address their need to dominate others by employing lower-status, younger, and less experienced top management team members who will be more deferential to and dependent on them. They manage each group differently through the use of different rewards, punishments, and influence tactics. We extend prior theory on CEO narcissism by exploring the mediating constructs that can link CEO narcissism and firm performance, offer a greater understanding of corporate governance by exploring how CEO personality traits influence governance structures, and demonstrate how a CEO’s personality characteristics can affect the acquisition of social approval assets.

159 citations


Cites background from "The Audit Committee: Management Wat..."

  • ...…they can nonetheless influence the selection process more indirectly—for example, by influencing which directors are on the nominating committee (Bruynseels & Cardinaels, 2014; Zhu & Chen, 2015b) or by recommending candidates to the committee (Stern & Westphal, 2010; Westphal & Shani, 2016;…...

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Journal ArticleDOI
TL;DR: In this paper, the authors examine whether social ties between engagement auditors and audit committee members shape audit outcomes and find that close interpersonal relations can undermine auditors' monitoring of the financial reporting process.
Abstract: We examine whether social ties between engagement auditors and audit committee members shape audit outcomes. Although these social ties can facilitate information transfer and help auditors alleviate management pressure to waive correction of detected misstatements, close interpersonal relations can undermine auditors' monitoring of the financial reporting process. We measure social ties by alma mater connections, professor-student bonding, and employment affiliation, and audit quality by the propensity to render modified audit opinions, financial reporting irregularities, and firm valuation. Our evidence implies that social ties between engagement auditors and audit committee members impair audit quality. In additional results consistent with expectations, we generally find that this relation is concentrated where social ties are more salient, or firm governance is relatively poor and agency conflicts are more severe. Implying reciprocity stemming from social networks, we also report some sugge...

157 citations

References
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Book
01 Jan 2001
TL;DR: This is the essential companion to Jeffrey Wooldridge's widely-used graduate text Econometric Analysis of Cross Section and Panel Data (MIT Press, 2001).
Abstract: The second edition of this acclaimed graduate text provides a unified treatment of two methods used in contemporary econometric research, cross section and data panel methods. By focusing on assumptions that can be given behavioral content, the book maintains an appropriate level of rigor while emphasizing intuitive thinking. The analysis covers both linear and nonlinear models, including models with dynamics and/or individual heterogeneity. In addition to general estimation frameworks (particular methods of moments and maximum likelihood), specific linear and nonlinear methods are covered in detail, including probit and logit models and their multivariate, Tobit models, models for count data, censored and missing data schemes, causal (or treatment) effects, and duration analysis. Econometric Analysis of Cross Section and Panel Data was the first graduate econometrics text to focus on microeconomic data structures, allowing assumptions to be separated into population and sampling assumptions. This second edition has been substantially updated and revised. Improvements include a broader class of models for missing data problems; more detailed treatment of cluster problems, an important topic for empirical researchers; expanded discussion of "generalized instrumental variables" (GIV) estimation; new coverage (based on the author's own recent research) of inverse probability weighting; a more complete framework for estimating treatment effects with panel data, and a firmly established link between econometric approaches to nonlinear panel data and the "generalized estimating equation" literature popular in statistics and other fields. New attention is given to explaining when particular econometric methods can be applied; the goal is not only to tell readers what does work, but why certain "obvious" procedures do not. The numerous included exercises, both theoretical and computer-based, allow the reader to extend methods covered in the text and discover new insights.

28,298 citations

Journal ArticleDOI
TL;DR: The homophily principle as mentioned in this paper states that similarity breeds connection, and that people's personal networks are homogeneous with regard to many sociodemographic, behavioral, and intrapersonal characteristics.
Abstract: Similarity breeds connection. This principle—the homophily principle—structures network ties of every type, including marriage, friendship, work, advice, support, information transfer, exchange, comembership, and other types of relationship. The result is that people's personal networks are homogeneous with regard to many sociodemographic, behavioral, and intrapersonal characteristics. Homophily limits people's social worlds in a way that has powerful implications for the information they receive, the attitudes they form, and the interactions they experience. Homophily in race and ethnicity creates the strongest divides in our personal environments, with age, religion, education, occupation, and gender following in roughly that order. Geographic propinquity, families, organizations, and isomorphic positions in social systems all create contexts in which homophilous relations form. Ties between nonsimilar individuals also dissolve at a higher rate, which sets the stage for the formation of niches (localize...

15,738 citations

Journal ArticleDOI
TL;DR: In this article, the authors proposed a new measure of one aspect of the quality of accruals and earnings, which is the residual from firm-specific regressions of changes in working capital on past, present, and future operating cash flow realizations.
Abstract: This paper suggests a new measure of one aspect of the quality of accruals and earnings. The major benefit of accruals is to reduce timing and mismatching problems in the underlying cash flows. However, accruals accomplish this benefit at the cost of making assumptions and estimates about future cash flows, which implies that accruals include errors of estimation or noise. Since estimation noise reduces the beneficial role of accruals, this study suggests that the quality of accruals and earnings is decreasing in the magnitude of estimation noise in accruals. More specifically, we develop a simple model of working capital accruals where accruals correct the timing problems in cash flows at the cost of including errors in estimation. Based on the model, we derive an empirical measure of accrual quality as the residual from firm-specific regressions of changes in working capital on past, present, and future operating cash flow realizations. The study concludes with two empirical applications that illustrate the usefulness of our measure of accrual quality. First, we explore the relation of accrual quality to economic fundamentals. We find that accrual quality is negatively related to the magnitude of total accruals, length of the operating cycle, and the standard deviation of sales, cash flows, and earnings, while it is positively related to firm size. Second, we show a strong positive relation between accrual quality and earnings persistence.

3,698 citations

Posted Content
TL;DR: In this paper, the residuals are sorted and the observation is located in the residual corresponding to the quantile in question, taking into account weights if they are applied, and the square root of the sum of the weights is calculated.
Abstract: We first sort the residuals and locate the observation in the residuals corresponding to the quantile in question, taking into account weights if they are applied. We then calculate wn, the square root of the sum of the weights. Unweighted data is equivalent to weighted data where each observation has weight 1, resulting in wn p n. For analytically weighted data, the weights are rescaled so that the sum of the weights is the sum of the observations, resulting in p n again. For frequency weighted data, wn literally is the square of the sum of the weights.

3,087 citations

Journal ArticleDOI
TL;DR: In this paper, the authors examined conceptually and empirically two estimation biases which can result when financial distress models are estimated on non-random samples and showed that these biases can result in biased parameter and probability estimates if appropriate estimation techniques are not used.
Abstract: Researchers typically estimate financial distress prediction models on nonrandom samples. Estimating models on such samples can result in biased parameter and probability estimates if appropriate estimation techniques are not used. This paper examines conceptually and empirically two estimation biases which can result when financial distress models are estimated on nonrandom samples. The first bias results from "oversampling" distressed firms and falls within the topic of choice-based sample biases. The second results from using a "complete data" sample selection criterion and falls within the topic of sample selection biases. The two issues examined in this paper arise because of sample selection/data collection constraints typically faced by financial distress researchers. The first constraint is the extremely low frequency rate of firms exhibiting financial distress characteristics (e.g., petitioning for

2,566 citations