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Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 
 2011, Vol. 2, No. 1, 179-193 

179 

 

Sarbanes-Oxley and the Need for Audit Committee Independence: Contrary Evidence in 

the Textile Industry 
 

Paula Cardwell, Elon University 
John Sennetti, Nova Southeastern University 
Linda Poulson, Elon University 
 

 

We investigate whether the appearance of audit committee independence, e.g., outside membership as 
defined by the Sarbanes-Oxley Act of 2002 (SOA), is necessarily related to effective independence, e.g., 

the audit committee’s support of an auditor’s going-concern opinion (Carcello and Neal 2003; 2000). 
The SOA makes the agency theory assumption, generally supported by current research, that seemingly 
non-independent audit committee members reduce the reliability of the financial reporting. Yet, prior to 

the SOA, other rulings permitted non-independent audit committee members to serve when it was “in the 
best interests of the firm,” and even the Carcello and Neal (2000) findings point to a possible industry or 

company-size effect in measuring audit committee effectiveness. It seems that manager-owner committee 
members of smaller companies may also do the right thing. Therefore, we reconsider this independence 
question for the textile industry, one severely stressed and possibly affected by firm size. We observe 

seventy-four companies during the years 2000 and 2001 when the SOA was not in effect to determine 
whether their non-dependent-appearing audit committees also would effectively act independent, without 

the constraint of the SOA.  We do find at least two SOA non-independent characteristics of audit 
committees, what would be two apparent SOA violations in 2011, contrarily associated with two actions 
of effective independence. We do not find any one of the ten recommended SOA requirements correlated 

with these actions of effective independence. These findings suggest that measures of effective 
independence may not necessarily be related to appearance, and may instead depend on company or 

industry size, adding to the growing body of research that argues for restricting government financial 
regulation (Gao et al., 2009; Hayes, 2009; Hart, 2009; Dodd–Frank Wall Street Reform and Consumer 

Protection Act, 2010; Orol, 2011). 
 

 

If a corporate audit committee of the board of directors, the one that chooses the company’s auditors, 
appears non-independent, e.g. has manager-owners as committee members, will this necessarily 
negatively affect the company’s long-term interests? By 2002, the United States Congress. Shaken by the 
accounting fraud by the Enron, WorldCom, Adelphia, Tyco, and their complicit board and audit 
committee members, created provisions of the Sarbanes-Oxley Act (SOA) requiring audit committees to 
be independent of management. By 2009 many regulations of the SOA were reduced, but companies still 
tried to avoid the SOA regulations by remaining “small,” by maintaining the SOA $75million market cap 
(Gao et al., 2009). Orol (2011) reports that companies still try to stay within the size limit of the SOA, but 
now to avoid the financial regulations of the Dodd-Frank Act (2010).  

The SOA idea of committee independence had been evolving since the establishment of the 1934 
Securities and Exchange Act (Klein, 2003). In July 1, 1978, the New York Stock Exchange (NYSE) 
became the first exchange required listed domestic corporations to have an audit committee “comprised 
solely of directors independent from management” (Klein, 2003, 345). In response to SOA, the NYSE 
added two additional rules: audit committee members must (1) not have a material relationship with the 
listed company (NYSE, 2002a and b) and (2) disclose membership on more than three audit committees 
of public companies (NYSE, 2003a).   

Yet, DeZoort et al., (2002, 66) asks whether new requirements for audit committees “result in largely 
cosmetic changes or whether they appear to be associated with increased audit committee effectiveness,” 
and others questioned whether these were related to actions that “would follow in the best interests of the 
corporation (Klein, 2002, citing NYSE Rule 303.01[B][3][b] and NASDAQ Rule 4310[c][26][B][ii]). 
Recently, lawmakers and the SEC have granted an exemption to smaller firms for one of the critical 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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components of SOA, audits of internal controls (Orol, 2011; Wild and Anderson, 2010), while still 

relying upon other provisions, such as audit committee independence, to encourage appropriate behavior 

and maintain investor confidence (Hart 2009). Gao et al., (2009) find that corporate governance in the 

exempt firms appears to exceed that of nonexempt firms, which supports the proposition that, in certain 

cases, management-owners may in fact do the right thing when government regulations are not in place. 

To date, the research on the SOA’s appearance-of-independence guide seems to correlate with 

stronger financial controls. Committees following the SOA are less associated (1) with fraudulent 

activities (Abbott et al., 2004; Abbott et al., 2000; Beasley et al., 2000) and (2) with financial restatements 

(Abbott et al., 2004), but more associated with stressed corporations who receive going-concern opinions 

(Carcello and Neal, 2000 and 2003), a measure of committee effectiveness. Chien et al., (2010) find 

independence related to reduced frequency of control problems and reduced financial stress for the largest 

government funded public hospitals. Yet et al., (2006) find hospital audit committee independence may 

not limit control issues for those hospitals without government funding. Therefore, some of these results 

may be funding- or industry-related, as suggested by Carcello and Neal (2000, 460). Carcello and Neal 

(2000) and Beasley et al., (2000) consider only a few industries. 

