When the 2019-20 school year began, Neel Corporate Governance Center research fellows at the Haslam College of Business could not have anticipated the changes that would sweep through corporations in 2020, shining a spotlight on the need for effective governance now more than ever.
Through the perspectives of accounting, economics, finance and law, the center’s research addresses timely topics in corporate governance with a focus on public policy. In the 2019-20 school year, CGC research fellows produced 10 governance-related publications and had working papers presented at more than 15 conference sessions or other universities nationally and internationally. Several planned presentations were cancelled due to COVID-19 travel restrictions. Throughout the year, 10 doctoral students from accounting and finance worked on governance-related research with CGC research fellows.
This year’s research summary includes the center’s new partnership with the Institute of Internal Auditors (IIA), which produced the Guiding Principles of Corporate Governance and the inaugural American Corporate Governance Index. The year’s highlights also include new CGC research fellows Scott Guernsey and Tim Pollock; the promotions of Larry Fauver, Lauren Cunningham and Matthew Serfling; and Roy Schmardebeck’s invitation to present research at the U.S. Securities and Exchange Commission. In addition, CGC fellows recently published research examining:
Analyst influence over accounting policies
Audit committee expertise and internal controls
Audit office rotations and audit quality
Earnings management and SEC comment letters
Women in Congress and in the boardroom
American Corporate Governance Index
This year, the IIA and the Neel Corporate Governance Center released a comprehensive annual index that, for the first time, measures the quality of corporate governance among publicly held companies in the United States. Using survey data from chief audit executives (CAEs), the center graded U.S. companies in 2019 with an overall index score of C+. Only 16 percent of surveyed companies received a score of A- or better (90 or above), while 10 percent scored an F (below 60).
The American Corporate Governance Index measures the quality of corporate governance benchmarked against the newly released Guiding Principles of Corporate Governance. The Principles reflect a compendium of viewpoints from leaders in the U.S. and around the globe, and are informed by the CGC’s research efforts. To form the survey questions that support the index, Lauren Cunningham, CGC director of research, and Terry Neal, CGC director of corporate governance, interviewed CAEs across the country about their views of corporate governance and their processes for evaluating corporate governance at their companies.
New Research Fellows
Scott Guernsey, an assistant professor of finance, joined the CGC research fellows in fall 2020. Scott’s research interests focus on empirical corporate finance, corporate governance, innovation, mergers and acquisitions, law and finance, competition and capital structure. Currently, Guernsey is working on research that investigates the benefits of stronger takeover protection during market downturns (e.g., the COVID-19 pandemic) as well as the firm value implications of having a more stakeholder-oriented board.
Tim Pollock, the Haslam Chair in Business and Distinguished Professor of Entrepreneurship in the management and entrepreneurship department, also joined the CGC research fellows in fall 2020. Pollock’s research interests focus on corporate governance, executive compensation and entrepreneurial market environments, with a focus on the initial public offerings (IPO) market. He has examined how social and political factors such as reputation, celebrity, social capital, impression management activities, media accounts and the power of different actors influence IPO firm performance, survival, alliance formation activities and executive recruitment and compensation. Currently, Pollock is working on studies exploring the behaviors and CEO characteristics that affect the likelihood that CEOs will become celebrities. He also is exploring how CEO celebrity affects the dynamics of earnings calls, and the types of language the CEO uses in these calls. He is conducting two studies exploring the effects of achieving high status on analysts. The first looks at how the relationship between an analyst’s performance and status changes as the analyst wins successive All-American Research Team designations. The second study explores how the different sources of analysts’ status (All-American designations or working for a high-status firm) affects whether they are likely to break ranks with other analysts and issue bold negative earnings statements, and whether other analysts follow their lead. Pollock is currently writing a book on how to use storytelling in academic writing that will be published by Edward Elgar Press in 2021.
Larry Fauver was promoted to professor of finance. Fauver is the recipient of the 2018 Paul Van Arsdell Best Paper Award in Corporate Finance. His research focuses on company performance, corporate governance, corporate culture and corruption, both in a domestic and international environment. In current research, he examines the impact of boardroom gender diversity reforms around the world and their impact on firm value.
Lauren Cunningham was promoted to associate professor with tenure in the department of accounting and information management. She is the recipient of the 2020 Haslam College of Business Rising Star Research Award and the 2020 AAA Auditing Section Innovation in Auditing and Assurance Education Award. Her published research has examined determinants of audit quality, as well as determinants and consequences of comment letter receipt under the SEC filing review process. In current research, she uses machine learning to examine the efficacy of audit committee appointments and documents current practices in evaluating corporate governance at publicly traded companies.
Matthew Serfling was promoted to associate professor of finance with tenure. Serfling is the 2018 recipient of the Haslam College of Business Vallett Family Outstanding Researcher Award. His published research has examined how corporate financial policies and investment decisions interact with labor market frictions and other non-financial stakeholders. He also has examined issues related to how CEO turnovers disrupt customer-supplier relationships. In current research, he examines whether changes in management practices are a source of synergies in mergers and acquisitions as well as whether takeover protections can be valuable to firms during market-wide downturns.
Invitation to Present at U.S. Securities and Exchange Commission
Research fellow Roy Schmardebeck was invited by SEC Commissioner Robert J. Jackson Jr. to present his research on the costs and benefits of SOX Section 404(b) auditor attestation of internal controls over financial reporting. Read about that visit here.
