The Lack of Consequences for Audit Committee Members Following Accounting Restatements and the Resulting Impact on Investors

Prior research has assumed that financial reporting failures indicate that individual directors have provided inferior monitoring of the reporting process and has found that directors suffer the loss of board positions following reporting failures. These penalties, however, are not uniformly applied across all outside directors. Using a sample of firms that have experienced multiple reporting failures and a matched sample of non-restating firms, I collect information on individual audit committee members and investigate whether retention on the audit committee is related to the quality of the director or to the influence of the CEO over the board of directors. I then examine whether the retention of directors on the audit committee is related to further aggressive accounting practices and to additional negative consequences for investors in the long run. I find that the retention of directors on the audit committee is positively related to the quality of the director and negatively related to CEO influence over the board for both the restating and nonrestating sample. I further find that the retention of directors on the audit committee following a reporting failure is not related to future aggressive accounting practices. Test examining other long-term consequences to investors are inconclusive. Overall, these results suggest that the labor market for directors operates in an efficient and effective manner.