This paper re-examines this question: in what way does appearance-of-independence characteristic 

relate to effective independence? We define effective independence in two ways: (1) does audit 

committee support the auditor’s going-concern opinion, as asked by Carcello and Neal, (2000; 2003) and 

Abbott et al. (2003) and (2) does audit committee support filing for bankruptcy protection (Morgenson, 

2006). [The latter is more indicative of the broader, corporate board effectiveness (McKeown et al., 1991; 

Mutchler et al.,1997)]. We examine seventy-four stressed textile-related companies from 2000-2001 that 

were under the BRC audit committee rules prior to the passage of SOA.  

We find these companies increased their level of SOA appearance characteristics from 2000 to 2001, 

but these increases do not correlate with corresponding measures of effective independence. Instead, 

violations of what would have been SOA rules seem more agreeable to the effective measures of 

independence. These results add some evidence, if only partial, to whether the appearance of SOA 

characteristics implies effective independence and whether such can be measured by the issuance of a 

modified audit opinion for a stressed company (Carcello and Neal, 2000, 2003; Audit Committee 

Institute, 2004). This research may explain why Geiger and Rama (2003) and Abbott et al., (2003) do not 

find strong support for the appearance characteristics. Finally, these results also confirm the suspicion that 

the effectiveness of appearance characteristics is industry-dependent (Carcello and Neal, 2000, 460).  

 The remainder of this paper is organized as follows. Section II states the research hypothesis and 

reviews the generally accepted audit committee characteristics of independence. Section III describes the 

application of these characteristics to the particularly financially stressed textile industry. Section IV 

describes the research design and Section V its results. Finally, in Section VI, the conclusions are drawn. 
 

AUDIT COMMITTEE INDEPENDENCE VARIABLES: MEASURES OF  

APPEARANCE AND OF EFFECTIVENESS 
 

Hypothesis 
 

Readers of the SOA would hypothesize that appearance characteristics should predict accepted 

measures of effective independence for audit committees, consistent with previous research:   
 

H: Effective measures of audit committee independence increase with appearance measures. 
 

We begin with accepted definitions. To be considered “appearing” independent prior to SOA, an audit 

committee member should not: 1) be a current employee or have been one within the previous three years, 

2) be an officer of another company where one of this company’s management serves on the committee 

member’s home company compensation committee (interlocking directorships), 3) have a business 

relationship, such as the company’s banker, accountant, or consultant, directly receiving non-director 

fees, and 4) be an immediate relative of an executive officer of the company or an affiliate.  



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 
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The SOA expands these requirements (see Table 1). First, SOA, requires that all audit committee 
members appear to be independent (by financial and other relationships), and eliminates case-by-case 
exemptions except in rare circumstances. Second, the waiting period for former employees or interlocking 
directorships has expanded to five years. Third, new requirements include disclosure for audit committee 
members serving on more than three audit committees of public companies or having a material 
relationship with a listed company. Also, the compensation committee is required to be independent.  
 

Table 1: Blue Ribbon, Sarbanes-Oxley, and Inferred Rules 
 

Requirement 

 

 

Blue Ribbon Committee 

NYSE (1999) and SEC 

 

Sarbanes-Oxley 

AICPA (2002) 

NYSE (2003a) ; SEC (2003) 

Inferred Rues 

 

 

Member cannot be:    

*Employee or relative w/in past 5 years (BRC) Yes (SEC) 3 yr.++ Yes, 5 yr. Compensation > $100,000 Yes, expanded 

*Non-directorship fees 
 

(BRC)Yes+/  
(SEC) No (disclose) 

Yes (no exceptions) 
 

~ 
 

*Partner, S/H or Exe. Officer of business 
making or receiving significant payments 
from the audit committee company 
w/in past 5 years. 

(BRC) Yes/  
(SEC) Yes, current yr.++ 

 
 

Yes, current yr., material** 
 
 

 

~ 
 
 

 

*Is or immediate family is an internal or 
external auditor within recent 5 years 

Not addressed 
 

Yes 
 

Yes, expanded 
 

*Interlocking directorships Yes Yes, 5 yr. ~ 

*Simultaneously serves on more than 3 
audit committees of public companies 

Not addressed 
 

Yes^^ 
 

~ 
 

*Has a material relationship with the listed 
company 

Not addressed 
 

Yes^^ 
 

Yes, expanded 
 

*On more than 3 other boards of public 
companies 

Not addressed 
 

Not addressed 
 

Yes 
 

*On the Company's compensation 
committee 

Not addressed 
 

Not addressed 
 

Yes 
 

*On more than 3 compensation 
committees of public companies 

Not addressed 
 

Not addressed 
 

Yes 
 

Minimum of 3 members, all financially 
literate 

Yes 
 

Yes 
 

~ 
 

Compensation committee composed 
entirely of independent directors. 

Not addressed 
 

Yes 
 

Yes, expanded above 
 

+ exemptions on case-by-case basis    
++ only if Board determines that relationship does not interfere w/ director's exercise of independent  
 judgment (should be in exceptional and unusual circumstances).  
**both indirect and direct; only current period   
^ general case-by-case exemptions are now not appropriate nor consistent with policies of the Sarbanes-Oxley Act. 
^^Board must determine and disclose determinations.    
~Component of dependent variable.   

