Audit committees and financial reporting quality

This thesis examines the impact of audit committee characteristics on financial reporting quality in the context of a large sample of UK companies over the period 2007-2010. The notion of financial reporting quality is assessed by looking at the audit quality and earnings quality of the firms. This study utilises the audit fee and non-audit fee ratio as its proxies for audit quality and accruals based earnings management models as its proxies for earnings quality. The findings from the multivariate analysis show that audit committee meetings and financial expertise exert a significant positive impact on audit fees. Investigating expertise further, this study finds no support for the notion that accounting expertise influences audit fees, however a significant positive influence on audit fees is recorded for the non-accounting financial expertise. However, the holding of additional directorships has a significant negative impact on audit fees. This study also finds that audit committee members' financial expertise has a negative and significant impact on non-audit fee ratio suggesting a strong support of members with financial expertise on issues relating to auditor independence. The study also documents that audit committee members serving longer on the boards do not prefer to purchase high amount of non-audit services from the incumbent auditor. This study also records a significant positive impact of the holding of additional directorships on the provision of non-audit fee ratio, thus signifying a profound support for the busyness hypothesis which argues that overstretched directors are not very good monitors of financial reporting quality. Furthermore, this study finds broadly consistent evidence that audit committees meeting three or more times per year and fully independent audit committees exert a significant positive impact on the quality of reported earnings. This study also finds some evidence (depending on the earnings model used) that the level of ownership of audit committee members also exerts a positive impact on the quality of reported earnings, highlighting the fact that audit committee members with an equity stake in their companies are considered more effective in their oversight of the financial reporting process. On the other hand, this study finds evidence that the busyness of audit committee members (busyness defined in terms of the holding of board seats in other companies) has a significant negative impact on the quality of reported earnings. The composite variables (i.e. ACE1, ACE2, ACE3 and ACE4) representing those companies that satisfy all aspects of current best practice in terms of audit committee composition and operation, has a positive impact on the quality of reported earnings. This study covers the period 2007 to 2010 and therefore offers a contemporary analysis of the influence of audit committee characteristics on financial reporting quality. The study is very comprehensive in its scope not only in the selection of audit committee characteristics and methods employed to quantify these characteristics, but also in the use of various proxies developed to capture the true essence of financial reporting quality. The choice of multiple measurement methods both for the dependent and independent variables facilitates a much richer investigation into the relationship between governance and financial reporting quality variables. Therefore this study makes a major contribution to our understanding of the association between the various audit committee characteristics and financial reporting quality in the wake of recently introduced regulatory recommendations. These findings will also have policy implications as regulators around the world continue to define and refine the desired characteristics and behaviour of audit committees. Therefore, the findings of this study will ensure future policy changes regarding audit committees are adequately informed.