Chair or Co-Chair
Dr. John L. Abernathy
Committee Member or Co-Chair
Dr. Divesh S. Sharma
Dr. Dennis J. Chambers
The general counsel (GC) plays a key role in a firm’s financial reporting system as a participant and governance monitor. As a participant in various disclosure and filing processes and advisor in transactional activities reflected in the firm’s reported results, the GC directly influences a firm’s reported results and disclosures. As a governance monitor, the GC holds a position of public trust and duty to investors based on various laws, rulings and regulations. Accordingly, accounting literature has begun to examine the role of the GC in financial reporting quality. The results of this research have produced conflicting results which indicate the GC can reduce or improve financial reporting quality.
The extant literature primarily focuses on the GC as a named executive officer (NEO, a member of the top management team) as the key GC characteristic. The purpose of this study is to examine other factors that may affect the impact of the GC on financial reporting quality. Specifically, I examine the relationship between financial reporting quality and (1) tenure of the GC, (2) compensation of the GC, and (3) prior work experience of the GC. Since the GC reports to the CEO and prior studies suggest the CEO can wield significant influence over other executives, I also examine how CEO power can affect the GC’s impact on financial reporting quality.
This study contributes to accounting and GC literature by being the first to examine how the GC’s characteristics are related to financial reporting quality. These characteristics may influence the GC’s approach to being a financial reporting governance monitor as (1) a gatekeeper focused on regulatory compliance and avoiding litigation or (2) a facilitator of management’s desired outcomes through avoidance or manipulation of the application of laws and regulations related to financial reporting and other corporate events and transactions. This study also contributes to corporate governance literature reflecting the effect of CEO influence on GC effectiveness as a governance monitor and the impact on financial reporting quality.
The analyses show that various GC characteristics are associated with higher financial reporting quality. Specifically, GC position tenure is associated with higher financial reporting quality, as proxied by class action lawsuits and reportable internal control deficiencies. GC total and equity compensation are associated with higher financial reporting quality, proxied by accrual quality, while GC total compensation is also associated with higher financial reporting quality proxied by restatements due to errors and reportable internal control deficiencies.
Examining CEO influence on the GC’s impact on financial reporting quality produces some interesting findings. Specifically, I find that CEO power reduces the effect of GC positional tenure on class action lawsuits and internal control deficiencies. Furthermore, when CEO power is introduced, GC firm tenure is positively associated with restatements due to both errors and irregularities. With respect to compensation, highly paid GCs in firms with high CEO power have lower accruals quality and higher incidences of restatements due to irregularities. On the other hand, the impact of GC prior work experience on internal control deficiencies is enhanced by CEO influence.
The study has practical implications for board members, investors and policy makers. All three constituencies need to be aware of the role that the GC plays in the financial reporting system, as well as the impact of CEO influence on the GC’s effectiveness as a governance monitor and the potential impact on financial reporting quality. Future research opportunities are identified related to GC firm tenure, GC prior work experience as a proxy for reputation, and the components of GC compensation relative to financial reporting quality.