To what extent does the audit committee curb downward earnings forecast guidance?

Abstract

Purpose – The purpose of this paper is to examine the association between audit committee characteristics and a firm’s ability to guide analysts’ forecasts downward to meet or beat earnings benchmarks. Design/methodology/approach – The authors expect that a more effective audit committee would be able to reduce managers’ propensity to use downward forecast guidance to avoid negative earnings surprises. Four committee characteristics are used to measure its effectiveness: independence, diligence, expertise and size. Findings – For the pre-SOX (Sarbanes-Oxley Act) period (1996-2002), none of the four audit committee characteristics are significantly associated with managers’ propensity to use downward forecast guidance to avoid negative earnings surprises. For the post-SOX era (2003-2004), however, the likelihood of engaging in downward forecast guidance is significantly lower for firms with larger and more independent audit committees. In addition, the likelihood is significantly lower for audit committees that are more diligent and have a higher proportion of the committee members with accounting or finance-related expertise. Research limitations/implications – Overall, the authors results suggest that, in response to the increased regulatory and listing requirements in the post-SOX era, audit committees have played a more active role in scrutinizing earnings guidance. Our results also suggest that a more effective audit committee in the post-SOX era curbs managers’ tendency to use downward forecast guidance to meet or beat quarterly earnings targets. Originality/value – To the authors knowledge, this study is one of the first to examine the role of the audit committee in reviewing managerial earnings guidance. As earnings guidance plays an important role in the overall financial reporting process over time and given the increasing importance of downward forecast guidance in earnings surprise games in recent years, the authors believe this study addresses an important question and adds to prior literature. Also, this study contributes to their understanding of the changing nature and scope of audit committee oversight activities since the passage of SOX.

Audit Committee Characteristics and Accounting Conservatism: Does the Power of People Matter?

“…It further argues that, post-revolution, audit committees with financial expertise create effective monitoring functions (Badolato, Donelson, and Ege, 2014;Carcello, Neal, Palmrose, and Scholz, 2011), and that higher audit committee diligence reduces earning management and increases the quality of accounting information (Kang, Kilgore, and Wright, 2011;Suárez, García, Méndez, and Gutiérrez, 2013;Sultana, 2015). Although having a large audit committee is positively associated with higher earnings quality and negatively associated with the likelihood of engaging in downward earnings forecast guidance (Jennifer, Liu and Wang, 2014), the study suggests that smaller sizes audit committee post the Egyptian Revolution would be more efficient to the Egyptian firm to decrease the likelihood of engaging in heated debates and conflicts after a large exogenous market shock like the Revolution. Finally, audit committee members with multiple directorships are more experienced and have an extra monitoring mechanism that helps them perform their duties well (Sun, Liu and Lan, 2012).…”