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(American Accounting Association, 2012) Jones, Keith L; Aier, Jagadison K; Brandon, Duane M; Carpenter, Tina D; Gaynor, Lisa Milici; Knechel, W Robert; Pevzner, Mikhail; Reed, Brad; Walker, Paul L
In August 2011, the Public Company Accounting Oversight Board (PCAOB or Board) issued a concept release to solicit public comment on the potential direction of a proposed standard-setting project on means to enhance auditor independence, objectivity, and professional skepticism. The Concept Release sought comments on and explores in detail the possibility of mandatory audit firm rotation. The PCAOB provided for a 121-day exposure period (from August 16 to December 14, 2011) for interested parties to examine and provide comments on the concept release. The Auditing Standards Committee of the Auditing Section of the American Accounting Association provided the comments in the letter below (dated December 13, 2011) to the PCAOB on PCAOB Rulemaking Docket Matter No. 37: PCAOB Release No. 2011-006, Concept Release on Auditor Independence and Audit Firm Rotation.
Debtholders’ demand has been widely discussed as a key determinant of conservatism but clear causal evidence is not yet established. Using a natural experiment setting, wherein a Delaware court ruled that the fiduciary duties of directors in near insolvent Delaware companies extend to creditors, we predict and find that firms subject to the ruling significantly increased their accounting conservatism. Additionally, our results suggest that the increase in conservatism is more pronounced in near insolvent Delaware firms with stronger boards, confirming that the court ruling takes effect through the channel of board of directors. Our results are robust to using alternative measures of conservatism and near insolvency status, and controlling for potential confounding factors and other stakeholders’ demand for conservatism. Overall, our study provides empirical evidence to support the causal relation between debtholders’ demand and accounting conservatism previously suggested in the literature, and offers some insights into the role of board of directors in financial reporting.
We examine whether a change in fiduciary duties of directors is associated with changes in firms’ financial reporting conservatism. A court ruling in 1991 expanded the scope of fiduciary duties of directors of near insolvent Delaware companies to include obligations to debtholders. In the immediate period following the ruling, we find that near insolvent Delaware firms significantly increased their levels of conditional accounting conservatism when compared to other Delaware and non-Delaware firms. Additionally, the increased conservatism is more likely in near insolvent firms that have a higher proportion of outside directors on the board. Our findings suggest that directors of near insolvent Delaware firms responded to the new obligations to debtholders by adopting more conservative accounting policies. Our results are robust to alternative measures of conservatism and near insolvency and controls for ex-ante expropriation risk, declines in firm accounting performance, and other stakeholders’ demand for accounting conservatism.