 

TEN PREDICTOR VARIABLES OF SOA 
 

First Six Variables 
 

  Therefore, from Table 1, we can summarize these first five violations of SOA characteristics as 
predictors for the firm that would fail effective independence: 
  

AC Members = 1 if number of audit committee members is less than 3 (SOA not satisfied), else 0.  
 

 Interlock = 1 if company member has an interlocking directorship (SOA not satisfied), else 0. 
 

Other AC = 1 if any audit committee member is on 4 or more audit committees of public companies 
(SOA not satisfied), else 0. 

 

AffilPay = 1 if an audit committee member receives non-director fee compensation (SOA not 
satisfied), else 0. 

 

AffilProf = 1 if an audit committee member is employed by professional advisors receiving payment 
from the company (SOA not satisfied), else 0.   



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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“AC Members” captures the BRC requirement that listed companies maintain audit committees with at 

least three independent directors. The BRC recommended this minimum number in recognition that the 

size of the committee is a balancing act: it should be small enough to allow all members to participate 

actively, yet large enough to represent a balance of views (Turner 1999, 40). The BRC also noted that 

independence is often impaired when there are interlocking directorships (Interlock) where an audit 

committee member is an officer of another company whose compensation committee includes executives 

from the audit committee company (NYSE, 1999). Vicknair et al., (1993) found that the highest potential 

violation for 100 NYSE firms was interlocking directorships. 

“Other AC” measures the member’s service to other audit committees. The possibility of overextended 

directors can reduce independence (DiCarlo, 2002). With too many directorships, an audit committee 

member may devote less time to their duties and become too reliant on corporate management 

(Raghunandan et al., 2001; Gulati and Westphal, 1999). Prior to SOA, the number of public directorships 

for each board member was disclosed in annual proxy statements. In 2003, NYSE required an additional 

disclosure of any audit committee member serving on more than three audit committees of public 

companies (NYSE (Amendment) 2003). 

Affiliated audit committee members, those receiving consulting fees (AffilPay) or having a business 

relationship with the company (AffilProf), can result in conflicts of interest (Felo, 2001). SOA provides 

that in order to maintain independence, an audit committee member may not receive, “other than for 

service on the board, any consulting, advisory, or other compensatory fee from the issuer” (AICPA 2002, 

Section 301). Also, payments for, “services to law firms, accounting firms, consulting firms, investment 

banks or financial advisory firms in which audit committee members are partners, members, executive 

officers or hold similar position” are indirect fees that should disqualify the audit committee member 

(SEC-Final Rule, 2003, II (A) 2). 

We define one more variable: SOA VAR = 1, if there is at least one violation in a Sarbanes-Oxley Act 

appearance characteristic, and SOA VAR = 0 if not.    
 

Next Four Predictor Variables 

 

In addition to these six SOA variables, the effect of four other variables on audit committee 

independence can be inferred from Table 1: 
 

OtherDir = 1 if any audit committee member is on 4 or more boards of public companies, else 0. 
 

OtherCC = 1 if any audit committee member is on 4 or more compensation committees of public 

companies, else 0. 
 

CompCom = 1 if any audit committee member is also on the company compensation committee,     

else 0. 
 

AffilOther = 1 if any audit committee member has an affiliated relationship not identified by SOA, 

else 0. 
 

“Other AC,” “OtherDir,” and “OtherCC,” consider the over extension of directors, which can reduce 

independence (DiCarlo, 2002) and increase reliance on corporate management (Raghunandan et al., 2001; 

Gulati and Westphal, 1999). Dual membership on the audit committee and the compensation committee 

(CompCom) presents conflicts in evaluating the company’s financial statements and management 

performance (Klein 2003; Vafeas, 2001). Although recent post-SOA corporate governance rules (SEC 

2003b) address this variable by requiring a company’s compensation committee composition to include 

only independent directors, they do not require separate independent committees as recommended by 

Klein (2003). The last inferred variable, AffilOther, encompasses additional affiliated relationships that 

are not covered by current SEC and NYSE rules, e.g., retired auditing partner-in-charge of current auditor 

or retired CEO of current servicing bank whose retirement occurred over three years before becoming a 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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member of the audit committee. These ten predictor variables define independence by appearance in 

much more detail than previous research (e.g. Abbott et al., 2003). 
 

Two Other Characteristics That May Reduce the Effective Independence 
    

To the above ten, we add two measures of audit committee independence from prior research: (1) the 

committee’s percentage of board stock ownership and stock options (AC Stock% of Board) from Carcello 

and Neal (2003) and Klein (2002) and (2) the company size defined by total assets (Total Assets, from 

Abbott et al., 2003; Carcello and Neal, 2000; Geiger and Rama, 2003; Palmrose, 1997). Large stock 

ownership may reduce the incentive to file for bankruptcy. Also, smaller companies are more likely to be 

financially stressed and have less leverage when filing for bankruptcy.  So we define: 
 

AC Stock% of Board = Audit Committee directors’ stock ownership to total directors and executive 

management. 
           

 Total Assets = natural log of total assets (in thousands). 
  

