J. Service Science & Management, 2010, 3, 336-344
doi:10.4236/jssm.2010.33039 Published Online September 2010 (http://www.SciRP.org/journal/jssm)
How Do Companies Adjust their Independent
Directors after a Mishap
—Evidence from Independent Directors’ Background
Xinyi Zhang, Fan Zhou
School of Economics and Management Tsinghua University, Beijing, China.
Received April 23rd, 2010; revised June 6th, 2010; accepted July 10th, 2010.
ABSTRACT
Selection of independent directors in China’s listed companies is a two-way choice dominated by listed companies.
Thereafter, most companies adjust their independent directors after a mishap (e.g. receiving qualified audit opinions or
punished by regulatory authorities). This paper investigates the behavior of how companies adjust their independent
directors from the perspective of independent directors’ background, by using data of Chinese listed companies to
which a mishap happened between 2002 and 2004 as our target sample. Evidence shows that listed companies will in-
crease independent directors with accounting background significantly after receiving qualified audit opinions or pun-
ished by regulatory authorities, for the purpose of mitigating distress from capital market and medium and minority
shareholders, which highlights the supervising role of independent directors with accounting background.
Besides,
these companies enjoy significantly contemporaneous return after the adjustment.
Keywords: Independent Directors, Adjust, Background, Corporate Governance
1. Introduction
Independent director system is widely believed as an im-
portant action to improve corporate governance and now
becomes the common choice among different corporate
governance patterns [1]. In China, the system comprised
of three parties (i.e. China Securities Regulatory Com-
mission, listed companies and independent directors) was
enforced as a “life saving straw” in 2001 when reform on
non-tradable shares encounters a variety of difficulties.
To better protect interests of medium and minority
shareholders, China Securities Regulatory Commission
(CSRC thereafter), one of the most important regulatory
authorities in China’s capital market, issued guidance on
establishing independent directors system in listed com-
panies (the Guidance thereafter) on August 16, 2001,
which gave birth to China’s independent directors sys-
tem.
In consequence, a huge “blind date” between listed
companies and independent directors carries on amid fire
and thunder. In reality, listed companies have made suf-
ficient comparison and consideration among different
candidates before formal invitations and employment. A
person who is assigned to be an independent director
must have some strength which is favored by companies,
such as social status, professional skills, networking re-
sources or just easy to be controlled [2]. Meanwhile, in-
dependent directors can not only get paid, but also repu-
tation, which was deem as the “fame and fortune” ap-
pointment. Therefore, selection of independent directors
in Chinese listed companies is a two-way choice domi-
nated by listed companies. What’s the motivation of
listed companies in the selections? Do they have ade-
quate incentives to choose independent directors for su-
pervising? This is the main question we are going to an-
swer first.
However, whether the system is perfect designed need
further investigation. The collapse of Enron, WorldCom,
and similar but less catastrophic disclosure failures viv-
idly demonstrated weaknesses in the board governance
system produced by the 1990s and pointed the way to-
wards new roles for independent directors and standards
of independence [3]. At the end of 1997, Zhengbaiwen
was operating at a loss, and so falsified its financial re-
port to make stockholders believe that the company was
doing well. This caused stockholders a 98.79% loss in

How Do Companies Adjust Their Independent Directors after a Mishap 337
1998. Listed companies have autonomies in initial selec-
tions; however, they will be challenged by medium and
minority shareholders or even punished by law when
mishap happens. Besides, mass media functions as a
“watch dog” on shareholders’ interest in the whole proc-
ess. As we all see that independent director Jiahao Lu
was fined RMB 100,000 in “Zhengbaiwen Event”, for
failing to take action when the company submitted a false
financial report. Thus, the question arises: will listed
companies adjust independent directors as a means to
mitigate pressures from regulatory authorities, capital
market and medium and minority shareholder? How do
market participants react to different adjustment of inde-
pendent directors? In this paper, we are trying to address
these questions.
