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Staggered Boards Impede Improvements to Audit Committees

Jun 24th 2016
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Amid ongoing debate about staggered corporate boards and whether they work against shareholders’ interests, a new study indicates that staggering also negatively affects audit committees.

The Efficacy of Shareholder Voting in Staggered and Non-Staggered Boards: The Case of Audit Committee Elections, published in the May/July issue of the American Accounting Association’s Auditing: A Journal of Practice & Theory, indicates that staggered boards can interfere with shareholders’ goals and hinder audit committee improvements. In staggered boards, only a third of the directors are up for re-election annually, with members elected to three-year terms.

“Low shareholder approval rates in firms with nonstaggered boards are associated with improvements to audit committee structure, activity, and financial reporting quality,” the study states.

The study’s authors, professors Ronen Gal-Or and Udi Hoitash of Northeastern University and Rani Hoitash of Bentley University, say their results indicate that “in addition to influencing the performance of corporate boards and the compensation committee, shareholders can also influence the performance of the audit committee and thus the quality of financial reporting. The differences in the efficacy of shareholder votes across staggered and nonstaggered elections reveal that while nonstaggered audit committees respond to low shareholder votes, staggered audit committees do not.”

Which, in turn, means that audit committee improvements are hindered.

No one has to look too far back to understand the genesis of the concern. After major corporate accounting scandals in the early 2000s rocked the financial world, the Sarbanes-Oxley Act and other laws gave audit committees a lot more muscle. And how much that muscle gets flexed is affected by the increasing power of shareholders over corporate boards.

Hence the professors’ interest in whether shareholder votes can influence the audit committee.

“We find that through voting, shareholders can increase the efficacy of the audit committee, leading to improvements in audit committee structure, diligence, and financial reporting quality,” they state, adding that those results are in companies with nonstaggered boards only.

With staggered boards, however, shareholders typically vote on any director every three years. Those directors who aren’t up for election after a poor performance won’t face shareholder scrutiny, the study states. That, then, can influence their accountability and responsiveness, plus the overall efficacy of shareholders’ votes.

“Importantly, the nonresponsiveness of staggered audit committees to shareholder disapproval presents an additional explanation for the weaker performance that is often documented for firms with staggered boards,” the professors state. “Overall, our results support the movement to de-stagger boards.”

Here’s a snapshot of the study’s findings.

  • Low shareholder votes are linked to an increased likelihood that accounting financial experts (AFEs) will leave the audit committee on a nonstaggered board, which is economically significant. There also was an increased likelihood that nonstaggered audit committees that get low votes will replace the AFE with another AFE, which also is considered economically significant. The low votes are not significantly linked to the departure of other audit committee members. None of the results are significant for staggered audit committees.
  • Nonstaggered audit committees increase the number of their meetings after getting low approvals from shareholders. Results indicated that wasn’t the case for staggered audit committees.
  • The audit committee is more likely to cut tax nonaudit fees (discretionary accruals) after low shareholder approvals only among nonstaggered audit committees. Shareholder disapproval of high tax nonaudit fees shows in low auditor ratification votes. Both low ratification and audit committee votes are linked to a reduction in auditor-provided tax services.
  • The link between low audit committee approvals and subsequent improvements in audit committee effectiveness suggest that shareholders can influence the audit committee’s oversight of financial reporting through votes and differentiation between audit committee and non-audit committee directors.