Governance Papers: Updates from academia - February 2014

Feb 20, 2014
<p>The first in a series of reviews of academic governance research looks at possible links between financial reporting transparency and lower audit fees, plus other topics</p>

Trim audit fees!

Scientists have uncovered a wealth of capital market benefits to enhanced corporate transparency, including greater share liquidity, increased analyst coverage and – ultimately – lower capital costs. Now investigators document yet another possible advantage: cheaper audit fees.

Examining the disclosure practices of almost 300 US firms, researchers find a strong negative relationship between financial reporting transparency and auditor fee assessments but no correlation with non-financial information such as corporate governance or ownership structure. ‘We expected that all aspects of transparency would influence auditors, but it didn’t turn out that way,’ says study co-author Andrew Felo, associate professor of accounting at Nova Southeastern University. ‘Auditors, it seems, focus only on the forthcomingness of the financial aspects they will be responsible for.’

While his research uncovers correlation rather than causation, Felo posits two reasons why auditors may favorably respond to financial reporting transparency by lowering fees. ‘More transparent financial reports can reduce the amount and scope of audit work,’ he explains. ‘And better financial reporting lessens the likelihood of fraud, which lessens the risk to an auditor.’

Governance and circumstance

In the highly competitive struggle for funding among junior life sciences firms, every advantage counts. New research sheds light on precisely which corporate governance practices are most likely to elicit investor confidence and drive company performance.

Sampling 62 life sciences firms listed on Canada’s TSX Venture Exchange, a study by Saint Mary’s University in Nova Scotia finds that while most companies implemented corporate governance best practices, some worked better than others. Among the findings:

    • Maintaining a majority of outside independent directors has no significant effect on company performance and may even produce poorer results as the percentage of independent directors increases
    • Gender diversity may dampen company performance
    • CEO duality has little, if any, effect on most measures of performance
    • Higher equity ownership by directors predicts better company performance.

‘Following governance best practices is thought to lead to superior firm performance,’ says Robyn Cook, director of corporate governance at Nova Scotia-based MedMira. ‘But for junior life sciences firms, these findings suggest linkages are contingent on specific circumstances within the firm or industry.’

Still, Cook notes that her findings remain inconclusive in defining the optimal governance structure for junior life sciences firms. ‘A consistently predictive link between governance and performance remains elusive,’ she concludes. ‘But these results do provide the scope for further investigation.’

Have post-SOX changes affected CEO compensation?

A St John’s University study reveals that while there’s no indication the increased use of independent directors has worked to rein in compensation, these directors could be responsible for CEO pay packages that are better tied to performance. The study, ‘Independent directors and dividend payouts in the post Sarbanes-Oxley era’, shows that firms compelled by law to change their boards experienced significant positive increases in average changes in dividend payouts and percentage changes in dividends paid when compared with firms that had adopted Sarbanes-Oxley board compensation requirements prior to the 2002 mandate.

Study author Timothy Coville, assistant professor of accounting and taxation at St John’s, says his results underline the effectiveness of independent directors.

‘We mustn’t abandon the push for greater use of independent directors,’ he advises. ‘It had a rational impact on compensation for CEOs at public firms and should be considered for the mutual fund industry.

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