We motivate this work by investigating the behavior
of how companies adjust their independent directors
from the perspective of independent directors’ back-
ground. We find that percentages of independent direc-
tors with accounting background increase significantly in
mishap companies. We found that 67% of companies’
independent directors have accounting background in the
event year, while increasing to 78% in the subsequent
year. Besides, adding accounting professionals after a
mishap can help companies mitigate distress from capital
market and medium and minority shareholders, which
highlights the supervising role of independent directors
with accounting background.
The remaining of this paper is organized as follows.
The second section provides institutional background and
hypothesis. The third section is data and variables de-
scription. The fourth section lists descriptive statistics.
The fifth section offers empirical test and explanation.
The sixth section concludes the paper.
2. Institutional Background and Hypothesis
2.1. Institutional Background
To put forward in order to further improve the corporate
governance structures and promote the standardized op-
eration of listed companies, on August 16, 2001 CSRC
issued the guiding opinion on establishment of inde-
pendent director systems by listed companies, which
gave birth to China’s independent directors system.
The Guidance requires independent directors with
strong economics and law background. In particular, one
of them should be accounting expert. Nevertheless, little
rigid requirement is addressed on the specific back-
ground of independent directors; people who can satisfy
as an independent director are not rare. Thus, independ-
ent directors can be from various industries with different
background, playing their own distinct role in companies.
The Guidance requires listed companies should establish
independent director systems. Besides, CSRS address
that an independent director should have the qualifica-
tions required to exercise his functions and powers as
such a person holding the position of independent direc-
tor, independent directors must be independent. The
nomination, election and replacement of independent
directors should be conducted in a legal and standardized
manner [4].
Lou [5] documented foreign researches and found that
independent directors work as supervisors, strategy de-
signers and politicians in companies. Research Center of
Shanghai Security Exchange [6] believed that functions
of independent directors are supervision, assistance and
networking. Zhou [7] considers independent directors
serve as supervisors and consultants for listed companies.
Due to the inconsistency of original intention on estab-
lishing independent system among CSRC, listed compa-
nies and independent directors, whether independent di-
rectors are competent and willing to work as a supervisor
and consultant need further consideration. This paper
uses incentive compatibility theory to analyze incentive
incompatibility in initial selections of independent direc-
tors and incentive compatibility in adjusting after a mis-
hap.
2.2. Incentive Incompatibility: In Initial Selections
Incentive incompatibility is a mechanism design in which
conflicting objects exists in principal and agent. Under
certain circumstance, agents have no incentive working
hard to fulfill principal’s goals; what is more serious,
agents may choose behaving negligence and profusion in
hopes of self-interest maximization.
The controller of such [joint-stock] companies, how-
ever, being the managers of other people’s money rather
than of their own, cannot well be expected, that they
should watch over it with the same anxious vigilance
with which the partners in a private copartnery frequently
watch over their own. Like the stewards of a rich man,
they are apt to consider attention to small matters as not
for their master’s honor, and very easily give themselves
a dispensation from having it. Negligence and profusion,
therefore, must always prevail, more or less, in the man-
agement of the affairs of such a company [8]. China’s
independent directors system was created from a manda-
tory institutional change led by CSRC, which gave birth
to a special principal-agent relationship — CSRC dele-
gate listed companies to employ independent directors.
In this case, CSRC is the principal, listed companies are
agent. CSRC, listed companies and independent directors,
as the main parties in this mechanism, have different
incentive and opinions in the implementation, therefore,
Qingquan Tang [9] analyze the three incentives. CSRC’s

How Do Companies Adjust their Independent Directors after a Mishap 338
incentive is optimizing board structures in listed compa-
nies, protecting interest of medium and minority share-
holders, improving information disclosure and interna-
tionalization. From the view of listed companies, they
induct independent directors in hopes of improving
company’s image and decision-making ability, dealing
with challenges and conquering financial stress. Speak-
ing of independent directors, this invitation means not
only get paid and easier to fetch resources, but also repu-
tation and self-fulfillment.
