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SUMMARY
Audit committees have become a major means for companies to monitor the reliability of the financial reporting process. Despite the increase in support and responsibilities of audit committees, there is little empirical evidence documenting how well they accomplish their objectives. The results of studies that examined differences between companies with and without audit committees have been inconclusive, suggesting the need for additional research. This study provides evidence concerning whether audit committees are associated with a reduced incidence of errors, irregularities and other indicators of unreliable financial reporting.
To determine if the presence of an audit committee is associated with financial reporting reliability, five potential consequences of audit committees are identified, involving the occurrence of errors, irregularities and illegal acts. This study uses the following variables as measures of these consequences: shareholder litigation alleging management fraud, quarterly earnings restatements, SEC actions, illegal acts, and auditor turnover involving an accounting disagreement. Five separate treatment samples are compared to randomly selected control samples.
Results of random approximation tests support the association between the presence of an audit committee and more reliable financial reporting. For all five financial reporting consequences, the audit committee variable is significant, even in the presence of other company-specific variables that could affect the quality of financial reporting. These results provide evidence that firms with reliable financial reporting (i.e., the absence of errors, irregularities and illegal acts) are more likely to have audit committees. These results have implications for regulators, such as the Securities and Exchange Commission (SEC) and the various stock exchanges, as they attempt to formulate future corporate governance policy.
Key Words: Audit committees, Financial reporting problems
Data Availability: Data used in the study are available upon request.
In recent years, the accounting profession, users of financial statements and the government have expressed concern over the incidence of fraudulent financial reporting. One response on the part of companies to this concern has been the establishment of audit committees. Harold M. Williams, former sec Chairman (1977, 71), noted "the audit committee can enhance, if not ensure the credibility of corporate financial reporting." The Treadway Commission (NCFFR 1987,183) emphasized the key role that the audit committee should play with regard to monitoring the integrity of the financial statements, noting that "an informed and...
