An empirical analysis of the relationship between audit committee multiple directorships and financial reporting quality

This study examines three major questions regarding the effect of audit committee multiple directorships (AC-MD) on financial reporting quality: (1) Is AC-MD associated with financial reporting quality? (2) Has the Sarbanes Oxley Act of 2002 (SOX) changed the incidence of AC-MD? (3) Has the association between AC-MD and financial reporting quality changed subsequent to SOX? In addition to the audit committee as a whole, I consider the implications of multiple directorships (MD) of key audit committee members - chairs and financial experts. In my analyses of a sample of 3,169 firm-years consisting of non-financial S&P 500 firms for the years 1997 to 2005, I find that: (1) High MD on audit committees as a whole (HMD_AC) is not significantly associated with financial reporting quality; however, high MD among audit committee chairs (HMD_CHAIR) and financial experts (HMD_FE) is positively related to financial reporting quality. The effect of HMD_CHAIR on final reporting quality is mostly driven by audit committee chairs who are also financial experts and the effect of HMD_FE on financial reporting quality is mainly driven by low AC-MD firms; (2) There is an inverted U-Shaped relationship between the magnitude of AC-MD and financial reporting quality, with an optimum percentage of high MD members of about 47%; (3)Although an audit committee as a whole tends to have lower MD post-SOX, key audit committee members are more likely to have higher MD post-SOX, consistent with greater demand for higher quality audit committee members post-SOX. However, supplemental analysis reveals that these increases in MD post-SOX are largely due to chairs and financial experts with low MD pre-SOX increasing their directorships post-SOX. Those with high MD pre-SOX actually reduce the number of their directorships post-SOX; (4) SOX mitigates the positive effects of HMD_CHAIR and HMD_FE on financial reporting quality that are observed earlier. This study clarifies conflicting results in prior literature on the consequences of multiple directorships. It further seeks to provide evidence on the effect of landmark corporate governance legislation - SOX - on the incidence of multiple directorships and its implication for the governance role of audit committees.