I examine the association between audit committee quality and the quality of corporate internal control. While information on the quality of internal control is not generally available, companies changing auditors are required to disclose any internal control problems that were pointed out by their predecessor auditors. The empirical results are based on a comparison of companies disclosing such internal control problems with a control sample of companies changing auditors but not disclosing internal control problems. Audit committee quality is measured in three dimensions: its size, its independence, and its expertise. The internal control problems are observed at two levels of increasing seriousness: reportable conditions and material weaknesses. The sample time period precedes the effective dates of recent policy changes regarding audit committees. The results indicate that independent audit committees and audit committees with financial expertise are significantly less likely to be associated with the incidence of internal control problems. This is true for both levels of internal control problems. The results are consistent with recent policy emphasis on audit committee independence and expertise.

Recent trends in corporate board composition indicate an increase in the appointment of directors with legal expertise. Using two financial reporting quality measures, accruals quality and discretionary accruals, we find—for a sample of Russell 1000 firms in 2003 and 2005—that the presence (and proportion) of directors with legal backgrounds on the audit committee is associated with higher financial reporting quality. These results obtain after controlling for accounting expertise on audit committees. Also, supplementary tests indicate a positive association between changes in legal expertise and changes in financial reporting quality, suggesting that legal expertise serves as a monitor rather than as a signal of financial reporting quality. Further, the two forms of expertise interact —i.e., the presence of directors with both forms of expertise enhances financial reporting quality, beyond the contribution of the individual forms of expertise. Additional tests suggest that the positive effects of legal expertise are greater in the post-SOX period compared with a pre-SOX year.

A number of recent studies examine whether the joint provision of audit and nonaudit services (NAS) impairs auditor independence, and yield mixed results. We examine whether investors perceive auditor independence as being impaired when auditors supply nonaudit services, by investigating the association between fee-based measures of nonaudit service purchases and the earnings response coefficient (ERC). We find that the nonaudit fee ratio and the level of nonaudit fees were negatively associated with ERCs in 2001. When we use unexpected fees (a measure of over- or underpayment of nonaudit fees), we find a negative association between NAS purchases and ERC, but this occurs mainly in the second and third quarters following the release of the proxy. Further investigation reveals that the quarterly differences may be driven by the increasing flow of information (i.e., the first-time disclosures of fees and media analyses of these disclosures) that became available to investors during our sample period. We speculate that, during the course of the year 2001, the increase in information allowed investors to engage in better comparative analyses of the fee disclosures. We interpret our results as indicating that investors did perceive NAS as impairing auditor independence.