The Audit Committee and Earnings Quality

Abstract

This paper provides empirical evidence on the association between audit committee formation and the quality of accounting earnings. The audit committee is responsible for overseeing the jnancial reporting and auditing process of the j r m . This paper assesses the eflectiveness of the audit committee in discharging these responsibilities by comparing the quality, or informativeness, of earnings reports before and after audit committee formation. For this paper, informativeness is measured by the extent to which the market reacts to the release of earnings reports. Economic theory predicts that the magnitude of the market's reaction to earnings is a nondecreasing function of earnings quality. The results show a signiJicant increase in the market's reaction to earnings reports subsequent to the formation of the audit committee. SpeciJically, the reaction to earnings reports is more than 20 percent greater after the forniatiorr of the committee than before. These findings are robust to alternative variations in the research design. Overall, the evidence is consistent with the audit committee providing meaningful oversight of the jnancial reporting and auditing process.

Board Characteristics and Firm Performance: Case of Saudi Arabia

“…Felo, Krishnamurthy andSolieri (2003) find a positive relationship between AC size and financial reporting quality. However, the previous studies indicated that better quality of financial reporting and disclosure leads to improve the performance of the firm (Wild, 1996).…”

“…Previous studies find that firms with ACs perform better than those without them and the ACs play a significant role in improving the firm performance (Wild, 1996;Weir, Laing & McKnight, 2002). On contrast, other studies revealed that ACs have no effect on the performance of the firms (Theodorou, 1998;Weir et al, 2002).…”

“…Over the time, the main role of the AC is to improve the quality of information (Pincus et al, 1989) which leads to improve firm performance (Wild, 1996). The Australian Corporate Governance Guidelines defines the role of AC to oversee and monitor the financial reporting quality and to oversee the independent of external auditors.…”

“…The main role of the AC is to improve the quality of the financial reporting (Pincus et al, 1989) which leads to improve the firm performance (Wild, 1996). Different perspectives have been stated on the size of AC.…”

The Impact of Managerial Opportunism on Earnings Reliability

“…Managers" incentive to exploit accrual basis accounting increases if they are bound to meet specific targets (Holland & Ramsay, 2003;Dechow et al, 1996). Wild (1996) and Dechow et al (1996) suggest that an appropriate monitoring system is essential in controlling the managerial opportunistic behaviour. Thus, the efficiency of such monitoring system shall affect the level of reliability of the accounting data.…”