The effects of audit committee ties and industry expertise on investor judgments—Extending Source Credibility Theory

Abstract

Personal ties (e.g., belonging to the same country club) and/or professional ties (e.g., serving on boards together) between the CEO and audit committee members can potentially impair members' objectivity. Additionally, prior research indicates that audit committee member industry expertise enhances financial reporting quality. In an experiment with 342 reasonably informed investors, we find, as hypothesized by Source Credibility Theory (SCT), personal ties negatively impact investors’ assessments of audit committee independence more than professional ties, and industry expertise enhances assessments of competence. We also find investors assess audit committees with no ties and industry expertise (personal ties and no industry expertise) as the most (least) effective and indicate the highest (lowest) likelihood of investing. Further, extending SCT we find the incremental positive effect of industry expertise is greater when there are personal ties than when there are no ties. In a path model, competence and independence assessments directly affect each other, and in turn affect assessments of audit committee effectiveness and investment decisions. Finally, in a second experiment we find reasonably informed investors recognize variations in the nature of personal ties and that industry expertise attenuates the effect of advisory ties but not close friendship ties.