Suraj Srinivasan

Consequences of Financial Reporting Failure for Outside Directors: Evidence from Accounting Restatements and Audit Committee Members

I use a sample of 409 companies that restated their earnings from 1997 to 2001 to examine penalties for outside directors, particularly audit committee members, when their companies experience accounting restatements. Penalties from lawsuits and Securities and Exchange Commission (SEC) actions are limited. However, directors experience significant labor market penalties. In the three years after the restatement, director turnover is 48% for firms that restate earnings downward, 33% for a performance-matched sample, 28% for firms that restate upward, and only 18% for technical restatement firms. For firms that overstate earnings, the likelihood of director departure increases in restatement severity, particularly for audit committee directors. In addition, directors of these firms are no longer present in 25% of their positions on other boards. This loss is greater for audit committee members and for more severe restatements. A matched-sample analysis confirms this result. Overall, the evidence is consistent with outside directors, especially audit committee members, bearing reputational costs for financial reporting failure.

Audit Quality and Auditor Reputation: Evidence from Japan*

We study events surrounding ChuoAoyama’s failed audit of Kanebo, a large Japanese cosmetics company whose management engaged in a massive accounting fraud. ChuoAoyama was PwC’s Japanese affiliate and one of Japan’s “Big Four” audit firms. In May 2006, the Japanese Financial Services Agency (FSA) suspended ChuoAoyama for two months as punishment for its role in the accounting fraud at Kanebo. This action was unprecedented, and followed a sequence of events that seriously damaged ChuoAoyama’s reputation for audit quality. We use these events to provide evidence on the importance of auditors’ reputation for audit quality in a setting where litigation plays essentially no role. Around one quarter of ChuoAoyama’s audit clients switched away from the firm as questions about its audit quality became more pronounced, consistent with the importance of auditors’ reputation for delivering quality. Larger firms and those with greater growth options were more likely to leave ChuoAoyama suggesting a greater value for audit quality in these firms.

Corporate Governance When Founders are Directors

We examine CEO compensation, CEO retention policies, and M&A decisions in firms where founders serve as a director with a non-founder CEO (founder-director firms). We find that founder-director firms offer a different mix of incentives to their CEOs than other firms. Pay for performance sensitivity for non-founder CEOs in founder-director firms is higher and the level of pay is lower than that of other CEOs. CEO turnover sensitivity to firm performance is also significantly higher in founder-director firms compared to non-founder firms. Overall, the evidence suggests that boards with founder-directors provide more high powered incentives in the form of pay and retention policies than the average U.S. board. Stock returns around M&A announcements and board attendance are also higher in founder-director firms compared to non-founder firms.

CEO and CFO Career Penalties to Missing Quarterly Analysts Forecasts

This study examines whether the board of directors penalizes CEOs and CFOs in the form of bonus cuts, fewer equity grants, and forced turnover for the act of barely missing the latest consensus analyst forecast and whether such penalties are consistent with efficient contracting or fixation. We find that CEOs are penalized when they just miss the latest consensus analyst forecast via bonus cuts, fewer equity grants, and forced turnover. CFOs are also penalized for just missing the latest consensus analyst forecast via bonus cuts and forced turnover, but do not appear to be penalized with fewer equity grants. Further, we find evidence suggesting that the penalties levied by the board for just missing the latest analyst forecast are more consistent with fixation than efficient contracting.

Securities Litigation Risk for Foreign Companies Listed in the U.S.

We study securities litigation risk faced by foreign firms listed on U.S. exchanges. We find that U.S. listed foreign companies experience securities class action lawsuits at about half the rate as do U.S. firms with similar levels of ex ante litigation risk. The lower rate appears to be partly attributable to higher transaction costs in uncovering and pursuing litigation against foreign firms. However, once a lawsuit triggering event like an accounting restatement, missing management guidance, or a sharp stock price decline occurs, there is no difference in the litigation rates between a foreign and comparable U.S. firm. This evidence suggests that effective enforcement of securities laws is constrained by transaction costs, and the availability of high quality information that reveals potential misconduct is an important determinant of litigation risk for foreign firms listed in the U.S.

Which U.S. Market Interactions Affect CEO Pay? Evidence from UK Companies

This paper examines how different types of interactions with U.S. markets by non-U.S. firms are associated with higher levels of CEO pay, greater emphasis on incentive-based compensation, and smaller pay gaps with U.S. firms. Using a sample of CEOs of UK firms and using both broad cross-sectional and narrow event-window tests, we find that capital market relationship in the form of a U.S. exchange listing is related to higher UK CEO pay; however, the effect is similar when UK firms have a listing in any foreign country, implying a foreign listing effect not unique to the United States. Product market relationships measured by the extent of sales in the United States by UK companies are associated with higher pay, greater use of U.S.-style pay arrangements, and a reduction in the U.S.--UK pay gap. The product market effect is incremental to the effect of a U.S. exchange listing, the extent of the firms non-U.S. foreign market interactions, and the characteristics of the executive. The U.S.--UK CEO pay gap reduces in UK firms that make U.S. acquisitions. Furthermore, the firms use of a U.S. compensation consultant increases the sensitivity of UK pay practices to U.S. product market relationships. This paper was accepted by Gerard P. Cachon, accounting.

Political Influence and Merger Antitrust Reviews

Antitrust regulators play a critical role in protecting market competition. We examine whether the political process affects antitrust reviews of merger transactions. We find that acquirers and targets located in the political districts of powerful U.S. congressional members who serve on committees with antitrust regulatory oversight receive relatively favorable antitrust review outcomes. To establish causality, we use plausibly exogenous shocks to firm–politician links and a falsification test. Additional findings suggest congressional members’ incentives to influence antitrust reviews are affected by three channels: special interests, voter and constituent interests, and ideology. In aggregate, our findings suggest that the political process adversely interferes with the ability of antitrust regulators to provide independent recommendations about anticompetitive mergers.