Can directors self interests influence accounting choices

Description
Eighty-eight audit committee members participated in an experiment designed to investigate the effects of audit issue
(adjustment versus restatement) and director status (single directorship versus multiple directorships) on the likelihood
of accepting an auditor’s recommendation. Results indicate that all participants are less likely to accept an auditor’s
restatement recommendation than adjustment recommendation. Further, directors holding multiple directorships are
less likely to accept an auditor’s restatement recommendation than directors with a single directorship.

Can directors’ self-interests in?uence accounting choices?
James E. Hunton
a
, Jacob M. Rose
b,
*
a
Department of Accountancy, Bentley College, Waltham, MA 02452, United States
b
School of Accountancy, Southern Illinois University Carbondale, Carbondale, IL 62901, United States
Abstract
Eighty-eight audit committee members participated in an experiment designed to investigate the e?ects of audit issue
(adjustment versus restatement) and director status (single directorship versus multiple directorships) on the likelihood
of accepting an auditor’s recommendation. Results indicate that all participants are less likely to accept an auditor’s
restatement recommendation than adjustment recommendation. Further, directors holding multiple directorships are
less likely to accept an auditor’s restatement recommendation than directors with a single directorship. Analysis of
post-experiment clinical debrie?ng items indicates that directors with multiple directorships are less willing to support
restatements due to the potential adverse e?ects of restatements on their reputation capital.
Ó 2007 Elsevier Ltd. All rights reserved.
Introduction
Analyses of recent corporate failures suggest
that boards of directors and audit committees of
failed ?rms inadequately monitored ?nancial
reporting and insu?ciently protected sharehold-
ers’ interests (see e.g., Powers, Troubh, & Win-
okur, 2002; Rosen, 2003). One indicator of low
quality corporate governance of this nature is
re?ected in earnings restatements (Huron Consult-
ing Group, 2004; Myers, Myers, & Palmrose,
2004). In response to rapid growth in earnings
restatements and other indicators of corporate
governance failures over the past decade, the Blue
Ribbon Committee recommended that increased
director independence would improve the quality
of corporate governance (Blue Ribbon Committee,
1999). Regulations, such the Sarbanes–Oxley Act,
SEC Rule 10A-3 and recently implemented
requirements of the NYSE, soon followed this rec-
ommendation, all of which emphasized the need to
increase director independence—particularly
directors who serve on audit committees (NYSE,
2003; Sarbanes & Oxley, 2002; US SEC, 2003).
Independent directors are directors who are not
current or past members of the corporation’s top
management (Brickley, Coles, & Terry, 1994). A
large percentage of independent directors serve
0361-3682/$ - see front matter Ó 2007 Elsevier Ltd. All rights reserved.
doi:10.1016/j.aos.2007.10.001
*
Corresponding author. Tel.: +1 618 453 1490; fax: +1 618
453 1411.
E-mail address: [email protected] (J.M. Rose).
www.elsevier.com/locate/aos
Available online at www.sciencedirect.com
Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
on multiple boards, and such directors are often
referred to as busy directors (see e.g., Ferris, Jagan-
nathan, & Pritchard, 2003; Fich & Shivdasani,
2006) or professional directors (see e.g., Brickley
et al., 1994; Keys & Li, 2005). We use the term
busy directors to indicate directors who serve on
multiple boards and non-busy directors to re?ect
directors who sit on a single board.
Archival studies conducted over the past decade
provide evidence that increasing the number of
independent audit committee members is associ-
ated with indicators of improved corporate
governance quality. For instance, increased inde-
pendence has been linked to improved ?nancial
performance, reduced fraud, less earnings manipu-
lation, fewer restatements, and positive stock price
responses (see e.g., Abbott, Parker, & Peters, 2004;
Beasley, 1996; Dechow, Sloan, & Sweeny, 1996;
Klein, 2002; MacAvoy & Millstein, 1999; Rosen-
stein & Wyatt, 1990). Further, extant research sug-
gests that independent busy directors acquire
knowledge capital by serving on more than one
board, and the presence of busy directors improves
?nancial performance (see e.g., Keys & Li, 2005;
Linn & Park, 2005). However, research also ?nds
that when a majority of board members are busy,
?nancial performance and monitoring can su?er
(Fich & Shivdasani, 2006); thereby suggesting that
too many busy directors on a board can be harm-
ful to stockholders.
We propose that a signi?cant threat to director
independence and the resulting e?ectiveness of
governance mechanisms could loom in an often
unobservable decision environment where archival
data are not readily available—whether to follow
the advice of auditors who recommend a restate-
ment of prior year ?nancial statements when man-
agement disagrees with the need for such
restatement. Restatements represent potentially
serious threats to the reputations of directors and
audit committee members because restatements
can signal failed monitoring (Srinivasan, 2005).
Directors operate in an environment where they
are rewarded by the director labor market for
e?ective monitoring and punished for ine?ective
monitoring (Srinivasan, 2005). Further, busy
directors stand to su?er the greatest penalties when
there are signals of monitoring failure, such as
restatements, as these directors have more to lose
than directors with fewer board seats (Srinivasan,
2005). Accordingly, we suggest that busy directors
are more likely than non-busy directors to com-
promise their independence in the face of restate-
ment decisions.
This investigation complements prior research
by leveraging one of the comparative advantages
of experimental research; that is, through control,
manipulation and randomization, experiments can
provide valuable insight into decision processes
where archival data are either unavailable or sam-
ple sizes are too small to conduct reliable statistical
analyses. Archival research documents potential
bene?ts and possible detriments of busy board
members based upon observed relationships
between ?rm performance and board composition
(see e.g., Ferris et al., 2003; Fich & Shivdasani,
2006). Di?erences in dependent measures and con-
trol variables between the archival studies, coupled
with the numerous alternative explanations for
observed ?rm performance e?ects, paint an
unclear picture of the e?ects of director busyness
on governance quality. Further, existing evidence
for weak performance associated with busy boards
may result from director shirking behavior, direc-
tor self-interests or both.
While archival literature has focused on shirk-
ing as an explanation for weak governance associ-
ated with busy boards, other research ?nds that
directors place great personal and ?nancial value
on their reputation capital (see e.g., Srinivasan,
2005), which can create a potential threat to their
objectivity. Our experimental approach allows us
to examine the role of director incentives on cor-
porate governance quality by controlling for
potentially confounding e?ects present in archival
studies, manipulating director status and incen-
tives, and randomizing experimental treatments
to participants. Additionally, we directly investi-
gate the in?uence of directors’ reputation capital
on their governance decisions.
In the current study, we designed and adminis-
tered a between-participants experiment to investi-
gate the e?ects of audit issue (adjustment versus
restatement) and independent director status (busy
versus non-busy) on the likelihood of accepting
auditor recommendations. A total of 88 experi-
784 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
enced audit committee members participated in the
study. The majority of sample participants (90%)
are considered the ?nancial experts on their audit
committees; thus, the participant pool re?ects a
sample of directors with a relatively high level of
?nancial literacy, which minimizes the possibility
that their responses in this study are bounded by
a lack of accounting or auditing knowledge.
Our participants evaluated an auditor–client
disagreement where the auditor recommended
either an audit adjustment prior to the release of
the current-year ?nancials or a restatement of prior
year ?nancials. The experimental results indicate
that both busy and non-busy audit committee
members are more reluctant to accept restate-
ment recommendations from auditors, relative to
audit adjustment recommendations, holding the
accounting issue constant. A reluctance to restate
can stem from several sources, such as reputation
threats associated with restatements, director
concerns that restatements are more harmful to
investors than adjustments, and more stringent
accounting standards for meeting the requirements
of restatement relative to adjustment. Our debrief-
ing questions rule out the potential that a concern
for shareholders explains the reluctance to restate,
as our director participants believed that the cur-
rent period adjustments resulted in more negative
e?ects for shareholders than the restatements. In
addition, manipulation of director busyness allows
us to test the e?ects of reputation concerns on
director decisions that are independent of di?er-
ences in accounting standard requirements for
restatements and adjustments. Finally, a panel of
experts, comprised of audit committee members,
academics, and a manager from the Financial
Accounting Standards Board, analyzed our exper-
imental case and indicated that acceptance of the
auditor’s recommendation to restate was the most
appropriate course of action. Thus, it is unlikely
that the participants’ reluctance to accept the
restatement recommendation in our experiment
re?ects an underlying belief that the recommenda-
tion is inappropriate.
