Does Industry Regulation Matter? New Evidence on Audit Committees and Earnings Management

This paper investigates the moderating role of industry regulation on the effectiveness of audit committees in restricting earnings management. Using comprehensive panel data of S&P 1500 firms between 2003 and 2007, we find that the proportion of CEO directors on an audit committee is positively associated with earnings management in unregulated industries, while this association is significantly weaker in regulated industries. Further, the proportion of financial experts on an audit committee is negatively associated with earnings management. Our results also indicate that the average board tenure of audit committee members is negatively related to earnings management in regulated industries, but positively affects earnings management in unregulated industries. Finally, audit committee members’ average directorship increases earnings management in regulated industries, but reduces earnings management in unregulated industries. Overall, our results suggest that the effectiveness of audit committees in reducing earnings management and improving financial reporting quality is influenced by industry regulation.