Research questions value of independent audit committee requirement

A new academic study casts doubt on the value of requirements for independent audit committee members in terms of corporate stock prices and financial restatements.

In December 1999, the Securities and Exchange Commission required audit committees to have at least three members and to consist exclusively of directors having “no relationship to the company that may interfere with the exercise of their independence from management and the company.” The SEC rule was later incorporated in the Sarbanes-Oxley Act of 2002.

However, a new study by two professors, Seil Kim of Baruch College of the City University of New York and April Klein of New York University, contends the rule has no benefit for investors. The study appears in the November issue of The Accounting Review, a journal published by the American Accounting Association.

SEC building with official seal
The Securities and Exchange Commission headquarters in Washington, D.C.

"The market placed no premium on firms being forced to move to compliance,” the researchers wrote. “Overall, our findings are consistent with the view that mandating a fully independent audit committee with at least three outside directors is not, on average, value enhancing…Assess[ing] changes in financial reporting quality…we find no evidence that [the rule] produced tangible benefits to shareholders.”

They examined financial and governance information for 1,122 companies drawn from several large databases. Given the possibility that the market could have underestimated the impact of the regulation, the professors looked at whether it enhanced accounting performance among previously out-of-compliance companies in the two years following its effective date. They focused on three specific indicators: the number of corporate financial restatements, instances of fraud, and the amount of manipulative earnings management. But despite different tests, they found no significant association between the regulation and the prevalence of these problems.

The Center for Audit Quality disputed the researchers’ conclusions. “The independent audit committee performs the critical role of serving investors by overseeing a company’s financial statement audit,” said CAQ executive director Cindy Fornelli. “The SEC requirement that audit committees be fully independent of management has helped boost investor confidence, which reached record highs in 2017, according to the CAQ’s Main Street Investor Survey.”

The CAQ also pointed to a statement last month from SEC chairman Jay Clayton. “The independent audit committee has emerged as one of the most significant and efficient drivers of value to Main Street investors,” he said.

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