Study results indicate that the desire of audit
committee members to avoid restatements is sig-
ni?cantly more acute for busy directors than
non-busy directors. Post-experimental debrie?ng
items indicate that busy directors face substantial
threats to their reputations as a result of restate-
ments; hence, they tend to avoid restatements
more than adjustments, even though study partic-
ipants indicated that the adjustment described in
the experiment would be more harmful to share-
holders than a similar restatement. Importantly,
our research evidence indicates that busy directors
face greater reputation threats from restatements
than non-busy directors, thus, they are more likely
to avoid restatements.
Background and hypotheses
Earnings restatements
Restatements indicate that prior ?nancial state-
ments included a material misstatement or omis-
sion that violated GAAP and suggest a
breakdown in the internal control system (Abbott
et al., 2004; Kinney & McDaniel, 1989; Palmrose
& Scholz, 2004; Srinivasan, 2005). Restatements
often result in adverse stock price reactions and
cost of capital increases (see e.g., Hribar & Jen-
kins, 2004; Wu, 2002). Restatements can send sig-
nals of weak corporate governance to the
marketplace (Agrawal & Chadha, 2005), and the
labor market for directors tends to impose severe
penalties on directors who are associated with
?rms that restate earnings (Srinivasan, 2005).
Directors who perform well in their corporate
governance role are often rewarded with addi-
tional director opportunities, while those who are
perceived to be ine?ective monitors can be pun-
ished through the loss of board seats and future
board opportunities (see e.g., Gilson, 1990; Kap-
lan & Reishus, 1990). For instance, downward
restatements of earnings result in the removal of
nearly 50% of the directors of the restating ?rm
within 3 years, and directors serving on multiple
boards also lose seats on the boards of other
non-restating ?rms (Srinivasan, 2005). Further,
audit committee members su?er the greatest
reputation harm and board seat losses in the face
of restatements (Srinivasan, 2005). Linn and Park
(2005) ?nd that the average compensation associ-
ated with each board seat for directors that
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 785
R
E
T
R
A
C
T
E
D
operate in large corporations is $160,000 per year
(with a maximum of $2.5 million/year). Thus, the
loss of multiple board seats and future opportuni-
ties can represent a substantial wealth risk. In
addition, directors are believed to derive signi?-
cant intrinsic value from holding board seats
(Fama & Jensen, 1983). Overall, prior research
indicates that directors face harsh ?nancial and
non-?nancial penalties when their ?rms restate.
Audit committees are speci?cally required to
evaluate accounting judgments and make decisions
regarding proposed audit adjustments and restate-
ments (Blue Ribbon Committee, 1999; Sarbanes &
Oxley, 2002). In response to accounting errors,
omissions or disagreements with management con-
cerning accounting judgments, auditors may pro-
pose audit adjustments prior to the release of
?nancial information or restatements of prior per-
iod results. SFAS No. 154 requires that accounting
errors be recorded as restatements, changes in
accounting principle be recorded retrospectively,
and changes in accounting estimates be recorded
as prospective adjustments.
While Abbott et al. (2004) document a signi?-
cant negative relationship between audit committee
independence and the incidence of restatement,
reduced restatements can be the result of either
e?ective monitoring or a reluctance to restate. Prior
literature suggests that restatements are viewed as
more threatening than audit adjustments by direc-
tors on audit committees, because restatements
send a signal to the director labor market that the
audit committee has failed in its monitoring role
(Srinivasan, 2005). Audit adjustments, on the other
hand, do not alter previously released information,
and can be viewed as e?ective monitoring of
management.
Directors are bound by strict duties to share-
holders that prevent them from acting in their
self-interests and are presumed to possess high
integrity. Therefore, one might argue that direc-
tors, especially independent directors, would not
intentionally avoid restatements simply to preserve
their reputation capital and further their personal
interests. From this perspective, directors could
avoid restatements to protect shareholders, assum-
ing that they believe that restatements are more
harmful to shareholders than adjustments to earn-
ings. In debrie?ng questions, we directly measure
director beliefs about the potential harm to inves-
tors created by the adjustment and restatement
conditions in our experiment. The participating
directors indicate that the current period adjust-
ment described in the experiment would be more
harmful to investors than the restatement, thereby
ruling out the possibility that our director partici-
pants were less likely to support a restatement in
order to protect shareholders.
Given that directors have high integrity and
assuming that they may elect a course of action
that serves their personal interests more than those
of shareholders, the theory of motivated reasoning
o?ers a potential explanation for behavior that
appears contrary to high integrity. Research on
motivation-based reasoning indicates that cogni-
tive processes, decision strategies and ultimate
decisions can be biased unwittingly when decision
makers are motivated to avoid one or more partic-
ular outcomes (Kunda, 1990). In a synthesis of ?ve
decades of motivation-based research, Kunda
(1990) ?nds that motives to arrive at speci?c con-
clusions can cause subconscious alterations in cog-
nitive processes. For example, decision makers can
develop illusions of objectivity where they sincerely
believe that their decision processes are entirely
objective (Kruglanski, 1980; Pyszczynski & Green-
berg, 1987). Cognitive distortion of this nature can
occur because decisions are based on memories of
facts and rules; however, such memories can be
subconsciously biased by personal motives (see
e.g., Greenwald, 1980). Kunda (1990) indicates
that cognitive distortion results from a complex
web of psychological processes that are not well
understood; however, one point seems clear: deci-
sion makers ‘‘. . . are more likely to arrive at those
conclusions that they want to arrive at.’’ (p. 27),
for the underlying motive to protect one’s self-
interest can lead to illusory objectivity and
rationalization.
While we cannot determine whether board
members’ decisions to accept or reject restatements
and adjustments are driven by conscious or sub-
conscious changes in cognitive processes, the the-
ory of motivated reasoning indicates that decision
makers with high integrity can be in?uenced by
personal motives. Because restatements hold the
786 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
potential to harm directors’ wealth and reputation
capital more than audit adjustments, restatements
can create a threat to the independence of directors,
even in the current legal environment where inde-
pendence is required and well-de?ned. Accord-
ingly, we posit that independent audit committee
members will be less inclined to accept an audi-
tor-proposed restatement relative to an auditor-
proposed adjustment (ceteris paribus).
H1: Audit committee members will be less
likely to accept a restatement recommenda-
tion, relative to an audit adjustment recom-
mendation, from auditors.
Busy directors
Section 303A.01 of the NYSE regulations
requires the majority of the board of directors to
be independent, and the Sarbanes–Oxley Act and
SEC regulations require all audit committee mem-
bers to be independent (NYSE, 2003; Sarbanes &
Oxley, 2002; US SEC, 2003). Independent or ‘‘out-
side’’ directors can generally be de?ned as direc-
tors who are not current or past members of the
corporation’s top management (Brickley et al.,
1994). Archival research has provided evidence
of a positive relationship between improved board
and audit committee e?ectiveness, and the inde-
pendence of board members. For example, ?rms
that have received enforcement actions from the
SEC have fewer independent directors than ?rms
without enforcement actions (Farber, 2005), and
earnings management attempts occur more fre-
quently in ?rms with fewer independent directors
(Klein, 2002).