Obviously, incentive conflictions among CSRC, listed
companies and independent directors bring disagreement
to the establishment of independent directors system.
Referring to the consultant role, incentive confliction
doesn’t exist. In detail, independent directors provide
listed companies with strategic, political and networking
assistance by using “knowledge capital” of their own,
which creates promotion to company’s performance. As
a result of that, independent directors will enjoy higher
reputation and compensation. Here is a “trilateral win
contract”, which indicates the realization of incentive
compatibility. There are conflict incentives of the three
parties in independent director’s “supervision role”. For
one thing, there is incentive conflictions originated from
the selection mechanism. The reality that independent
directors are nominated by majority shareholders in most
Chinese listed companies determines that independent
directors cannot stand in medium and minority share-
holder’s shoes as CSRC expected, otherwise incentive
incompatibility will come into being. Secondly, the com-
pensation mechanism in independent directors system
brings incentive conflictions. It is the listed company
controlled by the first majority shareholder and manage-
ment who pays for independent directors, but the main
duty them is supervising the company. In conclusion,
regulatory authorities expect independent directors serve
as a compatible supervisor; nevertheless listed companies
don’t want to see that condition happens by no means,
they hope independent directors are only consultant ra-
ther than watchdog, which shows the incentive incom-
patible in the selection of independent directors between
the principal (regulatory authorities) and agent (listed
companies).
2.3. Incentive Compatibility: Adjustment after
the Mishap
In mechanism design, a process is said to be incentive
compatible if all of the participants fare best when they
truthfully reveal any private information asked for by the
mechanism. As an illustration, voting systems which
create incentives to vote dishonestly lack the property of
incentive compatibility. In the absence of dummy bidders
or collusion, a second price auction is an example of me-
chanism that is incentive compatible.
Listed companies wish independent directors to be
consultant rather than supervisor. This intention is one-
sided romance to some degree because the Guidance
requires at least one accounting professionals should be
presented as an independent director. What’s more, listed
companies cannot dominate the selection confronting
with pressures from medium and minority shareholders,
regulatory authorities and capital market. More and more
challenges are heard these days focusing on the issue
independent directors are not independent, with little
awareness neither. The emergence of independent direc-
tors system is to protect medium and minority share-
holders, but what we can see is quite different from what
we hoped. Lack of independence means independent
directors are controlled and manipulated by majority
shareholders. Meanwhile, lack of awareness means they
cannot satisfy the general public as integrity and compe-
tent professionals. Anecdotal evidence shows that inde-
pendent directors will not only be challenged medium
and minority shareholders, regulatory authorities, but
also punished by law in serious circumstance after a
mishap. Thus, listed companies will adjust independent
directors after a mishap hoping to mitigate distress from
capital market and medium and minority shareholders,
hence, incentive compatibility happens.
2.4. Hypothesis
As the independence of independent directors is difficult
to measure, this paper mainly test the awareness of them
(i.e. competence and motivation of independent directors).
Jensen and Meckling [10] analyze how the cost of trans-
ferring specific knowledge encourages the decentraliza-
tion of decision rights and how this decentralization gen-
erates the rights assignment and control problems. They
pointed out that ignoring agency problem, assigning de-
cisions rights to individuals who have the decision-
relevant knowledge and abilities increases efficiency.
Self-interest on the part of individual decision makers,
however, requires a control system to motivate individu-
als to use their decision rights optimally. This paper uses
professional knowledge as a proxy to measure occupa-
tional competency of independent directors [7].
