Institutional directors and the quality of information: the role of directors appointed by banks

Abstract

Manuscript Type: Empirical Research Question: The objective of this paper is to study the impact that directors who represent institutional investors have on the quality of financial reporting. We focus on those who maintain business relations with the firm on whose board they sit (pressure sensitive directors), and analyze their influence both on Boards and Audit Committees. Additionally, we examine the specific role of bank directors on Boards and Audit Committees and examine their effects on the quality of information when they act as shareholders and directors. Research Findings/Insights: Our results suggest that institutional directors are an effective monitoring device that leads to higher quality of financial reporting and, therefore, to less likelihood of qualified audit reports. Consistent with the relevant role of business relations with the firm, we find that directors appointed by pressure sensitive investors, both in Boards and Audit Committees, have a higher impact on the unqualified audit opinion. Nevertheless, when analyzing separately, only savings banks representatives on the Board increase the pressure to issue a clean audit opinion. Theoretical/Academic Implications: The results confirm that Board characteristics have an important influence on financial reporting quality, in line with the views that have been expressed by several international bodies (e.g., FRC, 2003; OECD, 2004). The findings also suggest that both researchers and policy makers should no longer consider institutional investors as a whole, since directors appointed by different types of institutional investors have various implications on the audit opinion. Practitioner/Policy Implications: This study makes its core contribution by empirically showing that directors appointed by different types of institutional investors have diverse implications on the audit opinion. This evidence could be potentially helpful in providing a basis for regulatory actions, namely those aiming to influence the structure of the Board of directors. The results have significant implications for supervisors and regulators, whose role in safeguarding the financial system will benefit from an understanding of how the presence of savings banks and commercial banks in non-financial firms Boards impacts audit opinion in a bank-based system.