A long-held view of director independence
asserts that outside directors are better monitors
than inside directors (Fama, 1980; Fama & Jensen,
1983). Several archival studies support this asser-
tion, ?nding that the stock market reacts favorably
to the appointment of independent directors to the
board (Rosenstein & Wyatt, 1990), and the ?nan-
cial performance of ?rms with more outside direc-
tors is higher than similar ?rms with fewer outside
directors (MacAvoy & Millstein, 1999). Further,
?rms with more outside directors have lower levels
of ?nancial statement fraud and earnings manage-
ment relative to ?rms with fewer outside directors
(Abbott et al., 2004; Beasley, 1996; Dechow et al.,
1996; Klein, 2002). However, some studies have
failed to ?nd improved board e?ectiveness resulting
from increased board independence (see e.g., Core,
Holthausen, & Larcker, 1999; Fosberg, 1989;
Hayes, Mehran, & Schaefer, 2004; Klein, 1998;
Subrahmanyam, Rangan, & Rosenstein, 1997),
suggesting that increased independence may not
result in improved monitoring in all circumstances.
Busy (professional) directors re?ect a subset of
independent directors, and they represent a large
percentage of total independent directors (Keys
& Li, 2005). These directors actively serve on mul-
tiple boards (Brickley et al., 1994) and can be
viewed as career directors. Because busy directors
serve on multiple boards, there has been concern
that they might shirk their duties in response to
time demands (Council of Institutional Investors,
1998; Korn/Ferry International, 1998; National
Association of Corporate Directors, 1996).
Indirect evidence of busy directors’ e?ectiveness
suggests that shirking behavior may be overshad-
owed by the bene?ts of experience. Keys and Li
(2005) ?nd that busy directors are three times as
likely to receive new appointments relative to
non-busy directors when they lose a board seat
after a takeover. Keys and Li (2005) also propose
that busy directors acquire valuable human capital
from their experiences on multiple boards, and the
labor market for directors places a high value on
such intellectual capital. They further assert that
the strong market demand for professional direc-
tors’ intellectual capital indicates that the value-
added contribution of professional directors seems
to outweigh any potential costs associated with the
directors serving on multiple boards.
The belief that market demand for busy direc-
tors indicates that they are e?ective monitors is
consistent with theories of independence and e?ec-
tive monitoring proposed by Fama and Jensen
(1983), and is further supported by ?ndings of
increased compensation for directors that serve
on multiple boards relative to non-busy directors
(Linn & Park, 2005). However, market demand
for busy directors provides only indirect evidence
for improved monitoring by busy directors. In
order to more speci?cally analyze potential
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 787
R
E
T
R
A
C
T
E
D
shirking by busy directors, Ferris et al. (2003)
investigate the e?ects of the average number of
directorships held by board members on ?rm per-
formance measures. They ?nd no evidence that
?rm performance is damaged by directors with
multiple board appointments, and they indicate
favorable stock price reactions to the addition of
a board member who currently serves on multiple
other boards. As well, they ?nd no relationship
between securities fraud litigation and the presence
of directors with multiple board positions. They
conclude that that busy directors’ knowledge and
skills outweigh the potential detriments associated
with shirking behavior.
A more recent study by Fich and Shivdasani
(2006) challenges the methods employed by Ferris
et al. (2003), as they suggest that the Ferris et al.
study contains several methodological ?aws that
limit the value of its ?ndings. Contrary to Ferris
et al. (2003), Fich and Shivdasani (2006) ?nd evi-
dence of ine?ective monitoring stemming from
busy directors. The Fich and Shivdasani (2006)
results indicate that boards with a majority versus
minority of busy directors are associated with
weaker ?nancial performance and weaker associa-
tions between CEOturnover and ?rmperformance.
While busy directors possess valuable knowledge
capital, the results from Fich and Shivdasani
(2006) indicate that boards dominated by busy
directors fail to adequately monitor management.
Both Ferris et al. (2003) and Fich and Shivda-
sani (2006) examine the e?ects of boards on moni-
toring at the board level and ?rm level, and each
study ?nds di?erent ?rm-level e?ects. Fich and
Shivdasani (2006) point out that the disparate ?nd-
ings are likely the result of di?erences in measure-
ment techniques and lack of control variables in
the Ferris et al. (2003) study. Ferris et al. (2003)
measure director busyness with the average num-
ber of directorships held by the board, while Fich
and Shivdasani (2006) consider the overall compo-
sition of the board (they classify boards with more
than 50% of the directors holding three or more
board seats as busy, while other boards are non-
busy). Use of the average number of directorships
is more sensitive to outliers than the approach
employed by Fich and Shivdasani (2006). In addi-
tion, the Fich and Shivdasani (2006) study employs
crucial control variables in its ?rm performance
models that were not considered in earlier work,
and the failure of Ferris et al. (2003) to include
these controls could explain their lack of statisti-
cally signi?cant e?ects.
The results from archival studies are mixed,
but the design and measurement improvements
employed by Fich and Shivdasani (2006) suggest
that there are adverse e?ects of busy directors on
?rm performance. While their ?ndings reveal cor-
relations between overall board composition and
?rm-level e?ects, they do not speak to the e?ects
of director busyness on the behavior of individual
board members. As a result, existing research that
examines the monitoring e?ectiveness of busy
directors cannot separate the e?ects of shirking
from the e?ects of director self-interests. Both Fer-
ris et al. (2003) and Fich and Shivdasani (2006)
assume that shirking is the primary negative conse-
quence of director busyness, but research of the
director labor market suggests that busy directors
face strong labor market incentives to manage
their reputations (Srinivasan, 2005). Our experi-
mental approach allows us to determine whether
director busyness directly e?ects directors’ deci-
sions and monitoring e?ectiveness, and we are able
to determine whether director self-interests in?u-
ence governance and accounting choice.
In summary, prior research suggests that busy
directors acquire valuable intellectual capital; busy
directors are motivated by incentives to maintain
their personal reputations (Fama & Jensen, 1983)
and compensation levels (Linn & Park, 2005);
?rms may bene?t from the knowledge and experi-
ence of busy directors (Linn & Park, 2005; Keys &
Li, 2005); and monitoring may su?er from the
presence of a majority of busy board members
(Fich & Shivdasani, 2006). We propose that the
?ndings of Fich and Shivdasani (2006) can be
explained, at least in part, by the reputation con-
cerns of busy directors—an issue they could not
examine due to data unavailability.
We suggest that boards dominated by busy
directors will pursue courses of action that are
aligned with the incentives of busy directors.
Restatement decisions provide an opportunity to
assess the e?ects of director self-interests on corpo-
rate governance e?ectiveness. Restatements repre-
788 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
sent signi?cant threats to busy directors, as restate-
ments can signal poor monitoring thereby result-
ing in labor market penalties for directors and
audit committee members (Srinivasan, 2005). Busy
directors typically su?er greater reputation harm
and ?nancial losses than non-busy directors when
there are signals of ine?ective monitoring because
they have more current and future board opportu-
nities to lose (Keys & Li, 2005).
Taken together, research ?ndings from studies
of restatements and the literature on busy directors
indicate that busy directors face stronger motives
to avoid restatements than non-busy directors.
One might argue that all directors aspire to hold
more directorships and, as a result, all directors
face similar motives to avoid restatements in order
to preserve their reputations. However, survey evi-
dence indicates that a majority of non-busy direc-
tors do not wish to become busy directors, and
they often refuse additional director opportunities
(Korn/Ferry International, 1998). In addition,
archival studies ?nd clear evidence that directors
who currently serve on multiple boards su?er more
severe and more immediate penalties than direc-
tors who serve on single boards (see e.g., Keys &
Li, 2005; Srinivasan, 2005). As a result of director
motives to avoid restatements, investigation of
decisions to support or reject restatement repre-
sents an opportunity to directly assess the relative
independence of busy versus non-busy indepen-
dent directors. We expect that busy directors will
be more likely to reject restatements proposed by
auditors than non-busy directors.
H2: The likelihood of accepting an auditor’s
restatement recommendation relative to an
adjustment recommendation is smaller for
audit committee members who are busy
directors than for audit committee members
who are non-busy directors.
