THE EFFECT OF INDEPENDENT DIRECTORS, CEO TENURE AND CO-OPTED DIRECTORS ON 8-K FILING: EMPIRICAL STUDY.

• Author: Khaledi, Naser
• Position: Report

INTRODUCTION

Timely dissemination of trustworthy information to external users is crucial to market participants as it assists their decision making. Information dissemination is also important to efficiently allocate resources in the economy at the macro level. Delayed dissemination of information or untrustworthy information will affect investors in the process of making their investment decisions and will consequently get suboptimal returns on their investment. With inferior returns, investors move their financial resources to international markets, negatively impacting the domestic economy. To assist market participants, authoritative bodies implement regulations mandating public firms to release reliable material information without delay. Providing market participants with timely access to reliable information increases market efficiency as a result of the decisions made with said information.

Stakeholders often expose market inefficiencies caused by firms' practices. An example of such exposure is that of an environmental activism campaign against a firm that is polluting the environment. Naaraayanan et al. (2019) report that firms targeted by environmental activists reduce their total amount of pollution as a result. Another such example is the way in which labor unions negotiate for better working conditions and wages (Boeri et al., 2001). All stakeholders in a given firm require trustworthy information to be released to them without delay from the firm's management to guide their decisions.

If the information is not trustworthy, then the decisions made by users are not optimal. These suboptimal decisions have a cost associated with them in form of low returns or, in some cases, losses. Such outcomes, lead investors to seek out alternative investment venues with better returns, usually found in overseas markets. In this case, the local economy loses domestic investments, reducing cash flows in the national economy due to the increased outflows of capital to foreign markets. Therefore, eliminating financial misrepresentation will serve to increase the stability of investments made in the domestic market by gaining the trust of investors in the financial institutions.

With respect to financial misrepresentation, academic research has been focused on the independence of the board of directors, and their capacity to settle disputes between agents and principals (Abbott, Park, & Parker, 2000); Fama & Jensen, 1983). Some instances required government intervention in order to correct significant deviations in the market after Enron scandal in 2001, such authoritative intervention in the market was taken with the passage of the Sarbanes Oxley Act (SOX) in 2002. This legislation was enacted in an effort to eliminate fraudulent business practices and curb management opportunistic behavior.

SOX affects various divisions of public firms to ensure that accurate financial information is being conveyed to the market participants. Provision in SOX obligate firms to give the board of directors a certain level of autonomy to maintain trust in the financial information that they release. Research into the effectiveness of independent directors increased after the implementation of SOX. A study conducted by Ebrahim (2007) investigates whether the independence of the board of directors is negatively associated with earnings management as a proxy for earnings quality. He reported a negative association between the board and the audit committee's independence with earnings management indicating that directors' independence mitigates agency problems by protecting shareholders' interests.

With this in mind, an effective board of directors improves the reliability in timing of information released into the market, in compliance with the Security Exchange Commission's (SEC) regulations as they pertain to financial information filing. The SEC passed a regulation in 2004, requiring public firms to widen the scope of items to be filed and shorten the window of time to file material events relevant to shareholders' in the 8-K form. The SEC reduced the filing time window to four business days (see www.sec.gov) following the event date .

Events that trigger 8-K filing include--but are not limited to entry into a material definitive agreement, material impairments, unregistered sales of equity securities, changes in the registrant's certifying accountant, and shareholder director nominations (SEC, 2012). Several studies reported market reaction to the increase of the frequency and the scope of material events that can affect a firm's market value. McMullin et al. (2015) examined whether more frequent mandated disclosure is positively associated with the prompt market reaction.

They reported that market reacts positively to the frequent mandated filing. Lerman and Livant (2008) investigate whether the market reacts to new items now included in 8-K filing. They utilized 8-K filing data for the years 2005 - 2006. Lerman and Livant (2008) documented abnormal volume and returns volatility around the 8-K filing date. This study examines the effect of independent directors, tenured CEOs, and coopted directors (board members appointed by the current CEO) on the frequency of 8-K filing

LITERATURE REVIEW

Corporate governance drew more attention as some of firms' management deviated from their role as agents to the principals. The attention shed even more light on the need for a controlling mechanism to deter the opportunistic behavior of management by demanding the involvement of independent directors in the board of directors. Fama and Jensen (1983) argued that the cut of directors was not effective unless it can deter opportunistic management behavior. Independent directors on the board can deter such behavior because they are not associated with the management; thus, they do not jeopardize their economic value as independent consultants.

Prior academic research reported that the presence of independent directors as an effective control mechanism represents the shareholders' interest in the firm. A renowned study in corporate governance by Beasley (1996) examined whether the inclusion of independent directors on the board reduces the likelihood of financial statements fraud. He utilizes a sample of fraud and matching no-fraud firms to test his hypotheses. He reported that no-fraud firms have a higher percentage of outside directors than fraud firms, which indicates that independent directors' presence reduces the occurrence of fraud.

Another study investigated the effect of directors' independence on deterring fraud was carried out by Abbott et al. (2000). In their study, they examined whether two audit committee characteristics, independence, and activity, reduce financial statements fraud. They used a sample of firms that were sanctioned by the SEC between 1980 and 1996. Abbott et al. (2000) documented that firms with independent and active audit committees are less likely to be associated with fraudulent...