The adjusted Altman’s measure, Z-Score (Abbot et al., 2004), suggests a level of financial stress based 

on the company’s ability to meet cash demands, which could lead to filing for bankruptcy under Chapter 

11 (Chapter 11 Only) or whether a going-concern opinion, GCO (Carcello and Neal, 2000), is 

appropriate.
 
So we define: Z-Score = 1 if the Altman’s Z-Score is less than 2.6 (technically bankrupt), 

else 0. 
 

TWO DEPENDENT VARIABLES 
 

First Dependent Variable 
 

We can also define two measures of effective independence. The first is the going-concern audit 

opinion (GCO) given by the auditor (Carcello and Neal, 2000 and 2003; Abbott et al., 2003). For 

financially stressed companies this opinion must be supported and then facilitated by the audit committee. 

Although other measures of auditor (and hence audit committee) effectiveness have been suggested such 

as the quality of earnings or discretionary accruals, the use of the GCO is most widely known (e.g., 

Carcello and Neal, 2000 and 2003; Abbott et al., 2004).] So we can define: GCO = 1 if the company has a 

going-concern opinion for the year under review, else 0. 
 

Going-Concern Evaluation and Disclosure in Stressed Industries 
 

Currently, if there is substantial doubt that a company will continue as a going-concern for a 

reasonable period of time, AICPA Statements on Auditing Standards 59 (SAS 59) requires that the 

auditor must disclose this concern in the audit report (Robertson and Louwers, 2002). SAS 59 does not 

require auditors to perform more procedures than they normally perform or expect the auditors to predict 

future events. Also, it does not provide any new auditing procedures to discern going-concern problems. 

Although not required, many auditors use business failure prediction models, such as Edward Altman’s 

discriminant Z-Score bankruptcy predictor (Altman, 1968), to evaluate going-concern issues (Robertson 

and Louwers, 2002; Abbott, 1994).  

Another issue is whether or not the opinion actually anticipates or unnecessarily exacerbates the filing. 

Palmrose (1997) found that of the 655 public companies declaring bankruptcy between 1972 and 1992, 

less than twenty percent involved auditor litigation. Geiger and Raghunandan, (2002) found that the lower 

threat of litigation in the past decade was associated with the issuance of fewer going-concern opinions to 

stressed companies.  

Therefore, it is surprisingly likely that a company could be given a going-concern opinion after filing 

for bankruptcy rather than before. As explained by Mutchler et al., (1997), this could occur since some 

clients have contrary and mitigating information correctly not taken into account for the going-concern 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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opinion. One study finds only one-fourth of the companies receiving going-concern disclosures failed 

within a year and on average survived for approximately four years (Louwers et al., 1999). These trends 

support the issuance of going-concern opinions in distressed industries by independent auditors supported 

by effectively independent audit committees (Carcello and Neal, 2000; 2003). 
 

Another measure of effective independence 
  

A second measure of effective independence for the board of directors, if not audit committees, could 

be the actual filing of bankruptcy (Chapter 11 Only). Non-independent boards in fact would seek self 

interest and not file when a slow and prolonged recovery is the only option, because filing would imply 

that their stock is worthless immediately or in the least, that their stock is subordinated to the debt 

holders. Since filing for bankruptcy would cause an immediate decline in board wealth, self interest 

seeking non-independent boards would not be expected to file. This would buy time to permit short-term 

stock price manipulation for more opportunist stock dumping (Chenchuramaiah and Ramesh, 1995; Fama 

and Jensen, 1983).   

Self-interest seeking non-independent directors for financially stressed companies have other 

incentives to leave the company when it has not yet declared bankruptcy. To obtain a position as a 

director of another company, “One of the occurrences that will cause a director to be designate a 

‘problem’ is to be associated with…a bankruptcy,” declares Paul Hodgson, senior research associate, 

Corporate Library, a research firm (Morgenson, 2006). Therefore, we define the second measure of 

effective audit committee independence as the filing for bankruptcy, given as: Chapter 11 only = 1 if 

company has filed for bankruptcy under Chapter 11, else 0.  
 

Summary of Variables 
 

Statistically, for H to hold, the dependent variables GCO and Chapter 11 Only (at level = 1) are 

expected to be associated with the ten predictor variables (each at level = 0), likely (but not necessarily) 

associated with the Z score, and to be associated with lower values of ACStock% Board and higher values 

of Total Assets. In this case effective independence would be associated with appearance of independence 

and prior research. 

Carcello and Neal (2000), in finding the appearance of audit committee independence related to the 

effective characteristics of audit committee independence, consider heavy manufacturing and technology-

related industries (SIC codes 35, 37, and 87), which are more likely to receive a going-concern opinion.  

As suggested by a footnote in Carcello and Neal (2000, 460), their results could be industry dependent. 

This is likely because certain financially stressed industries would most likely have small companies 

(identified by Total Assets) with audit committee members (often original owners) possessing high the 

stock ownership (ACStock%Board). The textile industry serves as one example. 
 

APPLICATION TO A PARTICULARLY STRESSED INDUSTRY 
 

Stressed U. S. Textile Industry 
 

The textile industry experienced record shipments, strong profits and many product innovations during 

the majority of the 1990s. Yet, today the “U. S. textile industry is suffering from its worst economic crisis 

since the Great Depression” (American Textile Manufacturers Institute, 2002). After the 1997 Asian 

financial crisis, low-priced textile and apparel products resulted from devalued Asian currencies, lower 

labor costs and various country subsidy programs. Asian textile imports to the U. S. increased by 80% 

after 1996 causing major declines in U. S. textile company sales (American Textile Manufacturers 

Institute, 2001).  