Research Fellow Publication Spotlights
Do Financial Analysts Compel Firms to Make Accounting Decisions? Evidence from Goodwill Impairments, Review of Accounting Studies
Analysts play a key role in capital markets and could impact companies’ goodwill impairment decisions in at least two ways: (1) by improving the information environment through their analysis of company performance (i.e., ex ante monitoring) and (2) by increasing the likelihood the manager and company experience negative consequences when they fail to record a necessary impairment (i.e., ex post monitoring). James Chyz and his coauthors, John Campbell (University of Georgia) and UT PhD program graduates, Doug Ayers (Butler University) and Jonathan Shipman (University of Arkansas), find that analyst downgrades before a company’s reporting date increase the probability that management records an expected impairment at the reporting date. They also find that failing to record an expected impairment is associated with decreases in analyst following and a lower likelihood that managers are employed at the end of the following year. Thus, their study illustrates a key monitoring role of analysts in the financial reporting process.
Does Audit Committee Expertise Help to Promote Audit Quality? Evidence from Auditor Reporting of Internal Control Weaknesses, Contemporary Accounting Research
In March 2020, the U.S. Securities and Exchange Commission (SEC) redefined the threshold for classifying registrants as accelerated filers. This allowed more companies to forego audits of their internal controls over financial reporting because they met the definition of non-accelerated filers. Using a sample of company-years prior to the SEC’s new ruling, Linda Myers and her coauthors, Ling Lei Lisic (Virginia Tech), Tim Seidel (Brigham Young University) and Jian Zhou (University of Hawaii at Manoa), examine whether audit committee accounting expertise helps to promote audit quality by motivating auditors to conduct diligent internal control audits and make appropriate internal control assessments. They find that audit committee accounting expertise is associated with higher rates of adverse internal control audit opinions and, importantly, a lower likelihood of auditor dismissal following an adverse internal control audit opinion. This finding suggests that accounting expertise on a company’s audit committee can help to shield auditors from possible management retaliation. However, they also find some evidence that CFO (but not CEO) influence over the audit committee can negate these benefits.
The Effect of Office Changes Within Audit Firms on Clients’ Audit Quality and Audit Fees, Auditing: A Journal of Practice and Theory
The recent Wirecard scandal reminds us yet again that audit quality continues to be a concern for investors, regulators and other financial statement users. While previous research has examined the effects of audit firm rotation and audit partner rotation, there is little evidence on the disruptions caused when a client keeps the same audit firm but rotates audit offices (e.g., from Dallas to Charlotte). To examine these disruptions, Terry Neal and his coauthors, UT PhD program graduates Carl Hollingsworth (Clemson University) and Colin Reid (Washington & Lee University), identify a unique sample of companies where the audit firm issuing office changed but the audit firm did not change. They investigate the effect of these changes on both audit quality and audit pricing. Their results indicate that companies that have a change in their audit firm's issuing office exhibit a decrease in audit quality and an increase in audit fees. The authors’ analyses reveal that client-driven changes are more likely to result in a higher audit fee while audit quality is unchanged. Conversely, audit firm-driven changes do not result in a higher audit fee but do experience a decrease in audit quality.
The Switch-Up: An Examination of Changes in Earnings Management After Receiving SEC Comment Letters, Contemporary Accounting Research
On average, in any given year between 2006 and 2016, 20 to 35 percent of companies received a comment letter from the SEC as part of the Division of Corporation Finance’s filing review process. Recognizing that these comments often focus on the company’s accounting policies and disclosures, Lauren Cunningham and her coauthors, Bret Johnson (George Mason University), Scott Johnson (Virginia Tech) and Ling Lei Lisic (Virginia Tech), examine how companies change earnings management strategies following the receipt of a comment letter. They find that companies reduce their use of accruals-based earnings management because of the additional SEC scrutiny on accounting policies and instead use greater real earnings management. For example, a company may underestimate its reserve for bad debt as part of an accruals-based earnings management strategy, but following SEC scrutiny, a company may stop underestimating reserves and instead opportunistically reduce research and development expenditures to meet earnings benchmarks. Their evidence should be of interest to audit committees and investors monitoring earnings quality.
Me, Too and #MeToo: Women in Congress and the Boardroom, George Washington Law Review
The “Year of the Woman” (1992) and the year of #MeToo (2018) were landmark years for women in federal congressional elections. Both years also represent significant milestones for women’s roles as U.S. public company directors. In this essay, Joan Heminway examines and comments on possible gender effects of the #MeToo movement on public company board composition in relation to the possible gender effects of the #MeToo movement on the composition of legislative bodies. Although #MeToo has clarified, and perhaps expanded, the salient connections between business issues and women’s issues, those who have the power to elect corporate directors may not fully recognize this connection or other factors as unique values of female corporate board participation. Heminway concludes that until additional female membership on corporate boards is substantively valued, swift sustainable changes in the gender makeup of corporate boards may not be realizable without specific, enforceable legal mandates. Although California’s state legislature has taken a bold step in this direction in the #MeToo era, it seems unlikely that additional state legislatures will follow its lead. As a result, the pace of change in corporate board gender composition is likely to continue to be more evolutionary than revolutionary.