Research method
Participants
The participants were experienced audit com-
mittee board members who currently serve on
boards of directors of US publicly listed compa-
nies. A total of 88 audit committee board members
took part in the current study—each representing
a di?erent company. The mean (standard devia-
tion) annual gross sales for 2005 of the represented
companies are $51.30 billion ($27.12 billion).
There were 15 female (17%) and 73 male partici-
pants, with a respective mean (standard deviation)
age and years business experience of 53.22 (11.22)
and 23.34 (9.91). Of the 88 audit committee mem-
bers, there were 40 vice presidents, 8 chief execu-
tive o?cers, 20 chief ?nancial o?cers and 3
presidents. Seventy-nine (90%) of the 88 partici-
pants were considered the ?nancial expert on their
audit committees and 73 (83%) were certi?ed pub-
lic accountants. The mean (standard deviation)
number of boards on which they have ever served
and currently serve are 2.80 (1.05) and 1.88 (0.92),
respectively. The mean (standard deviation) num-
ber of audit committees on which they have ever
served and currently serve are 1.75 (0.72) and
1.35 (0.61), respectively. Seventy-four (84%) of
the 88 participants held a master’s degree and
the remaining 14 held a bachelor’s degree. Finally,
a minimum of seven and maximum of 13 board
members participated in each of the eight training
sessions.
1
Procedures
The experiment involved a between-participants
design with two randomized factors: (1) indepen-
dent director status – busy or non-busy and (2)
audit issue – adjustment or restatement. The par-
ticipants were attending an education program
facilitated by an international consulting ?rm.
The topic of the program focused on ?nancial
statement fraud prevention and detection, and
the program was held during a single day. At the
1
A multiple regression model was run for each of the
demographic factors reported in this section, where the inde-
pendent variables were the audit issue (adjustment or restate-
ment), director status (non-professional or professional), and
the interaction term. None of the demographic factors was
signi?cantly di?erent across the four experimental treatment
conditions (p > .10). These results indicate that the randomiza-
tion procedure was e?ective.
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 789
R
E
T
R
A
C
T
E
D
beginning of the program, the board members
were asked to volunteer to participate in a research
study designed to investigate the decision processes
of audit committee members who serve on Boards
of Directors. There were a total of eight one-day
programs held over a three-week period at various
conference locations across the US. The program
facilitator, an attorney at law, Certi?ed Public
Accountant and Certi?ed Fraud Examiner, was
trained and quali?ed by the researchers in admin-
istering the experimental materials, and the facili-
tator was unaware of the experimental
treatments.
2
At the beginning of each program, the facilita-
tor handed two sealed envelopes to each partici-
pant. The experimental materials were stacked in
random order by the researchers, and the trainer
handed out the materials from the top to the bot-
tom of the stack.
Participants were asked to open the ?rst enve-
lope and remove the materials, which included a
cover sheet, voluntary consent form and case
materials. After the participants read the cover
sheet and signed the consent form, they read the
case, responded to a dependent variable item,
and placed all materials into and sealed the ?rst
envelope. Next, the participants opened the second
envelope, removed the materials within, provided
some demographic information, responded to a
series of questions, and placed all open materials
back into and sealed the second envelope. Impor-
tantly, after sealing the ?rst envelope, the facilita-
tor assured that participants did not reopen the
envelope while the second envelope was open. As
an incentive to participate, the researchers pro-
vided to each participant a $100 contribution to
the charity of his/her choice.
The case
Participants ?rst read background material
about a company called BioMeasure—a publicly
traded company that provides data collection ser-
vices to pharmaceutical companies. They read
that BioMeasure is audited by one of the big-4
CPA ?rms, and there have been no signi?cant
disagreements between management and the
auditor during their tenure on the board. They
further read that, for the current ?scal year audit
(2005), the auditor has set materiality based on
5% of pretax income, consistent with how the
audit ?rm has set materiality for BioMeasure in
prior years and for other clients in similar indus-
tries. Next, each participant evaluated either a
case involving a proposed adjustment or a case
involving a proposed restatement. All elements
of the case were held constant across participants,
with the exception of the audit issue and the
board member status. Participants in the audit
adjustment [restatement] conditions read about
an audit issue that has been brought to the atten-
tion of the audit committee:
In 2005[2004] BioMeasure developed a new
form of long-term service contract, and several
of these new contracts were initiated. The con-
tract revenue was appropriately recognized
using a percentage of completion method.
Management estimated the amount of con-
tract completion in 2005 [2004], and its esti-
mate resulted in recognized revenue of
$2,600,000 on the new contracts in 2005
[2004]. The external auditor has gathered
additional evidence to develop an independent
judgment regarding the most appropriate
approach to estimate contract completion.
The auditor believes that management’s esti-
mate was developed in good faith, but the
auditor believes that management’s estimate
of contract completion was too aggressive
and lacks strong supporting documentation.
The auditor favors an alternative method of
estimating contract completion.
Independent variables
Audit issue
Participants in the audit adjustment [restate-
ment] treatments read the following:
The auditor’s approach would recognize only
$1,400,000 revenue on these contracts in
2
One of the researchers attended the ?rst one-day program to
observe the facilitator’s administration of the experimental
materials.
790 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
2005 [2004], and the auditor believes that an
audit adjustment of 2005 [restatement of
2004] contract revenue is necessary. There
are some understandable reasons to believe
that the method proposed by the audit sta?
may be more conceptually sound relative to
the method used by management.
The potential auditor-proposed adjustment
[restatement] of the 2005 [2004] ?nancial
statements (the adjustment [restatement] will
decrease the recognized revenue on the long-
term service contracts by $1,200,000) falls
below the auditor’s 5 percent of pretax income
materiality threshold. Relative to pre-adjusted
2005 [2004] balances, the auditor-proposed
adjustment [restatement] is approximately 3
cents per share and 1.7 percent of pretax
income. If the auditor-proposed adjustment
[restatement] were made in full, 2005
[2004] pretax EPS would be reduced from
$1.75 to $1.72. The consensus analyst forecast
of pretax earnings per share is [was] $1.73 in
2005 [2004].
Management has strong reservations about the
proposed adjustment [restatement] because
there is no authoritative guidance that speci?-
cally disallows management’s revenue recogni-
tion method, and management considers the
adjustment [restatement] to be immaterial.
SFAS No. 154 requires that errors from prior
periods be restated and that changes in account-
ing principle from a prior period be recorded ret-
rospectively. Errors or changes made prior to the
completion of the audit only require a current
period adjustment. We employed a disputed
adjustment [restatement] that involved revenue
recognition because revenue recognition errors
are the most common source of restatements in
practice (Huron Consulting Group, 2004). Fol-
lowing Ng and Tan (2003), we developed a case
where there is no explicit authoritative guidance
to determine the proper revenue recognition
method, but we indicate that there are reasons
to believe that the auditor’s argument is sound.
In this circumstance, the audit committee must
exercise professional judgment, and there is an
indication that the auditor’s proposed adjust-
ment [restatement] is appropriate (Ng & Tan,
2003).
Also consistent with Ng and Tan (2003), the
case involves a proposed adjustment [restatement]
where the amount of the adjustment [restatement]
is quantitatively immaterial according to the audi-
tor’s materiality threshold, but causes EPS to fall
below the analyst forecast. Failing to meet the
forecast would cause the adjustment [restatement]
to be construed as qualitatively material according
to SEC Sta? Accounting Bulletin No. 99 (US SEC,
1999a).
The lack of explicit authoritative guidance
and failure to meet quantitative materiality
thresholds give the audit committee participants
some basis for rejecting the auditor’s proposed
adjustment [restatement]. If an audit committee
participant determines that the proposed adjust-
ment [restatement] is immaterial, the adjustment
[restatement] could be avoided completely.
3
Fur-
ther, without clear authoritative guidance for the
speci?c contracts identi?ed in the case, revenue
recognition falls under the requirements of SEC
Sta? Accounting No. 101 (US SEC, 1999b).
