Do Friends matter? The relationship between social ties and financial reporting quality
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2016-12-06
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en
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Abstract
The independence of the audit committee is important to ensure the quality of its
functioning and therefore the financial reporting quality of the firm. The disclosure of accurate and reliable financial information is of critical importance for the functioning of the financial markets. For that reason, the European Parliament has issued a proposal regarding audit reform for the European Union to ensure the independence of the audit committee in EU firms. This proposal does not contain any requirements surrounding the social ties that might exist between audit committee members and senior anagement. The goal of this paper is to provide more insight in the relation between social ties between senior management and the audit committee and the financial
reporting quality and what the effect of culture is on this relationship, in order to strengthen or weaken the argument for the regulation surrounding the independence of the audit committee. The research question therefore is: What is the effect of social ties between the CEO, the CFO and the audit committee on a firm’s financial reporting quality?
To answer this question a quantitative research is carried out. Different types of social ties are regressed against four proxies of financial reporting quality. The social ties are based on former employment, education and non-professional activities. Financial reporting quality is measured using proxies based on discretionary accruals and unexplained audit fees. A sample of publicly listed European firms is used. Furthermore, the effect of culture on the central relationship is examined by classifying the countries based on their level of individualism.
The findings of this study show that social ties have a positive effect on the financial reporting quality. Friendship ties have a bigger positive effect on the financial reporting quality than advice ties. Furthermore, in countries characterized more by individualism the financial reporting quality is better compared to countries characterized more by collectivism. Thus, this study does not provide an argument for the inclusion of requirements against the social ties that audit committee members might have with senior management. If anything, these ties should be encouraged.
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Faculteit der Managementwetenschappen