We believe that independent directors with accounting
background are accomplished in solving financial prob-
lems, while management and technical knowledge will
provide companies with helpful suggestions on operating
performance. A body of foreign researches supports that
independent directors with accounting background play a
vital role in eliminating earnings management and fraud
[11-13]. The Sarbanes-Oxley Act of 2002 and the Guid-
ance emphasize the importance of independent directors

How Do Companies Adjust Their Independent Directors after a Mishap 339
with financial background. Johnson [14], Anderson and
Bizjik [15] and Zhao et al [16] find independent directors
with management background will improve companies
operating performance. Therefore, this study empirically
tests the following hypothesis:
Hypothesis 1: listed companies will increase the num-
ber of independent directors with accounting back-
ground after a mishap.
Fama and Jensen [17] argue that outside directors tend
to be more effective monitors of management than inside
directors because they are generally key decision makers
at other organizations who are concerned about their re-
putations in the managerial-labor market. According to
their argument, outside directors signal their abilities as
key decision makers through their board decisions. This
study uses reputation to proxy independent director’s
occupational motivation and will empirically tests the
following hypothesis:
Hypothesis 2: listed companies will increase the num-
ber of independent directors with higher reputation
after a mishap.
Gordon [3] point out that independent directors as de-
veloped in the U.S. context solve three different prob-
lems: First, they enhance the fidelity of managers to
shareholder objectives, as opposed to managerial inter-
ests or stakeholder interests. Second, they enhance the
reliability of the firm’s public disclosure, which makes
stock market prices a more reliable signal for capital al-
location and for the monitoring of managers at other
firms as well as their own. Third, and more controver-
sially, they provide a mechanism that binds the respon-
siveness of firms to stock market signals but in a
bounded way. The turn to independent directors serves a
view that stock market signals are the most reliable
measure of firm performance and the best guide to allo-
cation of capital in the economy, but that a “visible
hand,” namely, the independent board, is needed to bal-
ance the tendency of markets to overshoot.
How do investors react to adjustment to independent
directors after a mishap, to specify, increasing the num-
ber of independent directors with accounting background
or increasing the number of independent directors with
higher reputation? In this paper, we will empirically test
this question. Thus, we develop the following hypothesis
on firm’s market performance.
Hypothesis 3: listed companies will enjoy positive
contemporaneous return after adjusting independent
directors after a mishap.
3. Data and Variables
This part is organized as follows. First of all we will pro-
vide an introduction to the types of independent directors
listed companies appointed, and then we will empirically
test how companies adjust independent directors after a
mishap. Different independent directors play various roles
due from their functions and positions. Our test focuses
on the background of independent directors.
3.1. Sample
In this paper, our mishap companies during the year 2002
to 2004 are selected according to companies’ annual re-
port, announcement and other information. Independent
directors’ background and characters of companies (es-
pecially for important bad news) are obtained from
WIND and CSMAR database. Other data are collected
by hand.
3.2. Variables
Our empirical study comprises three groups of variables:
independent directors’ specialties, reputation and compa-
nies’ mishap.
3.2.1. Variables about Independent Directors’
Specialties
Independent directors’ majors can be divided into four
categories: economics and management, accounting, law
and technique, which correspond to four dummies in our
paper. The Guidance requires at least one accounting
professionals should be presented as an independent di-
rector. To better investigate the adjusting of accounting
professionals in listed companies, we design a continu-
ous variable to depict percentage of accounting profes-
sionals. Panel A in Table 1 presents variables about in-
dependent directors’ background.
3.2.2. Reputation Variables of Independent Directors
Reputation is hard to be quantified. Some scholars use
the average number of companies in which a person
serve as an independent director as a proxy for reputation
[16,18,19]. Actually, some prestigious independent di-
rectors are reluctant to accept more invitations, which
highlight the deficiency to this method. To be objective,
we use Xia et al. [20] and Wei [21] for reference and add
some improvement to the method. We use expert as-
sessment to evaluate independent directors’ reputation.
Panel B in Table 1 presents variables about independent
directors’ reputation.