SAB No. 101 indicates that the revenue recogni-
tion criteria outlined in the FASB’s conceptual
framework should be applied to determine the
appropriate revenue recognition approach. Use
of the general framework provides latitude in
determining the most appropriate revenue recog-
nition approach.
To verify that restatement was the most appro-
priate course of action for our experimental case,
we consulted with a panel of restatement experts
to develop the case materials. The panel consisted
of four corporate board members who were mem-
bers of audit committees, a national partner at an
international consulting ?rm (Protiviti), a former
Financial Accounting Standards Board (FASB)
academic fellow, several academic experts in the
areas of ?nancial restatements and long-term
3
If the participants deem the adjustment [restatement] issue
to be qualitatively immaterial (i.e., missing the consensus
forecast by $0.01), we would expect no or low likelihood of
agreement with the auditor’s recommendation in all condi-
tions, thereby the results would be biased toward the null
hypotheses.
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 791
R
E
T
R
A
C
T
E
D
service contracts, and a recent manager at the
FASB who is an expert on restatements. After
reviewing the case materials, the panel clearly
indicated that given the information in the case
materials in the restatement condition, they would
be highly likely to agree with the auditor’s recom-
mendation to restate. In addition, the FASB
manager stated ‘‘. . . the way you wrote the
scenario coupled with the auditor’s recommenda-
tion most de?nitely indicates that an audit com-
mittee should agree with the auditor. Frankly, I
would be surprised (and disappointed) in an audit
committee that would disagree with the auditor in
this circumstance and under today’s audit/gover-
nance environment.’’
Director status
Participants in the non-busy [busy] director
conditions read the following:
4
1. Assume that you currently serve on the Audit
Committee of the Board of Directors for Bio-
Measure, Inc.
2. Assume that you are not a professional director,
you only serve on the board of BioMeasure, and
you are not seeking additional directorships.
[2. Assume that you are a professional director
and you serve on the Boards of Directors of sev-
eral prominent, publicly traded ?rms in the bio-
technology industry.]
We employ the term ‘‘professional’’ director,
rather than ‘‘busy’’ director, in the experimental
materials because the board member practitioners
who aided in the development of the case materials
were more familiar with this term. We ask partic-
ipants to assume the role of a busy or non-busy
director, rather than using a direct measure of
busyness because measurement of director status
is fraught with confounds. For example, directors
that are currently busy were once non-busy; direc-
tors who are currently non-busy may have been
busy directors in previous years; and busy (non-
busy) directors may assume a non-busy (busy)
decision frame within the context of the experi-
ment. As a result of these problems with direct
measures of busyness, direct manipulation of the
director status is necessary to ensure that partici-
pants are employing the desired decision frame
during the experiment.
Asking participants to assume that they are a
professional (i.e., busy) director presumes that
participants will understand the various incentive
tradeo?s available to them as either professional
or non-professional directors. In light of this
manipulation, the e?ects of motivated reasoning
must be considered second order e?ects because
participants are motivated by their assumed role.
If participants are unable to consider incentive
tradeo?s, our results will be biased towards the
null hypothesis for H2. We verify that our par-
ticipants understand the reputation e?ects, poten-
tial board seat losses, and other incentives
associated with restatements in the debrie?ng
questions presented in an upcoming section.
Further, we conduct analyses to verify that our
results do not depend on the congruence between
assigned director status and actual director
status.
Dependent variable
After reading the case materials, all participants
responded to the following dependent variable
item: ‘‘Based only on the information presented
on the preceding pages, how likely is it that you
would agree with the auditor’s proposed adjust-
ment [restatement] of 2005 [2004] revenue?’’
Participants responded on a scale where: 0% =
No Likelihood, 50% = Moderate Likelihood,
100% = High Likelihood (in 10% increments).
After completing the dependent measures, the par-
ticipants responded to a series of psychological
4
Requiring our participants to assume the role of a busy
director or a non-busy director holds the potential to create a
self-presentation bias. That is, participants who were told to
assume that they were busy directors may attempt to mask their
true beliefs and judgments in order to present themselves
positively. We are con?dent that the self-presentation bias does
not adversely a?ect our study results or our interpretation of
these results for two reasons: (1) The presentation bias favors
our null hypotheses because the bias would cause directors to
hide their reluctance to accept restatements; and (2) in an
upcoming section, we employ supplemental tests based on
social projection theory to determine any e?ects of a presen-
tation bias on our results.
792 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
debrie?ng items and demographic items that were
included in the second envelope.
5
Results
Manipulation checks
As a manipulation check for the director status
treatment, participants read the following two
statements, and were asked to check the one that
best re?ects the assumption they were asked to
make while reading the case materials and
responding to the case question:
_____I am a professional director, and I serve
on the Boards of Directors of several promi-
nent, publicly traded ?rms in the biotechnol-
ogy industry.
_____I am not a professional director, I only
serve on the board of BioMeasure, and I am
not seeking additional directorships.
All participants responded correctly in accor-
dance with their randomized conditions; thus the
director status manipulation was deemed
successful.
The board members were also asked about the
nature of the audit issue in question. They read
the following two statements and checked the
one that was applicable to the case they just read:
_____The audit issue involved a possible
restatement of the 2004 ?nancial statements
_____The audit issue involved a possible audit
adjustment to the 2005 ?nancial statements
Once again, all participants responded correctly
in accordance with their treatment conditions; thus
the ‘‘audit issue’’ manipulation was deemed
successful.
There were two key assumptions, both of which
were held constant across treatment conditions.
The ?rst assumption re?ected the auditors’ materi-
ality threshold. In this regard, the participants
responded to the following item:
For the case you completed, the auditors had
set the materiality threshold at _____ percent
of pretax income (please write the percentage
on the line above).
All participants correctly indicated 5%. The sec-
ond constant assumption dealt with the materiality
of the proposed adjustment or restatement. The
item read as follows:
For the case you completed, did the proposed
adjustment [restatement] amount meet the
auditor’s materiality threshold (circle one)?
Yes ____ No ____
Once again, all participants correctly checked
‘‘No’’. The latter two items were included in the
debrie?ng materials because had the adjustment
in question exceeded the auditors’ materiality
threshold, in all likelihood, the participants would
have felt forced to accept the auditor’s
recommendation.
The issue of materiality is an important aspect
of the current study, for such determination is
the ultimate responsibility of corporate governors,
according to Sta? Accounting Bulletin Number 99
(US SEC, 1999a). Although the case study reveals
that the audit issue under consideration falls below
the auditor’s quantitative materiality threshold of
5%, board members should further consider other
qualitative considerations that might signal mate-
riality. One of these considerations involves
‘‘whether the misstatement hides a failure to meet
analysts’ consensus expectations for the enter-
prise’’ (US SEC, 1999a, p. 4). The position of the
Securities and Exchange Commission (SEC) in this
regard was reinforced in a recent court case (US
SEC, 2005). In this case, Huntington Bancshares,
Incorporated was charged with and found guilty
of ?nancial reporting fraud arising from account-
ing misstatements that hid the company’s failure
to meet analysts’ consensus forecasts—even
though each misstatement’s e?ect on earnings per
share (EPS) was less than the quantitative ‘‘rule
of thumb’’ benchmark used by Huntington of
5%, and most of the misstatements a?ected EPS
by less than 1%. In the current study, we add such
tension by choosing a scenario where the account-
ing issue falls under the auditors’ quantitative
5
Two experienced audit committee board members, who did
not participate in the study, read and helped to re?ne the case
materials and response items.
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 793
R
E
T
R
A
C
T
E
D
‘‘rule of thumb’’ materiality benchmark and below
management’s subjective materiality threshold, yet
the recommended adjustment [restatement] would
move BioMeasure’s EPS from above to below
the analysts’ consensus expectations.
6
Hypothesis testing
Analyses of the dependent variable (likelihood
of accepting the auditor’s proposed adjustment/
restatement recommendation) are shown in Table
1. Table 1(panel A) provides means, standard devi-
ations, medians and sample sizes for all treatment
conditions and main e?ects. Table 1(panel B) pre-
sents the results of an ANOVA model where the
dependent variable re?ects the participants’ likeli-
hood of agreeing with the auditor’s recommenda-
tion, and the independent variables are audit
issue (adjustment versus restatement), director
type (non-busy versus busy) and the interaction
term.
