Requisitos básicos para determinar los hallazgos de auditoría

(1) Recent developments

Prior to the SOX (2002), the formation of audit committees was voluntary. According to Turley and Zaman (2004), the formation of audit committees was usually an attempt to reduce agency costs. The variables hypothesised to support such a proposition were therefore mainly agency cost proxies (Dey, 2008; Rainsbury, Bradbury & Cahan, 2008). Subsequent to the SOX (2002), research into the audit committee’s formation has been geographically spread to other share markets where the regulatory requirement on the audit committee formation is regarded as less rigid than those of the United States and the United Kingdom.

(2) Synthesis of the determinants of audit committee formation and

composition

As a result of regulatory requirements, the establishment of audit committees in listed companies has been regarded as standard corporate governance practice for most of the world’s major stock exchanges. Despite some inconsistency in the research findings, it is generally established that the determinants of an audit committee: (i) formation, (ii) independence, and (iii) financial expertise, are associated with:

(1) Ownership structure (2) Leverage

(3) Source of funding

(4) Board of directors’ characteristics; and (5) Firm characteristics.

22

I. Determinants of audit committee formation

The discussion of the determinants of audit committee formation has been expanded and enriched. Using ownership structure as an example, Chau and Leung (2006) investigated the association between family ownership and the establishment of audit committees in Hong Kong listed companies, while Piot (2004) and Ruiz-Barbadillo, Biedma- López and Gómez-Aguilar (2007) examined the association between management ownership and the formation of audit committees in European companies. In addition, Vermeer, Raghunandan and Forgione (2006) and Iyer and Watkins (2008) studied the formation of audit committees in not-for-profit organisations, expanding the scope of the theoretical framework that can be applied to explain the formation of audit committees. See Table 2-1.

Table 2-1: Summary of post-SOX (2002) research into the determinants of audit committee formation and composition

Studies Ownership structure Leverage Source of funding BOD characteristics Firm characteristics

Piot (2004) Negative association

(+)3 with level of insider ownership Positive association () with debt to equity structure Positive association (+) with board size

Positive association (+) with the level of operational diversity Positive association (+) with firm size

Chau and Leung (2006)

Negative association (+) with family dominated ownership

Positive association (+) with board independence Vermeer, Raghunandan and Forgione (2006) Positive association (+) in non-profit organisations with level of government funding No association (-) in non-profit organisations with long-term debt or donations Positive association (+) with the size of the non- profit organisations, but negative association (-) with universities and hospitals

Iyer and Watkins (2008)

Positive association (+) with board size

Positive association (+) with board independence

Positive association (+) with the size of the budget

Rainsbury, Bradbury and Cahan (2008)

No association (-) with debt to equity structure

Positive association (+) with board size

Positive association (+) with board independence

No association (-) with firms’ growth

opportunity measured by the market to book ratio

3 _{(+) indicates that the test result confirmed the expectation of the audit committee impact, whereas (-) indicates that the test result did not support the expected}

impact of the audit committee.

24

I. Determinants of audit committee financial expertise

Given that the nature of the audit committee function is to oversee the financial reporting process, having financial experts serving on the audit committee has become a common practice in listed firms. With respect to members’ competencies, Section 407 of the SOX (2002) requires listed public firms to include at least one member who is a financial expert, or to disclose reasons for not adopting this requirement. Since then, two research studies in the USA have examined the number of financial experts on audit committees in relation to the ownership structure, leverage, and firm characteristics. See Table 2-2 for the studies’ findings.

Table 2-2: Determinants of audit committees’ financial expertise

Studies Ownership

structure

Leverage Firm characteristics

Carcello, Hollingsworth and Neal (2006) Positive association (+)with level of institutional ownership Positive associations (+) with firm size, level of litigious risk and firms’ financing activities

Dey (2008) Positive association (+) with separation of ownership and management Positive association (+) with debt to equity structure Positive associations (+) with other agency conflict attributes, including firm size, industrial complexity, growth, level of

operating risk, and free cash flows

Having financial experts on audit committees reflects the public expectation. However, what are the benefits of their financial expertise? Synthesis of the corporate governance impact of financial expertise will be discussed in section 2.3.3.

