Audit committee characteristics and loss reserve error

Abstract

Purpose -The purpose of this paper is to investigate two audit committee characteristicsindependence and expertise of the audit committee -and the property-liability insurers' financial reporting quality, which is proxied by loss reserve error. Design/methodology/approach -The authors' hypotheses are tested using multivariate analysis where the loss reserve error is the dependent variable, and audit committee independence, and four types of audit committee financial expertise (accounting, finance, supervisory, and insurance expertise) are the testing variables. Findings -It is found that accounting, finance, and insurance financial expertise are associated with more accurate loss reserve estimate. In contrast, a supervisory financial expertise and an independence audit committee are not found to be associated with better loss reserve quality.Research limitations/implications -The sample includes publicly-held property-liability insurers. Although the results from publicly-held insurers could provide a good laboratory for such investigation in all insurers, they might be limited due to different organization structures of public vs private insurers. Practical implications -The implications of the study are important for the SEC and NAIC. The results suggest that the requirements on the audit committee financial expertise would be necessary, even in highly regulated industry, such as property-casualty insurance. Originality/value -The paper contributes to the extant literature by studying audit committee characteristics in the insurance industry. It also contributes to the extant literature on audit committee effectiveness by decomposing the financial expertise into four types of financial expertise (accounting, finance, supervisory, or insurance expertise) and investigates which (if any) of these four types of expertise really drives the improvement of loss reserve quality.

The Governance Role of Audit Committees: Reviewing a Decade of Evidence

“…Lary and Taylor (2012) Australia AC independence and financial expertise are significantly related to a lower incidence and severity of financial restatements. Sun et al (2012) USA Accounting, finance and insurance financial expertise are associated with more accurate loss reserve estimates.…”

“…The three most discussed characteristics of audit committees in the empirical literature are the independence of audit committees; the number of meetings they hold annually and their financial expertise. The evidence from the earnings management literature shows that audit committee independence Davidson et al 2005;Ebrahim 2007;Kent et al 2010;Koh et al 2007;Lo et al 2010;Vafeas 2005;Xie et al 2003;Yang and Krishnan 2005) and financial expertise Krishnan and Visvanathan 2008;Lo et al 2010;Sun et al 2012;Xie et al 2003) have a positive influence on firms' earnings quality. 11 Similar findings are reported in meta-analysis investigating the relationship between audit committee independence, expertise, meetings and earnings management (Garcı'a-Meca and Sa'nchez-Ballesta 2009; Lin and Hwang 2010).…”

The Role of Internal and External Corporate Governance Mechanisms on Firm’s Financial Performance in Malaysia

“…A study by Sun, Wei, and Xu (2012) found that accounting, finance and insurance financial expertise in audit committees are associated with more accurate loss reserve estimates. Similarly, Lary and Taylor found that audit committees independence and financial expertise are significantly related to a lower incidence of financial re-statements (i.e.…”

Corporate Governance: An Overview. From Creation of Value for Shareholders by the Board to the Duality Role of Its Chairperson

“…The combination of financial expertise with practical experience in financial statements preparation or industry experience enhances the ability of audit committees to monitor the quality of financial reporting (Sun & al. 2012).…”