The Scope of Audit Committee Oversight and Financial Reporting Reliability: Are Audit Committees Overloaded?

Abstract

Audit committee (AC) responsibilities have been increasing over time, prompting concerns that overloading ACs may impair their effectiveness. Using new measures to capture AC responsibilities based on AC charters, we find that greater AC responsibilities are associated with improved financial statement reliability. Contrary to overload concerns, this association is strongest when ACs have very high levels of responsibilities. Cross-sectional analyses indicate greater AC responsibilities improve financial statement reliability at complex firms, following significant governance lapses, when AC members are capable and experienced, and when ACs also meet often to carry out their oversight duties. Further analysis suggests that our AC responsibility results are driven by duties related to financial reporting while, in stark contrast, allocating responsibilities unrelated to financial reporting to the AC (e.g., risk management) detracts from monitoring effectiveness by decreasing financial statement reliability. The latter is consistent with an overload effect driven by responsibilities that distract the AC from its core financial reporting oversight mandate. Our results inform recent regulatory changes at some exchanges to expand AC oversight.

When Does the Internal Audit Function Enhance Audit Committee Effectiveness?

“…In general, there is broad-based evidence that AC independence and expertise are associated with many different control, audit, and reporting outcomes (e.g., Klein 2002;Abbott, Parker, and Peters 2004;Krishnan 2005;Cohen et al 2014). 9 Despite the difficulty in measuring AC authority and diligence, some studies have shown that these dimensions also affect financial reporting quality (e.g., Badolato, Donelson, and Ege 2014;Ashraf, Choudhary, and Jaggi 2020;Bratten, Causholli, and Sulcaj 2019). 10 My study relates closely to the resources component of AC effectiveness.…”

“…Anecdotally, three AC chairs I interviewed confirmed without exception that they are careful to carry out every duty listed in their charter. Thus, I consider the AC charter a useful proxy for actual AC responsibilities and activities (Ashraf et al 2020).…”

“…As such, my sample period ends in 2006.16 I thank Musaib Ashraf and Preeti Choudhary for their assistance in gathering AC charters. The base sample of AC charters I use is the same as that used inAshraf et al (2020).…”

Connecting the right knots: The impact of board committee interlocks on the performance of Indian firms

“…Second, with increasing responsibilities of audit committee members, serving on multiple audit committees may well overburden the directors concerned and exacerbate the problem of information overload (Ashraf et al, 2020). Service on the audit committee involves a higher meeting frequency (Brandes et al, 2016), and greater responsibilities with respect to the management of financial risks (Vera‐Munoz, 2005), than is the case with any other mandatory committee.…”

Do companies try to conceal financial misstatements through auditor shopping?

“…We first investigate the effect of the financial expertise of the audit committee. The responsibilities of the audit committee have been ever-expanding (Ashraf et al, 2019). Since the audit committee oversees the financial reporting process and is directly responsible for the appointment, and oversight of the work of the external auditor, management's desire to engage in auditor shopping may face resistance from a diligent audit committee.…”