7
The ?rst study hypothesis (H1) proposes that
directors will be less likely to accept a restatement,
relative to an adjustment recommendation. The
coe?cient for audit issue is statistically signi?cant
(F = 48.39, p < .000). The ANOVA results indi-
cate that the mean likelihood of acceptance score
for restatement (69.78) is signi?cantly lower than
the mean likelihood score for adjustment (86.51).
Hence, the ?rst hypothesis (H1) is supported.
The second hypothesis (H2) posits that busy
directors will be less likely than non-busy directors
to accept a restatement recommendation relative
Table 1
Likelihood of Agreeing with the Auditor’s Recommendation
Director status Auditor’s recommendation Main e?ect: status
Adjustment Restatement
Panel A: Mean(standard deviation) [median] {sample size} responses across treatment conditions
Non-busy board member 90.91 80.43 85.56
(6.84) (8.78) (9.53)
[90] [80] [90]
{22} {23} {45}
Busy board member 81.90 58.64 70.00
(14.01) (14.24) (18.26)
[80] [60] [70]
{21} {22} {43}
Main e?ect: recommendation 86.51 69.78 77.95
(11.73) (16.02) (16.34)
[90] [70] [80]
{43} {45} {88}
Source Sum of squares d.f. Mean square F p Hypothesis
Panel B: ANOVA results
Director status (DS) 5213.06 1 5213.06 40.32 .000
Audit issue (AI) 6255.66 1 6255.66 48.39 .000 H1
DS · AI 899.36 1 899.36 6.96 .010 H2
Error 10860.37 84 129.29
6
The manipulation check item for materiality indicates that
the participants recognized the quantitative immateriality of the
audit adjustment [restatement] recommendation. However, if
they also deemed that the adjustment [restatement] was
qualitatively immaterial, this would bias the results toward
the null hypothesis for H1.
7
The dependent variable, likelihood of agreeing with the
auditor, neither exhibited a normal distribution (Shapiro–Wilk
W = 0.89, p < .01) nor equal variance (Levene F = 4.89,
p < .01). However, ANOVA is quite robust to violations of
normality and equal variance (Box, 2005). Nevertheless, we
conducted parallel non-parametric procedures where the data
were treated as ordinal. The parametric and non-parametric test
results were qualitatively the same, and the non-parametric
results held at conventional levels (p < 0.05) for the ‘‘self’’ and
‘‘referent-other’’ tests.
794 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
to an adjustment recommendation. The hypothesis
is tested with the interaction of director status and
audit issue, and planned contrast tests. As indi-
cated in Table 1 (panel B), the interaction of direc-
tor status and audit issue is statistically signi?cant
(F = 6.96, p = .01). The contrast test results are
presented in Fig. 1.
The ?rst contrast test indicates that the di?er-
ence (D9.01) between busy and non-busy directors
in the adjustment condition is signi?cant
(p = .013). The second contrast test suggests that
the di?erence (D21.79) between busy and non-busy
directors in the restatement condition is also signif-
icant (p = .013). The third contrast test compares
the di?erence scores between the restatement and
adjustment conditions (D21.79 À D9.01 = D12.78)
and the result is statistically signi?cant (p =
.011). Taken as a whole, the signi?cant interaction
term and contrast test results indicate that busy
directors, as compared to non-busy directors, are
less likely to accept restatements than adjustments,
thus supporting H2.
8
The results also indicate that
our participants properly internalized their audit
committee roles (i.e., busy versus non-busy).
Supplemental tests
The nature of the case involved a sensitive mat-
ter for audit committee board members—asking
them the likelihood that they would agree with
the auditor’s proposed adjustment or restatement.
Because of such sensitivity, we were uncertain (a
priori) of the participants’ willingness to express
their true beliefs; therefore we desired veri?cation
that our participants had assumed the decision
perspective of a busy or non-busy director.
Although the main results clearly support the
study hypotheses and the e?ectiveness of the
experimental manipulations, the lowest mean like-
lihood of 58.64 (found in the ‘‘professional ·
restatement’’ condition) is nevertheless signi?-
cantly higher than the mid-point of the scale
(t = 2.84, p < .01), which suggests that the partici-
pants were at least ‘‘moderately likely’’ to go along
with the auditor’s recommendation. Accordingly,
we also asked our participants about the likeli-
hood that other busy and non-busy board mem-
bers on BioMeasure’s audit committee would
agree with the auditor’s recommended adjustment
or restatement.
The reason for asking the participants to re?ect
on how other audit committee board members
might respond is grounded in the concept of social
projection. According to social projection theory,
when individuals are asked how referent others
might respond to the same stimuli, they frequently
project their own subconscious or repressed con-
scious beliefs onto the referent others (e.g., Beeler
& Hunton, 2002; Clement & Krueger, 2000;
Mikulincer & Horesh, 1999; Ruvolo & Fabin,
1999; Smith, 1997). Therefore, we felt that the
participants might indirectly project their true
Planned Contrast Test Results (assuming unequal variances):
Mean Difference t-stat
p-value
? 9.01 = 2.60 .013
? 21.79 = 6.15 .000
? 12.78 (21.79 – 9.01) = 2.61 .011
50
55
60
65
70
75
80
85
90
95
Adjustment Restatement
Non-Busy
Busy
90.91
81.90
80.43
58.64
?9.01
?21.79
Fig. 1. Likelihood of agreeing with the auditor’s recommen-
dation.
8
To verify that the results related to director busyness do not
depend on the congruence between assigned director status and
actual director status, we run an ANCOVA model that includes
actual busyness as a covariate. Results are not sensitive to the
inclusion of actual busyness as a covariate.
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 795
R
E
T
R
A
C
T
E
D
underlying beliefs onto referent other non-busy
and busy audit committee members at BioMea-
sure, thus revealing any self-presentation bias.
The pattern of referent other results is presented
in Fig. 2. The mean (standard deviation) response to
the referent other item in the ‘‘busy x restatement’’
condition was 36.82 (16.15). A t-test indicates that
the mean likelihood score of 36.82 is signi?cantly
less than the mid-point of the scale (t = 3.83,
p < .01). Also, the mean likelihood score of 36.82
is signi?cantly lower than the mean likelihood score
of 58.64 that the participants re?ected on them-
selves (t = 4.75, p < .01).
9
Fig. 2 indicates that the
‘referent other’ responses follow the same pattern
as the primary analyses, andfurther support the ?rst
and second hypotheses. The ‘referent other’ means
suggest that the participants’ resistance to the audi-
tor’s proposed adjustment and restatement might
be greater than initially indicated.
To verify that the pattern of responses to the
likelihood that referent others would accept the
adjustment [restatement] matches the pattern of
results found for the primary analyses, we conduct
an ANOVA of the responses to the ‘referent other’
scales. The dependent variable is the participant’s
assessment of the likelihood that referent others
would accept the adjustment [restatement], and
the independent variables are director status and
audit issue. Consistent with the results in the
primary analyses shown in Table 1, the audit issue
(F = 68.96, p < .000), the director status (F =
78.13, p < .000) and the interaction of audit issue
and director status (F = 16.93, p < .000) are all
statistically signi?cant.
Other debrie?ng items
To better understand the beliefs and motives of
audit committee board members’ willingness to
accept auditors’ proposed adjustments and/or
restatements, we asked participants to respond to
several ?nal debrie?ng items. The items’ wording,
response scale, mean, standard deviation, test
comparison, t-statistic and p-value are shown in
Table 2.