3.2.3. Mishap Variables
Different kinds of mishap can be invasion to medium and
minority shareholders interest. This paper chooses pun-
ishment from regulatory authorities and qualified audit
opinions as proxy for important mishap. The former in
dicates fraud in listed companies while the latter means
problems in financial reports. Two types of mishap are
closely related to companies’ financial reports, which

How Do Companies Adjust their Independent Directors after a Mishap 340
Table 1. Variable definations.
Variable Name Abbreviate Definition
Panel A: variables about independent directors’ knowledge background
Accounting ACCO1 If an accounting professional is appointed, ACCO1=1, otherwise ACCO1=0
Percentage of
accounting ACCO2 Number of independent directors with accounting background/Number of independent directors
Law LAW If a law professional is appointed, LAW=1, otherwise LAW=0
Economics and
management ECON If an economics and management is appointed, ECON=1, otherwise ECON=0
Technical TECON If a technical professional is appointed, TECON=1, otherwise TECON=0
Panel B: variables about independent directors’ reputation
Reputation REPUT
Average score, calculating process: how many companies a person serves as an independent director
(40%), reputation of his afflation (20%), position (20%), professional title (10%) and education degree
(10%)
Panel C: Definition of conviction events in mishap companies
Conviction UNRULE Punished by regulatory authorities or receiving qualified audit opinions
have a name “conviction events”. Panel C in Table 1 pre-
sents variables about mishap.
4. Descriptive Statistics
4.1. Status Quo of Independent Directors
The independent director system in China is basically
driven by mandatory rules rather than spontaneous
institutional change promoted by listed companies and
general public. Therefore, majorities of listed companies
carry it into execution by “the last bus”. Table 2 reports
the general situation of independent directors in China’s
listed companies. Only 325 companies have independent
directors in 2001, covering 28.56% of China’s listed
companies. From 2002 on majorities of China’s listed
companies put the system into practice. On average,
Boards are reelected every three years. Table 2 shows
that the number of independent directors decreased in
2005 compared to 2004, indicating that a body of listed
companies reelected during 2004 and 2005. Therefore,
we restricted our target sample mishap companies from
2002 to 2004, corresponding to reelection year. Data
Table 2. Status quo of independent directors.
Listed companies Independent
directors
Year
Number
Appointing
independent
directors
Percentage Number Average1
2001 1140 325 28.56% 741 2.28
2002 1204 1175 97.59% 2679 2.28
2003 1267 1261 99.53% 4035 3.20
2004 1354 1353 99.93% 4506 3.33
2005 1351 1351 100.00% 4461 3.30
Total 6316 5465 86.52% 16422 3.00
related to independent directors’ background spans from
2002 to 2005.
4.2. Statistics Relating to Independent Directors’
Background
Our data covers independent directors’ background from
2002 to 2005.
4.2.1. Statistics of Independent Directors’ Specialties
Table 3 reports distribution of independent directors’
specialties. Independent directors with economics and
management specialties represent 27% of all directors,
while technicians cover 23% and 11% for that of law in
2002. Obviously, the phenomenon that independent di-
rectors with economics and management majors or with
accounting background holding concurrent posts in dif-
ferent companies is not rare. Accounting professionals
and law experts are increasing year by year; percentage
grows from 27% in 2002 to 28% in 2005 for accounting
professionals, from 11% in 2002 to 13% in 2003 for law
experts respectively.
4.2.2. Statistics of Independent Directors’ Reputation
This paper uses expert assessment to evaluate independ-
ent directors’ reputation. How many companies a person
serves as an independent director, reputation of his own
afflation, position, professional title (or education degree)
are four proxies for reputation, each of them has their
own weight, which are 40%, 20%, 20%,10% and 10%
respectively. Full mark is 5 points. Table 4 reports scores
of independent directors’ scores. On average all of them
are larger than 1, [1,2) covers 8.4% of the whole sample,
[2,3) covers 65.0% , [3,4) covers 22.0%, while [4,5]
covers 5.7%. Due to strict assessment, few independent
directors’ reputation scores [4,5], which doesn’t influence
he accuracy of the final result. t

How Do Companies Adjust their Independent Directors after a Mishap 341
Table 3. Independent directors’ specialties.
