Does the Market Value Financial Expertise on Audit Committees of Boards of Directors?

We examine three‐day cumulative abnormal returns around the announcement of 702 newly appointed outside directors assigned to audit committees during a period before implementation of the Sarbanes‐Oxley Act (SOX). Motivated by the SOX requirement that public companies disclose whether they have a financial expert on their audit committee, we test whether the market reacts favorably to the appointment of directors with financial expertise to the audit committee. In addition, because it is controversial whether SOX should define financial experts narrowly to include primarily accounting financial experts (as initially proposed) or more broadly to include nonaccounting financial experts (as ultimately passed), we separately examine appointments of each type of expert. We find a positive market reaction to the appointment of accounting financial experts assigned to audit committees but no reaction to nonaccounting financial experts assigned to audit committees, consistent with accounting‐based financial skills, but not broader financial skills, improving the audit committee's ability to ensure high‐quality financial reporting. In addition, we find that this positive reaction is concentrated among firms with relatively strong corporate governance, consistent with accounting financial expertise complementing strong governance, possibly because strong governance helps channel the expertise toward enhancing shareholder value. Together, these findings are consistent with financial expertise on audit committees improving corporate governance but only when both the expert and the appointing firm possess characteristics that facilitate the effective use of the expertise.     

Audit committee composition and the use of an industry specialist audit firm

Independent, competent boards of directors and audit committees are said to be important mechanisms of corporate governance. The purpose of the present study is to empirically examine the association between audit committee composition and audit quality. Specifically, the link between the proportion of non‐executive directors on an audit committee, financial qualifications of directors and the number of audit committee meetings held in a year are investigated and expected to have a positive association with the quality of the audit firm used. Audit quality is proxied by industry specialization. The results support the link between a higher proportion of non‐executive directors on an audit committee and use of an industry specialist audit firm. Other measures of audit committee quality (those with a higher proportion of directors with financial qualifications and those that meet more frequently) are not significantly associated with the use of an industry specialist audit firm. Sensitivity analysis shows that the presence of an audit committee is linked to use of an industry specialist audit firm.     

The effect of audit committee shareholding,financial expertise and size on interim financial disclosures

In recent years, corporate failures and accounting irregularities have led to concerns about the effectiveness of audit committees in the financial reporting process. In response, corporate governance committees in different countries have made specific recommendations designed to enhance the role of the audit committee in executing its financial reporting oversight duties. We investigate in this study, the effect of some of these recommendations by empirically examining the relationship between selected audit committee characteristics and the level of disclosure in interim reports of a sample of 262 UK listed companies. Specifically, the audit committee characteristics examined are shareholding of audit committee members (as a proxy for audit committee independence), audit committee size and audit committee financial expertise. Employing both a weighted and unweighted index to measure interim disclosure, the results indicate a significant negative association between shareholding of audit committee members and interim disclosure. Our results provide evidence of a significant positive association between interim disclosure and audit committee financial expertise. We find no significant relationship between audit committee size and the extent of disclosure in interim reports. Overall, however, our results suggest that audit committee characteristics have an impact on its monitoring effectiveness of the financial reporting process. These results have important implications for corporate governance policy-makers who have a responsibility to prescribe appropriate corporate governance structures to ensure that shareholders are protected.     

Audit committee financial expertise,corporate governance,and the voluntary switch from auditor-provided to non-auditor-provided tax services

A prime objective of the SOX is to safeguard auditor independence. We investigate the relation between audit committee quality, corporate governance, and audit committees' decision to switch from permissible auditor-provided tax services. We find that firms with more independent boards, audit committees with greater accounting financial expertise, higher stock ownership by directors and institutions, that separate the CEO and Chairman of the board positions, and with higher tax to audit fee ratios are more likely to switch to a non-auditor provider. Further, we document that firms are more likely to switch prior to issuing equity. We find no evidence that broad financial expertise on audit committees is related to the switch decision, suggesting that the SEC's initial narrow definition of expertise is more consistent with the objective of the SOX. Overall, our results suggest that accounting financial expertise and strong corporate governance contribute to enhanced audit committee monitoring of auditor independence.     