The ?rst item (second item) asks the extent to
which there are personal ?nancial penalties for
audit committee members when audit adjustments
(restatements) are made to reduce revenues. The
relatively low mean of 11.25 (10.91) suggests that
there are little or no perceived ?nancial penalties
for either audit issue. The third item (fourth item)
assesses the extent to which the reputation of an
audit committee member is a?ected when audit
adjustments (restatements) are made to reduce rev-
enues. The mean response to item three (À1.15)
indicates some negative impact when audit adjust-
ments are involved, and the larger mean response
to item four (À3.97) suggests a considerable nega-
tive impact when the audit issue involves a restate-
ment. The two means are signi?cantly di?erent
(t = 20.27, p < .01), which suggests that the nega-
tive reputation e?ect is greater when the audit issue
involves a restatement, relative to an audit adjust-
ment. The ?fth item (sixth item) evaluates the
impact of an audit adjustment (restatement) on
future selection to another board. Consistent with
the prior set of reputation e?ect items, the impact
on future selection is lower when the audit issue
involves an adjustment (mean = À0.20) relative
to a restatement (mean = À4.08). Mean responses
to items ?ve and six are also signi?cantly di?erent
from each other (t = 40.31, p < .01).
30
40
50
60
70
80
90
100
Adjustment Restatement
Non-Busy (Self)
Busy (Self)
Non-Busy
(Referent Other)
Busy (Referent
Other)
Fig. 2. Self versus referent other likelihood assessments (self-
presentation bias)-likelihood of agreeing with the auditor’s
recommendation.
9
Both t-tests assume unequal variances.
796 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
The last item assesses which of the two scenar-
ios will likely result in more ?nancial harm to
investors: an audit adjustment that causes the cur-
rent year EPS to fall $0.01 below the current year’s
consensus analyst EPS forecast or a restatement
that causes the prior year EPS to fall $0.01 below
the prior year’s consensus analyst EPS forecast.
The mean response of À1.91 suggests that an audit
adjustment potentially causes more harm to inves-
tors than a restatement. If the participants’ pri-
mary motivation for resisting the auditor’s
proposed adjustment/restatement is rooted in
causing the ‘‘least ?nancial harm’’ to investors, this
would likely drive the experimental results toward
the null hypothesis, not the alternative. Given that
the board members in this study who were ran-
domized into the ‘‘busy · restatement’’ condition
recorded the lowest ‘likelihood’ mean, relative to
the other three treatment conditions, it appears
as though potential harmful self-interest e?ects
outweighed potential negative investor e?ects.
Conclusions
The relevance and importance of the audit com-
mittee to quality ?nancial reporting is clear. Audit
committees oversee the audit and ?nancial report-
ing processes, and they resolve disputes between
auditors and management. Regulations of the
SEC and stock exchanges place substantial author-
ity in the hands of the audit committee and require
independence for directors who serve on audit
committees. Independence is viewed as the essen-
tial ingredient for promoting e?ective governance.
Independent directors are assumed to be superior
monitors of management because their careers
are not controlled by top management, and they
are motivated to be e?ective monitors in order to
signal their quality and knowledge to the director
labor market. However, there may be certain cir-
cumstances under which audit committee mem-
bers, particularly busy directors, are faced with
reputation threats that can result in compromised
Table 2
Psychological debrie?ng items
Response items
a
Mean Std. Dev. Test t p
1. In general, to what extent are there personal ?nancial penalties for audit committee
members when audit adjustments are made to reduce revenue prior to the release of
?nancial information? (0% = No Penalties, 50% = Moderate Penalties, 100% = Severe
Penalties – in 10% increments)
11.25 3.33 =50 109.28 .01
2. Ingeneral, towhat extent are there personal ?nancial penalties for audit committee members
when restatements are made to reduce revenue on prior year statements? (0% = No
Penalties, 50% = Moderate Penalties, 100% = Severe Penalties – in 10% increments)
10.91 2.89 =50 126.83 .01
3. In general, how is the reputation of an audit committee member a?ected when audit
adjustments are made to reduce revenue prior to the release of ?nancial information?
(À5 = Very Negative, 0 = No Impact, +5 = Very Positive)
À1.15 1.06 =0 10.19 .01
4. In general, how is the reputation of an audit committee member a?ected when
restatements are made to reduce revenue on prior year statements? (À5 = Very Negative,
0 = No Impact, +5 = Very Positive)
À3.97 0.76 =0 48.64 .01
5. Assume that you are an audit committee member on a Board of Directors and an audit
adjustment is made to reduce revenue prior to the release of ?nancial information: How
would this a?ect the likelihood of you being selected to serve on another Board of
Directors? (À5 = Very Negative, 0 = No Impact, +5 = Very Positive)
À0.20 0.48 =0 3.97 .01
6. Assume that you are an audit committee member on a Board of Directors and a
restatement is made to reduce revenue prior to the release of ?nancial information: How
would this a?ect the likelihood of you being selected to serve on another Board of
Directors? (À5 = Very Negative, 0 = No Impact, +5 = Very Positive)
À4.08 0.76 =0 50.25 .01
7. Which item will result in more ?nancial harm to investors: (1) A restatement of prior year
revenue that causes the prior year’s EPS to fall $0.01 below the prior year’s EPS consensus
analyst forecast, or (2) An audit adjustment to current year revenue that causes current year
EPS to fall $0.01 below the current EPS consensus analyst forecast? (À5 = Adjustment
Causes More Harm, 0 = No Di?erence, +5 = Restatement Causes More Harm)
À1.91 0.77 =0 23.33 .01
a
The mean responses are not signi?cantly di?erent across treatment conditions (p > .10).
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 797
R
E
T
R
A
C
T
E
D
independence. In the current study, we investi-
gated one of those circumstances—when auditors
recommend a restatement of prior year results
and management disagrees.
In a between-participants experiment, we mani-
pulated audit issue (audit adjustment versus
restatement) and director status (busy versus
non-busy), and found that audit committee mem-
bers are less likely to support restatements than
adjustments when the underlying accounting issue
remains constant. Further, busy directors are more
resistant to restatements and more concerned
about potential negative reputation e?ects associ-
ated with restatements than non-busy directors.
Overall, research ?ndings reveal that busy direc-
tors’ independence might be compromised when
audit committees are faced with restatement deci-
sions, as restatements appear to trigger concerns
about reputation e?ects, which can potentially
cause them to focus more on self-interests than
stakeholder-interests. This is particularly unset-
tling, as regulators, shareholders and academics
have placed great faith in the role of directors in
promoting e?ective governance.
Post-experiment analyses provide several addi-
tional insights. When we asked participants to
indicate how other audit committee members
would resolve the restatement dispute, support
for the auditor-proposed restatement dropped sig-
ni?cantly for ‘referent other’ busy directors rela-
tive to their own ‘self’ indicators of support.
Based on social projection theory, this result sug-
gests that the e?ects of restatements on busy direc-
tors, while already statistically signi?cant in the
current study, may be even more acute in practice.
Debrie?ng questions also reveal that participants
were aware of the e?ects of restatements on their
reputations and future board seat prospects, thus
providing support for the theory that their deci-
sions to avoid restatements, relative to adjust-
ments, were at least partially driven by
reputation concerns. Finally, the participants
believed that the audit adjustments in the experi-
mental case would cause more harm to sharehold-
ers than the restatements, indicating that within
the context of the experiment they were more con-
cerned about their reputations than shareholder
interests.
Overall, this study provides evidence that inde-
pendent directors, and particularly busy directors,
might pursue self-interests when making account-
ing choices, particularly when they believe they
might su?er serious ?nancial and reputational
harm should there be market signals of poor mon-
itoring, such as restatements. One potential solu-
tion for the independence issue raised in this
study is to ensure that the balance of busy and
non-busy directors on audit committees does not
lean too heavily toward the former.
Acknowledgement
The authors acknowledge valuable contribu-
tions from the participants of research workshops
at Texas A&M University and University of Mis-
souri Columbia.
References
Abbott, L., Parker, S., & Peters, G. (2004). The e?ectiveness of
blue ribbon committee recommendations in mitigating
?nancial misstatements: An empirical study. Auditing: A
Journal of Practice and Theory, 23, 69–87.
