Rediscovering Board Expertise: Legal Implications of the Empirical Literature

Lawrence A. Cunningham

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Corporate Finance and Governance Auditing, Earnings Management, Governance Corporate Governance and Law

Abstract

People are rediscovering the value of expertise on corporate boards of directors. The rediscovery occurs after several decades of celebrating independent directors under the guise of the monitoring model of boards. While independence remains fashionable, and the Sarbanes-Oxley Act of 2002 (SOX) continues its long-standing promotion, SOX also requires companies to disclose whether their boards have expertise on the board audit committee and, if not, why not. This hastens an inchoate ten-year trend favoring expertise. The value of expertise is supported by theory and empirical research. Accidents of political history appear to explain its subordination, until recently, to independence. As a matter of theory, board expertise harmonizes with basic division of labor principles, yet little attention is paid to the specific expertise that directors offer. The most prominent model of director expertise, developed during the rise of the monitoring board, envisioned an expertise in “decision control.” But this views boards as monoliths and hides the significance of individuals in group decision making. Accompanying the rise of the monitoring board and its privileged place for independence was the rise of the board committee, especially the audit committee. Although committees have designated functions, until recently, the focus has been on member independence rather than expertise benefiting from division of labor. As an empirical matter, the value of expertise is supported by a large body of research. Most strikingly, research shows that accounting expertise is valuable in promoting audit committee effectiveness, while general financial and other expertise contribute less value.

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References

1983Separation of Ownership and Control 2005The economic implications of corporate financial reporting 2002Audit committee, board of director characteristics, and earnings management 1996Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC*1997An Empirical Analysis of the Relation between the Board of Director Composition and Financial Statement Fraud 2003Earnings management and corporate governance: the role of the board and the audit committee 2003Conservatism in Accounting Part I: Explanations and Implications 2004Board characteristics, accounting report integrity, and the cost of debt

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