Year 2002 2003 2004 2005 Total
Acc 727 27% 1092 27% 1236 27% 1249 28% 4304 27%
Law 295 11% 525 13% 582 13% 608 14% 2010 13%
Econ 1035 39% 1500 37% 1681 37% 1646 37% 5862 37%
Tecon 622 23% 918 23% 1007 23% 958 21% 3505 22%
Total 2679 100% 4035 100% 4506 100% 4461 100% 15681 100%
Table 4. Distribution of independent directors’ reputation.
Year
Reputation 2002 2003 2004 2005 Total
Missing 11 0.40% 5 0.10% 5 0.10% 5 0.10% 26 0.20%
[0，1) 0 0.00% 0 0.00% f0 0.00% 0 0.00% 0 0.00%
[1，2) 218 8.1% 335 8.3% 380 8.4% 381 8.5% 1314 8.4%
[2，3) 1769 66.1% 2592 64.3% 2884 64.0% 2936 65.8% 10181 65.0%
[3，4) 571 21.3% 929 23.0% 1013 22.5% 932 20.9% 3445 22.0%
[4，5] 108 4.0% 352 8.7% 221 4.9% 206 4.6% 887 5.7%
Total 2677 100% 4033 100% 4503 100% 4460 100% 15673 100%
4.2.3. Statistics of Conviction Event
As is known to all, China’s stock market is still in the
infancy period and institution investors need great
improvement in the days to come. Thus, irregular events
are not rare. Punishment from regulatory authorities and
qualified audit opinions from public accounting firm can
be seen each year in capital market, which indicates
serious financial problems in listed companies. Table 5
presents conviction events (i.e. punishment from regula-
tory authorities and qualified audit opinions from public
accounting firm) in listed companies.
5. Empirical Test and Explanation
5.1. Descriptive Statistics of Adjustment
We develop T-test and Z-test to find the difference of
independent directors in event year and subsequent year.
Panel A of Table 6 reports the results. Percentages of
independent directors with accounting background in-
crease significantly in mishap companies. 67% of com-
panies’ independent directors have accounting back-
ground in the event year, while increases to 78% in the
subsequent year, which is significant at 1% level. Ac-
counting directors covers 26.63% of all external directors
in the conviction year, while increases by 2.57% to 29.2%
in the subsequent year, significant at 10% level. Results
indicate that companies increase accounting professional
as independent directors after a mishap. However, empi-
Table 5. Conviction event in China’s listed companies.
Variable 2002 2003 2004 Total
UNRULE 157 111 164 432
rical results indicate that listed companies donot increase
independent directors with other background (e.g. eco-
nomics and management, law and technology). Account-
ing professionals are exerted in figuring out financial
problems. Companies appoint them to mitigate distress
between regulatory authorities and minority shareholders,
providing positive signals to the general public. Actually,
foreign and domestic researches emphasize the impor-
tance of accounting independent directors. Xie et al. [11],
Bedard et al. [12] and Bryan [13] find that independent
directors with financial background play a vital role in
supervision and restriction of management earnings ma-
nagement.
Besides, statistics shows that average score of inde-
pendent directors’ reputation in mishap companies is
2.5646 in the conviction year, while decreases to 2.55 in
the subsequent year. No statistic evidence supports our
second hypothesis. The reason listed companies don’t
increase the number of independent directors with higher
reputation after a mishap is two folded. For one thing,
higher reputation doesn’t predict more competence. An-
ecdotal events in capital market show that “vase direc-
tors” not only means incompetence but also dereliction
of duty. Lu Jiahao in “Zhengbaiwen Event” is a persua-
sive and vivid example for us. Wang et al. [19] finds
independent directors’ reputation improves company’s
performance significantly but Zhao et al. [22] supports
that independent directors’ reputation doesn’t improve
family firm’s performance significantly. No evidence
shows that reputation backs up independent directors as a
competent supervisor. Zhou [7] and Zhou et al. [23] are
otivated by their reputation, rather than restricted. m

How Do Companies Adjust their Independent Directors after a Mishap 342
Table 6. Independent director adjustment in event year and subsequent year.
