Audit Committee Diversity and Financial Restatements

Financial restatements reflect a governance and ethical failure in affected firms and lead to the particular scrutiny of the role played by the firm’s leaders and monitors. In this study, we examine the relationship between diversity in the audit committees of the board of directors and the incidence of financial restatements during the period 1996-2010. We investigate the effects of both relations-oriented (i.e., demographic) and task-oriented (i.e., functional) diversity of the audit committee. We also distinguish between financial restatements stemming from fraud (expected to be ethics-related) and those that are due to error (not expected to be ethics-related). Our results suggest that social categorization processes, which arise from relations-oriented diversity, may be positive forces in the audit committee’s monitoring role by preventing groupthink, and thus ethical failures. We also show that task- oriented diversity may increase the audit committee’s comprehensiveness and diligence, which translates into a lower probability for a firm to file a restatement as a result of error in the initial financial statement. Implications for research and practice are discussed.