The Composition and Effectiveness of Audit Committees in the Presence of Large Controlling Shareholders

The authors' study of audit committees in 450 large East Asian companies (150 each in Hong Kong, Singapore, and Malaysia) finds a strong positive correlation between the “cash flow” ownership (as opposed to just the voting rights) of large shareholders and the percentage of independent audit committee members. The study also reports a strong positive correlation between the “cash flow” ownership of large shareholders and the percentage of audit committee members with financial expertise and experience. This finding is consistent with the hypothesis that larger cash flow ownership provides large shareholders with strong incentives for more effective governance. Conversely, the lower percentages of independent or professional audit directors at companies with large disparities between cash ownership and voting rights is consistent with the authors' hypothesis that entrenched large shareholders prefer inferior governance structures that pose fewer obstacles to their tendency to exploit the wealth of minority shareholders. Furthermore, the authors find higher valuations (market‐to‐book ratios) for companies with audit committees that consist entirely of independent directors and have larger percentage of members with financial expertise. And when viewed as a whole, the authors' findings provide support for the argument that ownership structure affects the composition of audit committees, and that independent and professional audit committees can help increase firm value.     

The governance of risk management: The importance of directors’ independence and financial knowledge

We test the effects of the independence and financial knowledge of directors on risk management and firm value in the gold mining industry. Our original hand‐collected database on directors’ financial education, accounting background, and financial experience allows us to measure the effect of financial knowledge on risk management activities. We show that directors’ financial knowledge increases firm value through the risk management channel. This effect is strengthened by the independence of the directors on the board and on the audit committee. Extending the dimension of education, we show that, following unexpected shocks to gold prices, firms with financially educated directors are more effective in hedging than average firms in the industry. Firms that hedge more also attracts highly educated directors on their board and audit committee. As a policy implication, our results suggest adding the experience and education dimensions to the 2002 Sarbanes–Oxley Act and New York Stock Exchange requirements for better governance.     

Earnings conservatism and audit committee financial expertise

Using an Australian sample of 494 firm‐year observations, this study finds that accounting financial expertise is the primary type of expertise that influences earnings conservatism, rather than nonaccounting financial expertise. The association between accounting financial expertise and conservatism holds only when the accounting financial expert(s) on audit committees is (are) independent. Overall, results suggest that audit committee accounting financial expertise is important in recognising the asymmetrical timeliness of losses. Findings provide a better understanding of the dynamics between audit committee financial expertise and earnings conservatism and demonstrate the importance of accounting financial expertise in improving financial reporting quality.     

The existence and independence of audit committees in France

This paper uses an agency theory framework to investigate the determinants of audit committees in France. Empirical tests address a cross-sectional sample of 285 listed companies for the fiscal year 1997, which is two years after the first Viénot report recommending the creation of audit committees among listed companies. Multivariate analyses show that the existence of an audit committee, and the committee's independence, are both negatively correlated with insider ownership, consistent with the owner-manager agency theory that considers audit committees as devices aimed at strengthening the monitoring system, the quality of financial reporting and the whole corporate governance environment. The existence of an audit committee that complies with corporate governance recommendations (i.e., a minimum of three directors, all of whom are non-executive directors) also positively depends on leverage if the firm has a high-IOS (Investment Opportunity Set). The quality of accounting numbers thus seems important in shareholder-debtholder relationships if lenders are potentially more exposed to default risk and expropriation mechanisms. However, this result might be sensitive to the IOS measurement and classification of high- and low-IOS companies. Finally, the presence of an audit committee is found to be positively correlated with board size, firm size, auditor reputation, and with the diversity of the company's operations.     

