The Effects of Audit Committee Members’ Age and Additional Directorships on the Cost of Equity Capital in the USA

Abstract

In this paper, we examine the associations between the cost of equity capital and two audit committee (AC) characteristics: (1) average AC members’ age and (2) average number of AC members’ other directorships. This study is motivated by the recent emphasis on the important role of ACs in overseeing financial reporting and audit processes, as well as the recognition of the critical role of capital costs in firms' operational efficiency and profitability. The empirical results show that the cost of equity capital is lower in US firms with higher average AC members’ age. We do not find any evidence that the average number of AC members’ other directorships is associated with the cost of equity capital. We also find that age could be another proxy for AC members’ experience. Our findings provide evidence that supports the call of the US Securities and Exchange Commission for greater board diversity (including age). Our study not only demonstrates the important role of ACs in corporate governance, but also enriches the literature by examining the two AC characteristics that are rarely mentioned in prior studies.

Acknowledgements

The authors are grateful to Dr Salvador Carmona (Editor), Dr Ann Vanstraelen (Associate Editor), and two anonymous referees for their helpful comments and suggestions that have helped to improve this paper.

Hua-Wei Huang gratefully acknowledges the National Science Council, Taiwan, ROC (Project No. NSC 100-2410-H-006-102), for the financial support.

Notes

We also test this prediction in the Additional Analysis section.

Standard errors are robust to clustering along the two dimensions (firm-year).

The Corporate Library database provides data on AC financial expertise, which is used in the current study. According to the Corporate Library, AC financial experts are those financial experts designated by firms under Section 407 of SOX (and reported in firms' proxy statements). There have been controversies over the definition of AC financial expertise, and prior studies have used different definitions of financial expertise. For instance, some studies have used the original definition of financial experts of the SEC, requiring a financial expert to have experience as ‘a public accountant or auditor or a principal financial officer, controller, or principal accounting officer of an issuer, or from a position involving the performance of similar functions’ (US Securities and Exchange Commission, 2002) (e.g. Abbott et al., 2003a). Some other studies have used the broader definition of financial expertise adopted in the final rules of the SEC (US Securities and Exchange Commission, 2003), defining financial expert as including both accounting financial experts and non-accounting financial experts (e.g. Krishnan and Visvanathan, 2009). Other prior studies have also used firms' designations of AC financial experts (e.g., Krishnan and Lee, 2009). Our study employs only firms' designation of AC financial experts due to data availability issues.

We also compare the characteristics of our sample of American firms with the characteristics of the total population of American firms in Compustat by total assets and industry. No significant differences are found, indicating that our sample is a representative sample on the two tested dimensions (total assets and industry).

In order to eliminate outlier effects, we winsorise 1% for all control variables and eliminate all observations with absolute studentised residuals being greater than 2 (Song et al., 2010).

http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/.

Beta is measured as the slope coefficient from the regression of a firm's daily raw returns on the daily value-weighted market return over a rolling 5-year window ending in the current fiscal year.

We also examine the interactions of country legal regime index and our variables of interest on firms' cost of equity capital, but no significant results are found.

Additional information

Notes on contributors

Mai Dao

Paper accepted by Ann Vanstraelen.

Hua-Wei Huang

Paper accepted by Ann Vanstraelen.

Jishan Zhu

Paper accepted by Ann Vanstraelen.