When SOA was implemented, the U. S. textile industry suffered “from its worst economic crisis since 

the Great Depression” (American Textile Manufacturers Institute, 2002). Increasing losses forced many 

textile companies to reduce in size, eliminate jobs and facilities and, for some, to file for bankruptcy 

protection. The change in the industry is evident in the calculation of the industry’s relative earnings 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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growth as compared to stock price appreciation. The textile industry’s relative stock price strength, as 

compared to 90 other industries, was close to 100% of the broad index in 1998 versus slightly below 10% 

of the broad index in early 2002 (Sirois, 2002) with more stock in the hands of fewer owners. Since the 

financial markets reflect the distressed condition in textile publicly traded stocks, it should follow that 

concerns of a company’s future existence are addressed in the company’s financial reports. 
 

RESEARCH DESIGN 
 

Sample Selection 
 

We investigate the relationship of the research variables, the listed SOA, the extended SOA, the stress 

and the prior research variables (i. e., the ten predictor variables, Z score, ACStock% Board, and Total 

Assets), to the two effective measures of audit committee independence (GCO and Chapter 11 Only) for 

all textile companies from 1999 to 2001 in SEC Schedule 14A (Proxy Statement) filings. First, copies of 

the auditor’s report and financial information used to calculate the Altman Z-Score were obtained from 

the 2000 and 2001 company annual reports. Initially, we included all the publicly-traded textile 

companies under the Standard Institute Classification (SIC) code 2211, which represents the cotton, 

woven fabric business. In addition, the top five publicly-traded companies of other SIC codes summarized 

in Textile Manufacturing: Industry Breakdown 1997-2001 by Harris InfoSource International, Inc. (Harris 

InfoSource International, 2002) were selected. Also, a list of 263 textile and apparel companies was 

included from Mergent Online (Mergent Online, 2003).  
 

Table 2: Sample Selection Criteria 
 

Initial Sample of SIC Codes 22xx and 23xx 275 

Less:  Repeated companies in SIC Codes 26 

Less:  Proxy statements and/or Form 10-K not available 12 

Less:  Companies with GCOs before 1999 17 

Less:  companies excluded from the Harris InfoSource  

(Because of low sale activity in the 22xx and 23xx code) 146 

                                      Total sample 74 
 

Next, we deleted companies with missing proxy or financial statement data. Table 2 shows that this 

resulted in a final sample of seventy-four companies with fifty-four having two years of observations and 

twenty with only one year of observations for a grand possible total of 128. Companies with only one 

year of proxy information resulted from bankruptcy, privatization, or initial year of operation.  For the 

seventy-four, there are thirty-one bankruptcies filed but only thirty companies received going-concern 

opinions. 

The Proxy Statement discloses each director by name, his or her age, principal occupation and 

business experience, other directorships, length of service on the Board and committee assignments, 

equity ownership in the company, and the amount of director fees and non-director fees compensation to 

each director. This schedule also provides information about the total number of board and committee 

meetings held during the fiscal year. 
 

Methodology 
 

Using the data obtained on the seventeen variables identified in Section II we create two sets of 

analyses, one for the measure of independence by association with going-concern audit opinions and one 

by association with bankruptcy filings. Each set presents a correlation matrix of related variables and a 

corresponding logistic regression analysis for those variables identified as related. 
 

RESULTS 
 

Interrelationships of Appearance Characteristics 
 

Table 3 below provides the Pearson correlation matrix, and hence interrelationships, of the first nine 

variables, the first five SOA and the next four non-SOA characteristics to the two independent variables, 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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GCO and Chapter 11 Only. There are statistical relationships (with two-tailed p-value less than 0.05) 

between only two SOA variables, Interlock and AffilProf. Interlock and two other SOA variables are 

related to non-SOA variables. 

The first correlation between Interlock and AffilProf (r = + 0.181, p-value = 0.041) suggests some 

companies have two forms of non-independence under SOA. Interlock means that audit committee 

membership for Board A is compromised when a member of management for company A serves as a 

compensation committee member for Board B, the home company of the audit committee member. The 

correlation between Interlock and AffilProf suggests when there is this interlocking there are also 

members of that audit committee for A which also serve in other capacities for A (AffilProf). The second 

correlation (Interlock with the non-SOA characteristic, OtherCC, r = + 0.373, p-value = 0.00) suggests 

that given interlocking occurs an audit committee member also serves on four or more compensation 

committees of public companies. The third correlation (r = -0.198, p-value = 0.025) of the committee's 

membership (SOA , AC Members) with the position of having other directorships (non-SOA OtherDir) 

shows that those committees with memberships not violating the SOA  and having enough members also 

are likely to be serving on other boards. The fourth correlation (between the SOA-Other AC, and non-

SOA OtherCC, r = + 0.328, p-value = 0.00) shows that serving on four or more compensation committees 

(OtherCC) is related to serving on four or more audit committees (Other AC). This characteristic, other 

AC, is also found correlated as expected (p-value = 0.00), in those companies with members serving on 

four or more boards (OtherDir). [The relationship of OtherDir and OtherCC may be just due to the 

compensation committee membership.] 