An exploratory study of the effects of the European Union 8th Directive on Company Law on audit committees: Evidence from EU companies listed on the US stock exchanges

Member States in the European Union will be required to establish audit committees for all public-interest entities, according to the EU 8th Directive on Company Law. This EU 8th Directive creates a convergence of corporate oversight for both audit processes and financial reporting process and thus provides an opportunity to examine and contrast associations that exist among audit committee, board of directors characteristics with audit committee alignment, and the impact of such alignment on earnings management. Results of a logistic regression analysis suggest that firms with audit committees possessing greater financial expertise, with larger boards and more independent boards are less likely to engage in audit committee alignment while firms with audit committees possessing greater governance expertise are more likely to engage in alignment. In addition, we find that firms associated with audit committee alignment engage in less earnings management.     

Corporate governance,capital structure and firm performance: Evidence from Thailand

We examine the relationship between corporate governance and firm performance for a panel sample of 493 firms of non-financial firms in Thailand during the period 2001–2014. We find that for the full sample, corporate governance is not associated with financial leverage and firm performance. Leverage has a positive effect on firm performance. When we split firms into small and large firm subsamples, we observe some influence of corporate governance. The negative effect of audit committee size on firm performance is evident for large firms while the effect of audit reputation on firm performance is evident for small firms only. Furthermore, financial leverage mediates the effect of audit committee size on firm performance for the large firms.     

Are Audit Committees Red Herrings?

The common expectation of committees established in the wake of the corporate debacles during 1980s in the English-speaking world is that the audit committee device will raise the standards of corporate accountability and governance by improving the quality of financial reporting. That expectation is based on the prevalent belief that by strengthening the independence of auditors and non-executive directors audit committee members will monitor the financial reporting process in an independent manner. Unless accounting practices are reformed so that financial statements can be authenticated by recourse to reliable commercial evidence, audit committees are red herrings. Such reforms are essential if audit committee members are to keep under vigilant appraisal matters pertaining to the financial governance of, and reporting by, firms: the raison d'être of their appointment.     

The effect of disclosure committees on non-GAAP reporting quality

I examine whether company-implemented disclosure committees help to improve non-GAAP reporting quality. I find that firms with disclosure committees provide higher quality non-GAAP performance metrics and that the exclusions used to calculate their non-GAAP numbers are less persistent for future operating income and operating cash flows. Moreover, I find that firms with disclosure committees are less likely to receive SEC comment letters about non-GAAP disclosure. For firms that receive comment letters about non-GAAP reporting, disclosure committees can help to improve non-GAAP reporting quality. Comparing the influence of audit committees and disclosure committees, I find that audit committee financial experts have stronger monitoring effects than those on disclosure committees. Meanwhile, legal experts on disclosure committees provide similar monitoring compared to audit committees’ financial experts. Finally, the interaction between audit committee financial experts and disclosure committee legal experts produces the strongest effect on non-GAAP reporting quality. In sum, my analyses suggest that disclosure committees can provide important monitoring of non-GAAP reporting.     

Board risk committees: Insurer financial strength ratings and performance

We hypothesize and find that the existence of a board risk committee is positively related to A.M. Best’s Financial Strength Ratings, a measure widely used in the insurance industry to assess financial health. Using a sample of insurance firms from 2007 to 2013, we measure the impact of board risk committees on financial strength ratings and performance after controlling for various factors such as corporate governance characteristics. We find that firms with board risk committees report higher financial strength ratings, but only in the post-financial crisis period. Also, the formation of a board risk committee is positively associated with an increase in financial strength ratings from the year prior to committee formation to the year after committee formation. Further, we find that the presence of a board risk committee is not related to short-run firm performance benefits and that it takes five years for the presence of a board risk committee to be associated with future performance. Overall, our results provide evidence suggesting board risk committees are effective and beneficial from the standpoint of rating agencies and long-term financial performance.     

