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Discussion of Consequences of Financial Reporting Failure for Outside Directors

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Discussion of Consequences of Financial Reporting Failure for Outside Directors

Research by Suraj Srinivasan of the University of Chicago examines the turnover rates of outside directors at companies that restate their results. He finds that outside directors (in particular outside members of the audit committee) are more likely to leave the board of the company issuing a restatement; they also tend to lose directorships at other firms. These results are seen as evidence of outside directors bearing reputation costs from financial reporting failures.

Understanding the reputation consequences for outside directors following a financial reporting failure is an important research question. This type of analysis offers insights into the design of governance structures and possibly how the managerial labor market serves an ex post role in disciplining managerial oversight or error. However, several substantive issues limit the inferences we can draw from the empirical analysis.

Although the focus and inferences that can be drawn from the empirical analysis in Srinivasan are limited, it makes a good first step toward improving our understanding of the design of governance mechanisms. Plenty of work remains before we can map out any theoretical basis for the design of the many governance mechanisms employed by stakeholders to protect their interest (financial or otherwise) in the firm.

Published In

Journal of Accounting Research

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