Agrawal, A., & Chadha, S. (2005). Corporate governance and
accounting scandals. Journal of Law and Economics, 48,
371–406.
Beasley, M. (1996). An empirical analysis of the relation
between the board of director composition and ?nancial
statement fraud. The Accounting Review, 71, 443–465.
Beeler, J. D., & Hunton, J. (2002). Contingent economic rents:
Insidious threats to audit independence. Advances in
Accounting Behavioral Research, 5, 21–50.
Blue Ribbon Committee (1999). Report and recommendations of
the blue ribbon committee on improving the e?ectiveness of
corporate audit committees. New York Stock Exchange and
National Association of Securities Dealers. www.nyse.com.
Box, G. (2005). Statistics for experimenters: Design, innovation,
and discovery (2nd ed.). Hoboken, New Jersey: John Wiley
and Sons.
Brickley, J., Coles, J., & Terry, R. (1994). Outside directors and
the adoption of poison pills. Journal of Financial Economics,
35, 371–390.
Clement, R. W., & Krueger, J. (2000). The primacy of self-
referent information in perceptions of social consensus.
British Journal of Social Psychology, 39(2), 279–299.
Core, J., Holthausen, R., & Larcker, D. (1999). Corporate
governance, chief executive o?cer compensation and
?rm performance. Journal of Financial Economics, 51,
371–406.
798 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D
Council of Institutional Investors (1998). Core policies, positions
and explanatory notes. Washington, DC.
Dechow, P., Sloan, R., & Sweeny, A. (1996). Causes and
consequences of earnings manipulation: An analysis of ?rms
subject to enforcement actions by the SEC. Contemporary
Accounting Research, 13, 1–36.
Fama, E. (1980). Agency problems and the theory of the ?rm.
Journal of Political Economy, 88, 288–307.
Fama, E., & Jensen, M. (1983). Separation of ownership and
control. Journal of Law and Economics, 26, 301–325.
Farber, D. (2005). Restoring trust after fraud: Does corporate
governance matter? The Accounting Review, 80, 539–561.
Ferris, S., Jagannathan, M., & Pritchard, A. (2003). Too busy
to mind the business? Monitoring by directors with multiple
board appointments. The Journal of Finance, 58, 1087–1111.
Fich, E., & Shivdasani, A. (2006). Are busy boards e?ective
monitors? Journal of Finance, 61, 689–724.
Fosberg, R. (1989). Outside directors and managerial monitor-
ing. Akron Business and Economic Review, 20, 24–32.
Gilson, S. (1990). Bankruptcy, boards, banks, and bondholders:
Evidence on changes in corporate ownership and control
when ?rms default. Journal of Financial Economics, 27,
355–388.
Greenwald, A. (1980). The totalitarian ego: Fabrication and
revision of personal history. American Psychologist, 35,
603–618.
Hayes, R., Mehran, H., & Schaefer, S. (2004). Board committee
structures ownership and ?rm performance. University of
Chicago and Northwestern University.
Hribar, P., & Jenkins, N. (2004). The e?ects of accounting
restatements on earnings revisions and estimated cost of
capital. Review of Accounting Studies, 9, 337–356.
Huron Consulting Group (2004). Annual review of ?nancial
reporting matters. Washington, DC.
Kaplan, S., & Reishus, D. (1990). Outside directorships and
corporate performance. Journal of Financial Economics, 27,
389–410.
Keys, P., & Li, J. (2005). Evidence on the market for
professional directors. The Journal of Financial Research,
28, 575–589.
Kinney, W., & McDaniel, L. (1989). Characteristics of ?rms
correcting previously reported quarterly earnings. Journal of
Accounting and Economics, 11, 71–93.
Klein, A. (1998). Firm performance and board committee
structure. Journal of Law and Economics, 41, 275–302.
Klein, A. (2002). Audit committee, board of director charac-
teristics, and earnings management. Journal of Accounting
and Economics, 33, 375–400.
Korn/Ferry International (1998) 25th Annual Board of Direc-
tors Study. Los Angeles, CA.
Kruglanski, A. (1980). Lay epistemology process and contents.
Psychological Review, 87, 70–87.
Kunda, Z. (1990). The case for motivated reasoning. Psycho-
logical Bulletin, 108(3), 480–498.
Linn, S., & Park, D. (2005). Outside director compensation
policy and the investment opportunity set. Journal of
Corporate Finance, 11, 680–715.
MacAvoy, P., & Millstein, I. (1999). The active board of
directors and its e?ect on the performance of the large
publicly traded corporation. Journal of Applied Corporate
Finance, 11, 8–20.
Mikulincer, M., & Horesh, N. (1999). Adult attachment style
and the perception of others: The role of projective
mechanisms. Journal of Personality and Social Psychology,
76(6), 1022–1034.
Myers, J., Myers, L. & Palmrose, Z. (2004). Mandatory auditor
rotations: Evidence from restatements. In Proceedings of the
mid-year meeting of the auditing section of the American
Accounting Association, Clearwater, FL.
National Association of Corporate Directors (1996). Report on
the NACD blue ribbon commission on director professional-
ism. Washington, DC.
Ng, T., & Tan, H. (2003). E?ects of authoritative guidance
availability and audit committee e?ectiveness on auditors’
judgments in an auditor–client negotiation context.
Accounting Review, 78, 801–818.
New York Stock Exchange (2003). Standard 303A.06 Audit
Committee.
Palmrose, Z., & Scholz, S. (2004). The circumstances and legal
consequences of non-GAAP reporting: Evidence from
restatements. Contemporary Accounting Research, 21,
139–190.
Powers, W., Troubh, R., & Winokur, H. (2002). Report of the
Investigation by the Special Investigative Committee of the
Board of Directors of Enron Corp. Austin, TX.
Pyszczynski, T., & Greenberg, J. (1987). Toward an integration
of cognitive and motivational perspectives on social infer-
ence: A biased hypothesis-testing model. In L. Berkowitz
(Ed.). Advances in experimental social psychology (Vol. 20,
pp. 297–340). New York: Academic Press.
Rosen, R. (2003). Risk management and corporate gover-
nance: The case of Enron. Connecticut Law Review, 35,
1157–1184.
Rosenstein, S., & Wyatt, J. (1990). Outside directors, board
independence and shareholders wealth. Journal of Financial
Economics, 26, 175–191.
Ruvolo, A. P., & Fabin, L. (1999). Two of a kind: Perceptions
of own and partner’s attachment characteristics. Personal
Relationships, 6(1), 57–79.
Sarbanes, P., & Oxley, M. (2002). Sarbanes–Oxley Act of 2002.
Washington, DC: US Congress.
Smith, E. (1997). Private selves and shared meanings: Or forgive
us for our projections as we forgive those who project into
us. Psychodynamic Counseling, 3(2), 117–131.
Srinivasan, S. (2005). Consequences of ?nancial reporting
failure for outside directors: Evidence from accounting
restatements and audit committee members. Journal of
Accounting Research, 43, 291–334.
Subrahmanyam, V., Rangan, N., & Rosenstein, S. (1997). The
role of outside directors in bank acquisitions. Financial
Management, 26, 23–36.
United States Security and Exchange Commission (1999a).
SEC Sta? Accounting Bulletin 99—Materiality. Washing-
ton, DC.
J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800 799
R
E
T
R
A
C
T
E
D
United States Security and Exchange Commission (1999b).
SEC Sta? Accounting Bulletin 101—Revenue Recognition.
Washington, DC.
United States Security and Exchange Commission (2003). 17
CFR 240.10A-3. Washington, DC.
United States Security and Exchange Commission (2005).http://www.sec.gov/litigation/complaints/comp19243.pdf.
Wu, M. (2002). Restatements. Unpublished Dissertation, New
York University.
800 J.E. Hunton, J.M. Rose / Accounting, Organizations and Society 33 (2008) 783–800
R
E
T
R
A
C
T
E
D

doc_384503799.pdf