Corporate Governance and Default Risk of Firms Cited in the SEC's Accounting and Auditing Enforcement Releases

We examine the relationship between corporate governance and default risk for a sample of firms cited in the Securities and Exchange Commission's (SEC's) Accounting and Auditing Enforcement Releases (AAERs). Using hazard analysis of actual default incidence and OLS regressions of a continuous variable capturing a firm's “closeness to default,” we document changes in the relationships between various governance characteristics and default risk from the pre-AAER period to the post-AAER period. Specifically, smaller board size, greater board independence, greater gender diversity of the board, and lower concentration of institutional ownership are all shown to have a more favorable effect on lowering default risk in the post-AAER period relative to the pre-AAER period. Our comparative analysis of a group of firms with accounting restatements (but not cited in the AAERs) does not show similar changes in the relationships between the various corporate governance characteristics and default risk from the pre-restatement to the post-restatement period. This suggests that the regulatory sanctions experienced by AAER firms may have prompted creditor reevaluation of the firms' information environment and the perceived efficacy of various corporate governance mechanisms in mitigating default risk