Tuesday, September 02, 2008

Good Accounting Saves BODs' Jobs

Want to keep your seat on a corporate board of directors? Implement more systems and internal processes to ensure that accounting mistakes come to light early on, so you avoid the need to restate any earnings.

That’s one of the conclusions reached by a Haas School of Business at UC Berkeley study that examined what happened to board directors in the wake of restatements.

Assistant Professor Jo-Ellen Pozner studied more than 300 earnings restatements filed between 1997 and 2003 by 266 S&P 1500 firms. She looked at when the restatement occurred, the reason for the restatement, the company’s performance, and how long individual directors stayed with a company after the restatement.

She then compared directors at those companies with directors at a control sample of “clean” companies and concluded that corporate board members associated with firms that restate earnings may lose their jobs for reasons that have nothing to do with the numbers.

Patterns emerged, showing board members did not have to have held their positions at the time of restatement to be stigmatized, or guilty by association, to lose their seats on other boards.

“We like to think that we choose directors based on a rational assessment of their skills and track record, but this does not appear to be the case. Instead, it’s like a witch hunt. Companies get nervous about associating with other tainted companies, and their directors are essentially used as scapegoats,” says Pozner.

When a director’s individual skills are outweighed by this negative stigma, rather than any substantive facts, many board members step down to disassociate themselves from the stigmatized company, she found. Even if they leave, tainted directors face an increased probability of losing seats at other companies, although Pozner adds, “It is difficult to know for sure if they leave voluntarily or are asked to leave.”

Directors who managed to hold on to their seats until the end of their terms were more likely to be judged by the severity of the actual restatement.

“In the third year after restatement, outside directors are much more likely to lose seats on other boards if the restatement reduced income, if it was the result of fraud, and if they were in office at the time of the restatement,” according to Pozner’s paper.

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