 

Table 3: The Correlation of Characteristics of Non Independence 
 

 

 

 
 

Appearance versus Effective Measures of Independence 
 

Table 3 also presents the results of correlating these first nine (SOA, non-SOA) appearance-of-

independence characteristics with the other five financial variables of Section II used in previous research 

to demonstrate independence in fact as shown by the frequency of the auditor’s going-concern opinion 

(GCO).   

For the variable GCO, the first correlated variable is AffilPay (p-value = 0.023). This suggests that if a 

member receives affiliated payments (AffilPay = 1), the company is likely to receive a going-concern 

 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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opinion (GCO = 1). This is evidence of a dependent audit committee associated with evidence of 

independence, and this is contrary to Carcello and Neal (2000) and expectations. The characteristics of 

dependence (e.g., AffilPay = 1) should be negatively not, as it is, positively related (Pearson r = + 0.202) 

to the measure of effective independence (GCO). For GCO, the next correlated variable is filing for 

bankruptcy (Chapter 11 Only, p-value = 0.00). The variable found predictive of the GCO in prior 

research, Total Assets, is not related (two-tail p-value = 0.201), but the sign of the Pearson correlation 

coefficient (r = -.114) is negative, in the correct direction, consistent with prior research and if held to a 

one-tail p-value standard, it would be close to being significant (with one-tailed p-value = 0.10).   
 

Correlated in the Direction Opposite to Expectations for the Going-Concern Opinion 
 

The measure of audit committee independence, GCO, is not related to the percent of stock ownership 

by the AC committee, AC Stock% of Board, (with two-tailed p-value, 0.11, one-tail, 0.06), but 

considering only the one-tailed p-value it could be. Since AC Stock % of Board is also related to AffilPay 

(p-value = 0.003), which is related to the GCO, this suggests that those with larger shares of stock, i.e., 

those most likely to lose under bankruptcy or a given going-concern opinion, are also those who have 

affiliated payments (in stock) and may be from smaller companies (since this is negatively related to Total 

Assets, r = -0.26, p-value = 0.003). Surprisingly, Table 3 shows only two of the five SOA “appearance-of-

independence” characteristics (the AC membership size (AC#) and belonging to other audit committees, 

Other AC) as having the correct corresponding sign of the correlation coefficients (r = + 0.102, r =            

-0.039) as would be anticipated from their definitions with GCO. In this regard, the appearance 

characteristics under the Sarbanes-Oxley Act fail again and provide contrary support as in Gao, et al., 

(2009). 
 

Table 4: Statistical Tests-Chi Square or Phi (Normal z) Test 

Characteristics versus Measures of Effective Independence 
 

Effective  Variable Effective  Variable 

Independence Affiliated Pay No Affil. Pay Total Independence Interlocking No Interlock Total 

 GCO 9 21 30  Chapter 11 filed 5 26 31 

 No GCO 12 85 97 No Chap 11 filed 4 92 96 

 Total 21 106 127 Total 9 118 127 

 Phi coef z test p-  value  Phi coef z test p-value 

 0.20156 2.27149 0.024  0.20025 2.25670 0.024 

        

Effective  Variable Effective  Variable 

Independence AC # < 3  !"#"$"% Total Independence AC # < 3  !"#"$"% Total 

GCO 7 23 30  Chapter 11 filed 2 29 31 

No GCO 14 83 97 No Chap 11 filed 19 77 96 

Total 21 106 127 Total 21 106 127 

 Phi coef z test p-    value  Phi coef z test p-value 

 0.10176 1.14681 0.250  -0.15425 -1.73825 0.082 

        

Effective Combined  Variable Effective Combined  Variable 

Independence  VAR=1  VAR=0 Total Independence  VAR=1  VAR=0 Total 

GCO 19 11 30 Chapter 11 filed 20 11 31 

No GCO 55 42 97 No Chap 11 filed 54 42 96 

Total 74 53 127 Total 74 53 127 

 Phi coef z test p-value  Phi coef z test p-value 

 0.05713 0.64381 0.520  0.07201 0.81146 0.420 

 

 Because of these relationships and those from prior research, we consider in Table 5 the correlation of 

effective independence (GCO) with the four variables: AffilPay, AC Stock% of Board, the Z-Score for 

determining Chapter 11 Only, and ASSETS (from Table 3, company size defined by the natural log of 

total assets). Logit models are used for prediction purposes, and since we have already established 

AFFILPAY as significant, its predictive purpose remains. In the logit model for predicting GCO, AffilPay 

becomes less predictive (two-tailed p-value = 0.174) in the presence of stock ownership and the size of 

the company, but AffilPay still has the correct sign and is still the most predictive variable, even better 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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188 

 

than the ZSCORE (0.997) and company size (ASSETS, has a p-value of 0.363 and a negative sign for its 

coefficient indicating smaller companies). The variable, AC Stock% of Board, while not significant 

(0.318) in predicting GCO in this logit model, was shown in Table 3 correlated with AffilPay, and 

obviously is multicolinear. Those with AffilPay =1 also have a larger percentage of the stock. In Table 5, 

this model of four variables does predict ten of the thirty GCO companies, only one more than the nine 

that can be found just with AffilPay =1. 

