Does the Market Value Financial Expertise on Audit Committees of Boards of Directors?


  • We thank the Corporate Library for providing the director data for this study. We also thank Melissa Boyle for her capable research assistance and workshop participants at the 2004 American Accounting Association meeting, the 2004 Deloitte/KU Symposium on Auditing Problems, 2004 International Symposium on Audit Research, 2004 Journal of Accounting Research conference, The Ohio State University, University of California–Berkeley, University of British Columbia, University of Southern California, and Louisiana State University, as well as Qiang Cheng, Joe Carcello, Il-Horn Hann, Maria Nondorf, Abbie Smith (the editor), and an anonymous reviewer for their helpful comments.


We examine three-day cumulative abnormal returns around the announcement of 702 newly appointed outside directors assigned to audit committees during a period before implementation of the Sarbanes-Oxley Act (SOX). Motivated by the SOX requirement that public companies disclose whether they have a financial expert on their audit committee, we test whether the market reacts favorably to the appointment of directors with financial expertise to the audit committee. In addition, because it is controversial whether SOX should define financial experts narrowly to include primarily accounting financial experts (as initially proposed) or more broadly to include nonaccounting financial experts (as ultimately passed), we separately examine appointments of each type of expert. We find a positive market reaction to the appointment of accounting financial experts assigned to audit committees but no reaction to nonaccounting financial experts assigned to audit committees, consistent with accounting-based financial skills, but not broader financial skills, improving the audit committee's ability to ensure high-quality financial reporting. In addition, we find that this positive reaction is concentrated among firms with relatively strong corporate governance, consistent with accounting financial expertise complementing strong governance, possibly because strong governance helps channel the expertise toward enhancing shareholder value. Together, these findings are consistent with financial expertise on audit committees improving corporate governance but only when both the expert and the appointing firm possess characteristics that facilitate the effective use of the expertise.