6 Discussions and conclusion
This study advances corporate governance literature by applying the three-tier agency model and social exchange theory to study the effectiveness of audit committees in reducing financial restatements and improving financial reporting quality. We argue that social exchange relationships in the three-tier hierarchy between audit committee members (the supervisor), top management (the agent), and shareholders (the principal) affect motivations and decisions of committee members, and in turn influence the effectiveness of audit committees in supervising a firm’s financial reporting process. Using financial restatement data for a sample of U.S. listed firms during the post-SOX period of 2002–2005, we find that firms with a greater proportion of audit committee members appointed after the CEO are associated with a larger likelihood of restatements, while the presence of an allindependent nominating committee helps reduce the incidence of restatements. In addition, firms whose audit committee members have longer tenure and receive higher fees are less likely to engage in restatements. Our paper thus extends extant empirical studies on financial reporting quality to explicitly investigate how audit committees’ monitoring effectiveness may be affected by interpersonal influence and social exchange processes in a three tier principal-supervisor-agent hierarchy.
From a theoretical standpoint, our paper explicitly utilizes behavioral theory of corporate governance to investigate effectiveness of audit committees in improving financial reporting quality and protecting shareholder interests. A common critique of the agency theory is that it ignores the relational aspect of the interaction between principals and agents but only focus on explicit contract designs (Wiseman et al. 2012). The behavioral theory of corporate government in contrast enables us to consider the agency relationship under a broader social context by explicitly taking into account ‘‘socially situated agency’’ and ‘‘socially constituted agency’’ in the term of Westphal and Zajac (2013). Specifically, our paper indicates that social exchange relationships not only affect motivations of agents (managers) but also those of supervisors (audit committees) in the three-tier agency framework.