Event year Subsequent year
Variable N Mean Median N Mean Median T-test Z-test
Panel A: background of specialties
ACCO1 432 0.6728 1 423 0.7801 1
–3.54*** 3.51***
ACCO2 432 0.2663 0.33 423 0.2920 0.33
–1.75* 1.83*
LAW 432 0.3921 0 423 0.4397 0
–1.41 1.41
ECON 432 0.7517 1 423 0.7683 1
–0.57 0.64
TECON 432 0.4316 0 423 0.4704 0
–1.14 0.57
Panel B: background of Reputation
REPUT 432 2.5646 2.55 423 2.5613 2.55 0.12
–0.98
***, **, and * represent significance levels at the 1%, 5%, and 10% levels, two-tailed, respectively. Independent directors’ specialties data are unavailable for 9
mishap companies.
Table 7. Discriptive statistics of accounting independent direcors by year.
ACCO1 ACCO2 ACCO1 ACCO2
Year N
Mean Median Mean Median T-test Z-test T-test Z-test
2002 1135 0.59 1.0 0.26 0.33
2003 1248 0.76 1.0 0.27 0.33 02&03 –9.15*** –8.99*** 0.02 –0.96
2004 1347 0.79 1.0 0.27 0.33 03&04 –1.42 –1.42 –0.65 –0.35
2005 1329 0.78 1.0 0.28 0.33 04&05 –1.02 1.02 –0.93 0.89
***, **, and * represent significance levels at the 1%, 5%, and 10% levels, two-tailed, respectively.
Secondly, unqualified opinions from external auditors
indicate deficient in companies, therefore, there is no
reason for prestigious people to accept invitation from
mishap companies for the sake of avoiding risk.
5.2. Robust Tests: Is That Resulted from
Institutional Change
Implementation of independent directors system in China
is a progressive process. The Guidance requires inde-
pendent directors should be included in the board before
July 30, 2002. Besides, at least one third directors in the
board should be external directors, one of whom should
be accounting expert. Obviously, companies increase
accounting directors to meet the mandatory requirement
from 2002 to 2003. Does the increase result from institu-
tional change? We will develop additional test in the fol-
lowing. Table 7 reports descriptive statistics on inde-
pendent directors’ accounting background. Result shows
that percentage of companies in which accounting ex-
perts present as an independent directors are 59% in 2002,
while 76%, 79% and 80% for the year 2003, 2004 and
2005 respectively. Besides, empirical evidence point out
that percentage of companies in which accounting ex-
perts present as an independent directors increases from
2002 to 2003 significantly in 1% level. However, the
percentage increases insignificantly by year from 2003 to
2005. Thus, listed companies appoint more accounting
expert as independent directors not only because of their
own demand, but also consequence from institutional
change. Besides, nonparametric test shows that percent-
age of independent directors with accounting background
in companies doesn’t increase year by year from 2002 to
2005, which indicates that the increase in mishap com-
panies are not resulted from institutional change. In con-
clusion, our result is robust.
5.3. Adding Accounting Independent Directors is
Helpful for Market Performance
Empirical evidence shows that China’s listed companies
will add accounting professionals as their independent
directors, however, whether they can benefit from this
choice need further investigation. We use market ad-
justed model to calculate cumulated abnormal return
(CAR thereafter), which are computed as the stock’s raw
return over the interval minus the corresponding equally-
weighted market return. We selected 70 companies which
add accounting independent directors after the mishap.
Table 8 shows that they experienced negative CAR 2
years before the conviction and significant in 1% level,
but CAR is negative but insignificant during the convic-

How Do Companies Adjust Their Independent Directors after a Mishap 343
tion year. After the mishap, market performance increase
year by year. We may infer that mishap companies enjoy
market performance improvement by adding accounting
independent directors. Accounting professionals are fa-
vored by market participants.