Table 5: Logistic Regression Results for Going-Concern Opinions 

 

 
           Legend: 
                      __________________________________________________________________________________ 

           Number of observations 127 

           Chi-Square for model  37.551 

           p-value     00.0 
   

Therefore, adding these three other variables (AC Stock% of Board, the Z-Score, and Assets) to 

AffilPay does not greatly improve the prediction. This one characteristic of appearance of non 

independence, AffilPay =1, predicts effective independence. Members who are affiliated and have larger 

stock ownership tend to support the going-concern opinion. 
   

Correlated in the Direction Opposite to Expectations for Filing for Bankruptcy 
 

 We find similar results in predicting bankruptcy. First, Table 3 presents only two variables related to 

the filing of bankruptcy (Chapter 11 only): (1) Interlock (with p-value = 0.024), whether an audit 

committee member is on interlocking boards, an SOA violation and (2) GCO (with p-value = 0.00). 

Another SOA independence variable, the size of the audit committee required to be three or more (AC#), 

has a contrary correlation with bankruptcy (r = -0.154, p-value=0.083) and is almost significant. 

 In Table 4 we find these two SOA characteristics again. First, for the AC#, as with the negative 

Pearson correlation coefficient in Table 3, the Phi coefficient (-0.15) for the size of the audit committee 

(AC#) is negative, and this is consistent with the appearance of non-independence. Its two-tailed p-value 

(0.082 as opposed to 0.083, the approximation) is not significant but close, and would be significant as a 

one-tailed test. As in Table 3, the SOA characteristic Interlock is statistically significant, this time with 

exactly the same p-value (0.024). Of the nine committees that had this Interlock violation, five (more than 

half) were associated with those that filed for bankruptcy, contrary to the expectation that none would be 

so associated. 

 In Table 4 for bankruptcies (Chapter 11 filed), the p-value (0.42) is not significant for the variable, 

having at least one violation, SOA VAR. With this low p-value there is not enough evidence as to 

whether the SOA Variable can predict bankruptcy.  Still, contrary to expectations, this sample found that 

more non-independent boards (20) than independent boards (11) filed for bankruptcy. 

Classification Tablea

89 8 91.8

20 10 33.3

78.0

Observed

0

1

GCO

Overall Percentage

Step 1

0 1

GCO Percentage

Correct

Predicted

The cut value is .500a. 

Variables in the Equation

.804 .591 1.851 1 .174 2.235

20.659 5768.654 .000 1 .997 9.4E+08

-.065 .108 .363 1 .547 .937

1.020 1.021 .997 1 .318 2.773

-20.699 5768.654 .000 1 .997 .000

AFFILPAY

ZSCORE

ASSETS

ACSTOCK

Constant

Step

1
a

B S.E. Wald df Sig. Exp(B)

Variable(s) entered on step 1: AFFILPAY, ZSCORE, ASSETS, ACSTOCK.a. 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

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189 

 

 Next, when the same variables of Table 5 are considered in Table 6 for predicting bankruptcy (with 

AffilPay substituted with Interlock), Interlock becomes less predictive (p-value = 0.263). Because of this 

increased p-value we see that members who are on interlocking boards filing for bankruptcy are in those 

in the most distressed (low ZSCORE, p-value = 0.002), perhaps larger (not smaller) companies (ASSETS, 

p-value = 0.095, with a positive sign for the coefficient indicating the larger companies), and with higher 

stock ownership relative to Board, ACSTOCK. Again the coefficient of ACSTOCK has the correct 

positive sign and this time is less significant (p-value = 0.129, one-tail p-value = 0.07). Notice that now, 

as before when predicting GCO companies, we are able to predict one more bankruptcy: instead of the 

five bankruptcies with Interlock =1, we now can predict six bankruptcies using the model of all four 

variables. Also, it appears that for this small study the larger companies with board members owning 

perhaps the larger amount of stock (if only marginally statistically significant) are effective. Still 

according to Table 2, the smaller companies have audit committees with the larger percentage of stock 

ownership (with correlation coefficient, -0.026 and p-value, 0.003). 
 

Table 6: Logistic Regression Results for Bankruptcy Filings  

 

 
           Legend: 
           _______________________________________________________________________________________ 

           Number of observations 127 

          Chi-Square for model  32.141 

           p-value        00.0 
 

CONCLUSIONS 
 

Summary 
 

We reject the research hypothesis.  We find (what would eventually become) required Sarbanes-Oxley 

appearance characteristics of independence not to be meaningful predictors of effective independence for 

this one industry. Instead, we find evidence contrary to expectations. We find one measure of effective 

independence, the issuance of a going-concern audit opinion, related to the SOA appearance measure of 

non-independence, in nineteen of thirty cases, when we would anticipate none. We find another measure 

of effective board independence, the declaration of bankruptcy, also related to what would be SOA non 

independence in twenty out of thirty-one bankruptcies, also when we would expect none. More 

importantly, we find two appearance measures of SOA non independence, whether an audit committee 

member receives affiliated payments, and whether a member is on interlocking boards, to be associated 

with filing for bankruptcy, a predictor of effective independence. These results suggest either a need for 

other appearance measures of effective independence or that theses measure of independence may be 

industry dependent, as Carecllo and Neal (2002) suggest. These results also support Geiger and Rama 

(2003) who find little evidence of a connection between effect and appearance. 

