The effectiveness of the board of directors monitoring function is increased by the inclusion of outside (i .e., non-management) directors on the board (e.g.,
Fama 1 980, Fama and lensen 1 983, Pfeffer 1 98 1 , Bradbury 1 990). Outside directors are presumed to be more independent of management and limit
opportunities for the board of directors to become an instrument of management (e.g., Williamson 1 984). Outside directors are generally managers or directors of other corporations. The value of their human capital is directly linked to their reputations for high quality decision making, which they maintain by
demonstrating expertise in decision control on the board of directors (e.g., Fama 1 980).
The value of outside directors in the governance of private sector companies has been confirmed through many studies (e.g., Kosnick 1 987, 1 990, Brickley and lames 1 987, Weisbach 1 988, Cotter et al 1 996, Brickley et al 1 994). Most notably, Rosenstein and Wyatt ( 1 990) provide evidence of increases in positive stock returns around announcements of outside director appointments. Beasley ( 1 996) fi nds that the l i kelihood of management fraud decreases with the higher percentage of outside directors on the board, while B easley and Salterio (2002) find that boards with greater proportion of outsiders are more likely to
voluntarily form audit committees. In New Zealand, Bradbury ( 1 990) provides evidence that proportion of outside directors on the board and intercorporate ownership are important determinants of enhanced corporate governance through voluntary formation of audit committees. Cahan and Wilkinson ( 1 999) provide evidence that in New Zealand the proportion of outside directors on the board increased in 1 990s after the Companies Act 1 993, which enhanced
corporate governance requirements, came into effect (also see Prevost et al 2000).
Further, Beasley and Petroni ( 1 998) find that the likelihood of a specialist high quality auditor (Big 6 firm) being chosen as a firm 's auditor increases with the percentage of outside directors on the board. This suggests that overall
monitoring of a firm ' s performance increases in quality with the increase in proportion of independent directors on the board.
F inally, Mayers et al ( 1 997) find that with companies where ownership rights are not transferable (mutual insurance companies) and where important corporate control mechanisms such as hostile takeovers and share-based incentive compensation are missing, the importance of monitoring function performed by outside directors is greater than for companies with transferable ownership rights. This finding is particularly significant for understanding the rol e of outside directors on the state owned corporations' boards. Since state owned corporate entities suffer from the lack of transferable ownership rights or shares, the monitoring role of directors, especially outside directors is increased.
In terms of the effect of outside directors' monitoring on auditing process and audit effort, the enhanced management monitoring by outside directors in general leads to a more effective control environment which, according to the ARM , reduces control risk for auditors and should therefore reduce audit effort.
In the New Zealand public sector, the Public Sector State Services Commission and Crown Company Monitoring Advi sory Unit (CCMAU) appoint directors of public sector corporate entities and maintain strict rules about directors'
independence.
Therefore, in case of New Zealand public sector corporate entities almost all appointed directors wil l be outside directors. However, in few instances the CEO is also a member of the board of directors. Jensen ( 1 993) recommends that the CEO should be separated from the board chairman function as his dual role can reduce board of directors effectiveness. The CEO's power to control the board is often attributed to the belief that the CEO can have the strongest influence in determining who is on the board of directors (e.g., Mace 1 986, Vancil 1 987, Patton and Baker 1 987). That can lead to the reduced ability of outside board directors to effectively monitor management by management's ability to limit board activities through controlling the board's chairperson position. The board chairperson's function is to run board meetings and to oversee the process of hiring, evaluating, compensating and firing senior
management. One way for shareholders to limit the CEO's ability to dominate the board of directors is to segregate the key positions of CEO and board chairperson .
Consistent with the view o f CEO duality i nappropriateness are findings of Dechow et al ( 1 996) who find that firms manipulating earnings are more likely to have a CEO who is also a board chairperson. Beasley and S alterio (2002) also find that the concentration of board power in one person as both board chair and CEO increases the potential for less effective monitoring by creating audit committees that have fewer outside directors with relevant financial reporting knowledge and experience.
In the New Zealand public sector, a CEO of a public sector corporation cannot also serve as the chairman of the board of directors, but his/her presence on the board can stil l have an i nhibiting effect on the effectiveness of the board' s monitoring function. The reduction i n monitoring effectiveness of the board may lead to an increase in control risk for auditors and, consequently, may impact on audit effort. Therefore, it is hypothesised in this study that:
H3 Audit effort wil l increase when the CEO is also a member of the board of directors.