On the Interrelation between Corporate Governance, Audit and Earnings Quality: A Review of the Underpinning Theories

Abstract

The quality of reported earnings is important to investors in the financial market, as investors and analysts heavily rely on the company's reported earnings in making investment decisions. The board of directors, the audit committee, and the internal audit function represent the internal monitoring mechanism within a company, whereas the external auditors serve as an external monitoring mechanism providing independent verification of the quality of a company's financial reporting. Besides that, interdependencies exist between a firm's internal corporate governance structure and its external audit function. Given the important effect of these monitoring mechanisms on a company's financial reporting process, this paper aims to to discuss the relevance of various theories used in academic research in explaining the role of corporate governance and auditors in promoting higher earnings quality. Through the review of literature, we have found that the agency theory, stewardship theory, institutional theory, and managerial hegemony theory as the main theories that provide significant insights into the efficiency and effectiveness of corporate governance and audit functions from various perspectives. Hence, this suggests that future research could consider the use of multiple theories together in the explanaining the interrelation between corporate governance, audit, and earnings quality. Our paper would be of interest to academicians, practitioners, regulators, and policymakers in trying to understand how a company's internal corporate governance characteristics such as the board, audit committee, and internal audit function, as well as how the external auditors affect the quality of financial reports produced by companies. Our paper also contributes to the literature as this paper comprehensively provides a synthesis and a holistic view of how these four theories complement each other in explaining the interrelation between the different governance mechanisms and financial reporting.

The Competence of Audit Committee Members concerning the External Audit Ethics

“…The members of these committees must possess a deep understanding of key audit concepts to effectively fulfill their responsibilities, which encompass monitoring the audit process, safeguarding audit quality, and maintaining trust in the financial reporting of PIEs. This role is emphasized by various scholarly sources, including Al-Baidhani (2014), Hay (2015), Fallatah (2017), andMohd Kharuddin (2016), which stress the importance of audit committees in upholding the integrity and quality of financial reporting in the context of PIEs.…”

“…It is critical to recognize that, despite their advantages and disadvantages, audit committees do not have executive authority (Mohd Kharuddin, 2016;Al-Baidhani, 2014). Fan (2016) asserts that audit committees primarily act in advisory roles, with their decisions not directly impacting the day-to-day operations of PIEs.…”

The Historical Evolution, Developments and Accounting Implications of Cryptocurrency Operations

“…The fundamental basis of stewardship theory focuses on understanding how corporate executives could be motivated in order to contribute to the realization of organizational goals and objectives. According to Kharuddin and Basioudis (2022), the stewardship theory assumes that the management team of an organization comprises trustworthy people whose interests are aligned properly with the organization as well as her owners. Further, they denoted running an organization based on stewardship theory would eliminate monitoring cost as well as opportunistic performance such as creative accounting.…”

“…This indicates that such organization does not need non-executive directors because all the individuals will be working in the favor of the organization as assumed by the theory. Nevertheless, Albrecht et al, 2004 in Kharuddin andBasioudis (2022) criticized the assumption of stewardship theory that management team comprises trustworthy person. They were of the belief that this assumption could open doors of opportunities for management to perpetrate fraudulent acts or other misrepresentations.…”