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Reputation and regulation effects on director turnover and change of directorships

Author

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  • Jui-Chin Chang
  • Huey-Lian Sun

Abstract

Purpose - This study aims to examine the reputation effect by assessing whether fraudulent financial reporting is associated with high board turnover and significant loss of directorship held by directors affiliated with fraud firms. Although the Sarbanes–Oxley Act (SOX) and major stock exchanges enhance board independence and formalize committee requirements, the new rules also create a high demand for qualified directors in the director labor market. Thus, this study further examines the change in the reputation effect of directors at fraud firms after SOX. Design/methodology/approach - This paper intends to answer two research questions: Do directors suffer significant loss of reputation when firms are caught in fraudulent financial reporting schemes? Is the loss of reputation of directors at fraud firms affected by the regulation of SOX? To examine the reputation effect, this paper investigates the differences in director turnover and loss of directorships between fraud and non-fraud firms. To examine the regulation effect, this paper investigates the differences in director turnover and loss of directorships of directors at fraud firms by comparing non-fraud firms’ director turnover and directorship loss between the pre-SOX and post-SOX periods. Findings - Consistent with the reputation effect, this paper found that director turnover at fraud firms is significantly higher than that at non-fraud firms. It also found that the loss of directorships of directors at fraud firms is not significantly higher, which is consistent with findings of some prior research. The paper also investigates whether this reputation effect has changed after SOX but found no significant difference in the reputation effect at fraud firms. In conjunction with prior research that finds an increased demand for qualified directors in the labor market after SOX, the results imply that this shortage of qualified directors does not help fraud firms discipline directors after SOX. Research limitations/implications - The findings are limited by the sample selection of only the initial litigation of US firms which are charged of fraudulent financial reporting. The findings suggest that SOX creates an increased demand for qualified directors, and consequently results in a shortage of qualified directors in the post-SOX labor market. The shortage of qualified directors slows the director turnover and weakens firms’ ability to replace culpable directors. Future research is needed on how governance practices might contribute to the lack of turnover among board members and how to promote ongoing overhauls of boards. Practical implications - The decision process for removing a director is complicated and lacks transparency. Shareholders often do not know the real reason for a director’s departure from the board. To increase the accountability of individual directors and information transparency, new rules are needed for the disclosure of evaluations of individual directors’ governance effectiveness. Originality/value - Survey of previous studies (Helland, 2006; Srinivasan, 2005; Fich and Shivdasani, 2007) indicates mixed evidence on reputation effect and no evidence so far on the SOX regulation effect. This study fills the gap by extending the findings of prior research to investigate the reputation effect along with the regulation effect of SOX at fraud firms. Different from findings of some previous studies (Helland, 2006; Fich and Shivdasani, 2007), this paper provides evidence consistent with the reputation effect. It also provides new evidence on the unintended consequences of SOX on director turnover.

Suggested Citation

  • Jui-Chin Chang & Huey-Lian Sun, 2016. "Reputation and regulation effects on director turnover and change of directorships," Review of Accounting and Finance, Emerald Group Publishing Limited, vol. 15(3), pages 274-293, August.
  • Handle: RePEc:eme:rafpps:v:15:y:2016:i:3:p:274-293
    DOI: 10.1108/RAF-12-2014-0138
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    Citations

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    Cited by:

    1. Chang, Wen-Ching & Chen, Jui-Pin, 2020. "Auditor sanction and reputation damage: Evidence from changes in non-client-company directorships," The British Accounting Review, Elsevier, vol. 52(3).
    2. Unsal, Omer & Brodmann, Jennifer, 2020. "The impact of employee relations on the reputation of the board of directors and CEO," The Quarterly Review of Economics and Finance, Elsevier, vol. 78(C), pages 372-388.
    3. Roman Lanis & Grant Richardson & Chelsea Liu & Ross McClure, 2019. "The Impact of Corporate Tax Avoidance on Board of Directors and CEO Reputation," Journal of Business Ethics, Springer, vol. 160(2), pages 463-498, December.

    More about this item

    Keywords

    SOX; Change of directorships; Director turnover; Regulation effect; Reputation effect; G18; G32; G34; J41; J44; M40; M41;
    All these keywords.

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • J44 - Labor and Demographic Economics - - Particular Labor Markets - - - Professional Labor Markets and Occupations
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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