paper audit uas - NEW YORK UNIVERSITY SCHOOL OF LAW NYU...

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NEW YORK UNIVERSITY SCHOOL OF LAW NYU Center for Law and Economics Audit Committee, Board of Director Characteristics, and Earnings Management April Klein October 2006 LAW & ECONOMICS RESEARCH PAPER SERIES WORKING PAPER NO. 06-42 http://ssrn.com/abstract=246674
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Audit Committee, Board of Director Characteristics, and Earnings Management April Klein* This paper can be downloaded without charge from the Social Science Research Network Electronic Paper Collection: http://papers.ssrn.com/paper.taf?abstract_id=246674 October 2000 I would like to acknowledge the helpful comments of Eli Bartov, James Doona, Lee-Seok Hwang, Jayanthi Krishnan, and Carol Marquardt and the participants at the Temple University and NYU workshops. The Stern School of Business provided financial support. *Leonard N. Stern School of Business New York University 40 West 4 th Street New York, N.Y. 10012 (212) 998 – 0014 [email protected] .nyu.edu
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2 Abstract This study examines whether audit committee and board characteristics are related to earnings management by the firm. The motivation behind this study is the implicit assertion by the SEC, the NYSE and the NASDAQ that earnings management and poor corporate governance mechanisms are positively related. A non-linear negative relation is found between audit committee independence and earnings manipulation. Specifically, a significant relation is found only when the audit committee has less than a majority of independent directors. Surprisingly, and in contrast to the new regulations, no significant association is found between earnings management and the more stringent requirement of 100% audit committee independence. Empirical evidence also is provided that other corporate governance characteristics are related to earnings management. Earnings management is positively related to whether the CEO sits on the board’s compensation committee. It is negatively related to the CEO’s shareholdings and to whether a large outside shareholder sits on the board’s audit committee. These results suggest that boards structured to be more independent of the CEO may be more effective in monitoring the corporate financial accounting process.
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1 I. Introduction In December 1999 the NYSE and NASDAQ modified their requirements for audit committees for all listed, large U.S. companies. 1 Under the new standards, firms must maintain audit committees with at least three directors, “all of whom have no relationship to the company that may interfere with the exercise of their independence from management and the company.” 2 These new requirements are in response to the SEC’s call for improving the effectiveness of corporate audit committees in overseeing the financial reporting process. One specific area of concern to the SEC was inappropriate “earnings management” by the firm defined as “the practice of distorting the true financial performance of the company.” 3 The common thread running through the SEC and stock exchange proposals is an implicit positive connection between earnings management and non-independent audit committees.
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paper audit uas - NEW YORK UNIVERSITY SCHOOL OF LAW NYU...

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