We find other interesting results that are statistically significant or nearly so. For example, in Table 3 

we see the percentage of ownership of stock by the audit committee (AC stock% of board), although not 

Classification Tablea

91 5 94.8

25 6 19.4

76.4

Observed

0

1

Chapter 11 only

Overall Percentage

Step 1

0 1

Chapter 11 only Percentage

Correct

Predicted

The cut value is .500a. 

Variables in the Equation

.885 .791 1.252 1 .263 2.423

3.283 1.043 9.901 1 .002 26.657

.183 .109 2.788 1 .095 1.201

1.614 1.064 2.299 1 .129 5.022

-6.382 1.777 12.904 1 .000 .002

INTERLOC

ZSCORE

ASSETS

ACSTOCK

Constant

Step

1
a

B S.E. Wald df Sig. Exp(B)

Variable(s) entered on step 1: INTERLOC, ZSCORE, ASSETS, ACSTOCK.a. 



Cardwell, Sennetti, and Poulson                                                                                                                                   Advances in Business Research 

 2011, Vol. 2, No. 1, 179-193 

190 

 

strongly related to the effective measures of independence (see GCO, going-concern opinions, with the 

one tail p-value of 0.055), it is more strongly related to the significant variable, affiliated payments 

(AffilPay-SOA, p-value, 0.003), which is a stronger predictor of this effective measure, GCO (with a      

p-value of 0.023). This larger stock ownership variable is associated with the smaller companies (see 

Table 3, Total Assets with a negative correlation, -- 0.272, p-value 0.002). Therefore it appears that 

smaller, stressed companies having audit committees with larger stock ownership, a seemingly dependent 

measure, may in fact do the right thing in permitting going-concern opinions, just as would independent 

and not affiliated audit committees for larger companies. Similarly, boards with possibly larger stock 

ownership by the audit committee from larger companies may do the right thing and file for bankruptcy. 

These suggestions, consistent with the agency work of Fama and Jensen (1983), argue that more closer-

held companies would have non appearing independent owner-managers-directors who act in their 

companies' best interest, as would directors (on audit committees) with a large percentage of ownership 

(Shleifer and Vishny, 1997). 

The interrelationships of non-SOA appearance characteristics also seem to support these results as 

found in company board members serving other company boards, compensation committees, and other 

audit committees. Changes to these relationships involving audit committees and corporate boards since 

the passage of the Sarbanes-Oxley Act suggest that members are accepting fewer positions, and therefore 

the interlocking and other membership relationships are now fewer (Holstein, 2004).   
 

Limitations 

  

This is a relatively small sample study of seventy-four companies, with only thirty going-concern 

opinions (twenty-six that are not repeated) and thirty-one bankruptcies (nineteen that are not repeated), 

limited by design to one industry during two years before the SOA rules were enacted, and conducted 

over two years as found in Carcello and Neal (2000). Despite these limitations, Tables 3, 4, and 6 still 

demonstrate statistically significant findings. 

Although limited in size to seventy-four companies, this study does not support an association of SOA 

appearance-of-independence characteristics with audit committee effectiveness for this specialized 

industry. Rather, they are supportive of contrary expectations. Explanations for this result are suggested 

by company size and percentage of committee stock ownership but this study is too small to show strong 

statistical evidence for these variables. Larger studies of stressed but industry-limited companies with the 

SOA characteristics may be possible since the Act has been in effect since 2002, but may difficult, now 

that some of the SOA rules recently changed even though these changes do not affect audit committees.  

Further research could also continue with other measures of effectiveness such as the quality of earnings 

or a company’s discretionary accruals in determining whether the appearance requirements for audit 

committees are effective (DeZoort et al., 2000). 

These limited findings contribute to the growing body of research that argues for restricting 

government financial regulation by company size and industry (Gao et al., 2009; Hayes, 2009; Hart, 

2009; Dodd–Frank Wall Street Reform and Consumer Protection Act, 2010; Orol. 2011). 

 

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Paula Weller is a lecturer of accounting at Elon University. She received her DBA in accounting from 

Nova Southeastern University. Her current research interests include design and implementation of 

assessment for accounting programs and evaluation and improvement of accounting students’ writing-

skills. She has published in National Public Accounting and International Business and Economic 

Research Journal. 
 

John Sennetti is a professor of statistics and accounting at Nova Southeastern University. He received 

his Ph.D. in mathematical statistics from Virginia Tech. He has published in Communications in 

Statistics, Journal of Finance, Journal of Accounting Education, Journal of Business Ethics, Advances in 

Accounting Behavioral Research, and others. 
 

Linda Poulson is an associate professor of accounting at Elon University. She received her Ph.D. in 

accounting from Saint Louis University. Her current research interests include financial accounting and 

personal finance. She has published in Journal of Academy of Business Education and CPA Journal. 

 


