Abstract
This paper empirically examines specific characteristics of an audit committee that could be associated with the likelihood of earlier voluntary ethics disclosure. The sample includes firms that were investigated by the Securities Exchange Commission for fraudulent financial reporting before the Sarbanes–Oxley Act's ethics rule became effective, and their matched no-fraud firms. This study finds that the level of voluntary ethics disclosure was very low compared to the current mandatory disclosure. Results based on a logit regression analysis suggest that firms which made earlier voluntary ethics disclosure were likely to have a larger and more independent audit committee that met more often, and were less likely to engage in fraudulent financial reporting. These results should help policy-makers, investors and boards of directors focus on these audit committee characteristics, which could be crucial not only to ethics disclosure, but also to the ethical conduct of a firm. In particular, results regarding size and meeting frequency highlight how to further improve the effectiveness of an audit committee and the quality of an ethics code not only in the United States, but also in other countries. These characteristics may also indicate a firm's propensity to make any voluntary disclosures, and may help to explain the differential quality of current mandatory ethics codes in the United States. Additionally, these results should be useful to global investors who desire to use corporate governance criteria for screening stock investments in countries where there are no ethics-code requirements.
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Notes
The SEC currently allows three options for its registrants to make their code of ethics publicly available: (1) filing a copy of the code as part of the SEC Form 10-K or 20-F, (2) posting the code on the firms’ website as well as stating in the annual report and Form 10-K or 20-F that the code of ethics is available on the website, and (3) stating in the annual report and Form 10-K or 20-F that a free copy of the code will be provided to any person upon request.
If there is no potential control firm with the closest net sales in the same four-digit SIC code industry, the search for such firm will be expanded to the three-digit SIC code and the two-digit SIC code, respectively.
In particular, 40 out of 46 firms (87 per cent) received no more than five out of 18 ethics-disclosure points, with the highest concentration of 21 firms receiving only three out of 18 points. A detailed discussion of the ethics-disclosure points is given in the Research Design section.
Similar to the SEC definition, this study defines directors with accounting or financial expertise as those with a CPA, CFA or experience in corporate financial management (for example, chief financial officer, treasurer, controller or vice-president – finance).
These 18 aspects are common ethics disclosure among public companies after the SOX and the NYSE ethics requirements became effective.
Insiders are major stockholders and all employees including directors and top executives. These individuals have access to inside non-public information that provides them an unfair advantage in terms of stock trading.
Correlations of the seven variables are relatively low, ranging from −0.175 (between AUDTEN and FRAUD) to 0.344 (between AUDSIZE and INDAUD). Such low correlations suggest that multi-collinearity problem is not a concern in the regression model.
This study also performed another diagnostic test by re-estimating the model with DIRSHIP as a dummy variable taking the value of 1 if DIRSHIP is more than three and 0 otherwise. This test addressed the NYSE's concern and requirement that the board of directors determines whether there is any impairment to the ability to serve if an audit committee member serves on an audit committee of more than three public companies. An example of such impairment is that the audit committee members may be too overly burdened to consider voluntary code-of-ethics adoption and disclosure. The re-estimation applies to both dichotomous and ordinal measures of ETHICS. Inferences based on results of this second diagnostic test (not reported here) are virtually the same as earlier inferences.
CalPERS is California Public Employees’ Retirement System. TIAA-CREF is Teachers Insurance and Annuity Association-College Retirement Equities Fund.
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Acknowledgements
I am grateful for financial support via the Davis Fellowship from the College of Business Administration, Rider University. The data used in this study are publicly available from the sources indicated in the text.
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Persons, O. Audit committee characteristics and earlier voluntary ethics disclosure among fraud and no-fraud firms. Int J Discl Gov 6, 284–297 (2009). https://doi.org/10.1057/jdg.2008.29
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DOI: https://doi.org/10.1057/jdg.2008.29