Barth et al. [24] developed a cross-sectional model to
test whether improvement in company’s market per-
formance benefits from increasing in brand value. To
investigate correlations between market return and change
in brand value, company’s contemporaneous return is
regressed on net income, change in net income compare
to last year and change in brand value. The coefficient of
change in brand value defines the correlation between
market return and change in brand value.
We are trying to investigate the correlation between
market return and whether mishap company adding ac-
counting independent directors, so we introduce a new
dummy addacco. New model is shown as follows.
tiitititit addaccoNINIRETURN ,221





 (1)
RETURNi,t denotes firm i’s contemporaneous return in
year t. The deadline of China’s listed companies’ annual
report is April 30th in the subsequent fiscal year, there-
fore, we use the first trading day in May in the fiscal year
as our beginning date for contemporaneous return. NIi,t is
net income per share (extraordinary items are excluded),
and NI
△
i,t denotes change in net income compare to last
year. Adda cco is a dummy, which equals 1 if mishap
company adding an accounting independent director, 0
otherwise.
Table 9 reports our OLS regression result. Empirical
result shows that net income per share (extraordinary
items are excluded) is highly correlated with contempo-
raneous return, adding accounting independent director
help companies improve their market performance sig-
nificantly (the coefficient of addacco is 0.2179, signifi-
cant at 0.01 level). Accounting professionals can help
mishap companies mitigate distress from capital market
and medium and minority shareholders, which highlights
the supervising role of independent directors with ac-
counting background.
Table 8. Descriptive statistics of car around the mishap.
N Mean Min Max
CAR[–750, –500] 70 –0.0739** –1.1414 0.4204
CAR[–500, –250] 70 –0.1837*** –0.9635 0.3005
CAR[–250,0] 70 –0.3021*** –1.0568 0.7177
CAR[0,250] 70 –0.0890 –1.8013 1.8653
CAR[250,500] 70 0.0894* –0.8915 0.9016
CAR[500,750] 70 0.6382*** –0.5249 3.9936
CAR[–750, –500] 70 –0.0739** –1.1414 0.4204
***, **, and * represent significance levels at the 1%, 5%, and 10% levels,
two-tailed, respectively.
Table 9. OLS regression examining whether market approves
adding accounting independent directors.
Dependent Variable
Independent
Variable Predicted sign Coeff. t-Stat.
Intercept ?
–.6109 –13.53***
NI + .4665 4.58***
△NI + .0019 1.36
Addacco + .2179 2.63***
Number 417
Adjusted R2 0.24
***, **, and * represent significance levels at the 1%, 5%, and 10% levels,
two-tailed, respectively.
6. Conclusions
This paper investigates the behavior of how companies
adjust their independent directors from the perspective of
independent directors’ background, by using data of Chi-
nese listed companies to which a mishap happened be-
tween 2002 and 2004 as our target sample. Evidence
shows that listed companies will increase independent
directors with accounting background significantly after
a mishap (i.e. receiving qualified audit opinions or pun-
ished by regulatory authorities). Nevertheless, listed com-
panies don’t increase the number of independent direc-
tors with higher reputation after a mishap. On one hand
companies don’t resort to prestigious independent direc-
tors for assistance, and on the other hand prestigious in-
dependent directors don’t want to work for mishap com-
panies. Empirical evidence shows that listed companies
will increase independent directors with accounting back-
ground after a mishap for the purpose of mitigating agent
distress between majority shareholders and minority
shareholders, enjoying significantly positive cumulative
abnormal return after the adjustment in the long window.
Our result indicates that listed companies will increase
accounting independent directors for the purpose of
mitigating distress from capital market and medium and
minority shareholders, which highlights the supervising
role of independent directors with accounting background.
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