Audit committee characteristics and financial statement comparability

Financial statement comparability enables weighing the similarities and differences in financial performance between firms. Prior studies mainly focus on the role of accounting standards in the production of comparability, but the role of economic agents has been largely overlooked. We find that a firm's audit committee size and financial expertise affect its financial statement comparability. Financial information tends to be more comparable among industry peers when audit committees are larger and more members have financial and accounting expertise. The effect of audit committee expertise on comparability is stronger for firms with less independent and smaller boards, for firms with non-Big 4 auditors and for firms with CEOs serving as the chairperson of the boards.     

Management earnings forecasts and the quality of analysts’ forecasts: The moderating effect of audit committees

This study investigates whether effective audit committees influence the association between management earnings forecasts and the properties of analysts’ forecasts. We posit that this influence on the part of an audit committee would likely result from increased responsibility for monitoring voluntary disclosure. Using the four attributes that the Blue Ribbon Committee (1999) and prior research suggest as being indicative of audit committee effectiveness, we find that analysts’ forecasts exhibit higher accuracy and lower dispersion with the issuance of management forecasts for those firms employing audit committees that are composed exclusively of independent directors, include an accounting expert, and act with due diligence. We also find that effective audit committees strengthen the association between management and analyst forecast accuracy. Our evidence, therefore, supports the notion that effective corporate governance influences the reliability of voluntary disclosure, and thereby benefits the users of financial information.     

Audit Committee Regulation in Australia: How Far Have We Come?

This paper presents a synopsis of the major developments in corporate governance regulations and recommendations for Australian audit committees, categorised into three distinct periods of regulation from 1976 to 2004. Earlier Australian research on audit committee formation, composition and diligence is summarised and compared. The research is then extended by presenting the results of an empirical study of 188 of the top 300 ASX listed companies with a financial year end of 30 June 2004, the first year of the third period of regulation. The results indicate that compliance with corporate governance regulations and recommendations had improved substantially with respect to: audit committee formation; the number of audit committee members, non‐executive directors on the audit committee; financial expertise of audit committee members; and the frequency of audit committee meetings. However, the number of independent directors on audit committees was well below ASX best practice guidelines.     

Audit committee financial expertise and properties of analyst earnings forecasts

An important role of financial accounting information is to aid financial statement users in forming expectations about the firm's future earnings. Prior research finds that accounting financial expertise of the audit committee is associated with higher financial reporting quality. We extend this literature by examining the association between audit committee financial expertise and analysts' ability to anticipate future earnings. We find a significant association between accounting financial expertise on the audit committee and analyst earnings forecasts that are more accurate and less dispersed. In contrast, we do not find a significant association between non-accounting financial expertise (i.e., supervisory expertise) and forecast accuracy or forecast dispersion. These findings contribute to our understanding of the benefits of accounting expertise in audit committees by demonstrating an association between accounting financial expertise and improvements in analyst earnings forecasts.     

Audit committees’ oversight of bank risk-taking

This study examines whether audit committee effectiveness affects bank risk-taking and risk management effectiveness. We find that banks with long board tenure audit committees have lower total risk and idiosyncratic risk, and banks with busy directors on their audit committees have higher total risk and idiosyncratic risk. These suggest that high audit committee effectiveness may constrain bank risk-taking activities. We also find that firm performance is more positively associated with bank risk for banks with long board tenure, more female audit committee members, or large size audit committees than for other banks, consistent with the notion that audit committee effectiveness may increase risk management effectiveness. However, this finding should be interpreted cautiously as it is contrary to the results on audit committee busyness.     

On the demand for independent and active audit committees

We extend the literature on director independence and the role of the board by focusing on the importance of audit committees in the contracting process. We find that the demand for independent and active audit committees is positively related to the demand for accounting certification. In particular, we find that the likelihood of a firm having a completely independent and active audit committee is negatively related to firm growth opportunities and managerial ownership and positively related to firm size and leverage. Our results suggest that audit committees are an important organizational construct related to the demand for accounting certification.