II. Determinants of audit committee independence

Although independence is considered to be a crucial element for an audit committee to be effective in discharging its responsibilities, there has been disagreement about the ideal proportion of independent directors and what causes it to vary between firms. See Table 2-3 for a summary of the studies.

Table 2-3: Determinants of audit committee independence Studies Ownership structure Leverage Source of funding BOD

characteristics

Firm characteristics Cotter and Silvester

(2003)

Negative association (-)4 with debt to equity structure

Positive association (+) with board independence

Piot (2004) Negative association

(+) with level of insider ownership

Weak association (-) with debt to equity structure Vermeer,

Raghunandan and Forgione (2006)

Positive association (+) in non-profit

organisations with level of government funding No association (-) in non-profit organisations with long-term debt or donations

Positive association (+) with the size of non-profit organisations, but negative association (-) in universities and hospitals

Charitou, Louca and Panayides (2007)

Positive association (+) with firms’ complexity of financing activities Ruiz-Barbadillo, Biedma-López and Gómez-Aguilar (2007) Negative association (+) with level of management ownership Positive association (+) with board independence

Negative association (+) with CEO/director duality

Dey (2008) Positive association (+)

with separation of ownership and management

Positive association (+) with debt to equity structure

Positive associations (+) with overall agency conflict, including firm size, industrial complexity, growth, level of operating risk, and free cash flows Rainsbury,

Bradbury and Cahan (2008)

No association (-) with debt to equity structure

No association (-) with firms’ growth opportunity

4 _{(+) indicates that the test result confirmed the expectation of the audit committee impact, whereas (-) indicates that the test result did not support the expected impact of}

the audit committee.

26 (3) Discussion

Firstly, firm size as a determinant of audit committee formation and composition is inconsistently measured, but results in relatively consistent, positive test results with a few exceptions. Fama and Jensen (1983) suggested that agency conflicts become more severe as firm size increases and that greater control of managerial actions is therefore required. If this is so, a positive relationship between firm size and desirable audit committee composition and control activities would be expected (Dey, 2008). Research has established that firm size was positively associated with audit committee existence (Piot, 2004; Iyer & Watkins, 2008). Firm size, however, was measured in different ways in these studies. Piot (2004) and Vermeer, Raghunandan and Forgione (2006) measured firm size as the book value of total assets.

Carcello, Hollingsworth and Neal (2006) and Raghunandan and Rama (2007) used total market value (share price at the year-end times total shares outstanding) to measure firm size. Dey (2008) measured firm size as the natural logarithm of sales, but did not provide any explanation for adopting this specific measurement. By surveying the CFOs of 215 non-profit

organisations, Iyer and Watkins (2008) suggested that the size of their budgets was positively associated with the formation of audit committees.

Vermeer, Raghunandan and Forgione (2006) examined the formation and composition of audit committees in 128 non-profit organisations in the USA. They found that the voluntary establishment of audit committees and the committees’ independence were positively associated with reliance on government funding rather than reliance on long-term debt or donors. They also provided evidence that contrary to expectation, universities and hospitals were less likely to have solely independent directors on the audit committee, even though they were usually large in size and subject to a high level of public scrutiny of their efficiency.

Secondly, leverage, usually measured as the ratio of long-term debt to total assets, is also presumed to be one of the important determinants for firms adopting an audit committee on a voluntary basis (Turley & Zaman, 2004). As agency conflicts rise with the level of debt, debt holders may require better governance mechanisms in place to safeguard their interests 5 (Jensen & Meckling, 1976). Leverage is therefore normally hypothesised as being positively associated with the establishment of good quality audit committees. However, in circumstances of the

5

Under a high leverage structure, owner–managers have an incentive to prioritise shareholders’ benefits to the detriment of the creditors’ benefits.

27

voluntary adoption of audit committees, only Dey (2008) confirmed that high leverage correlates with audit committee members being independent and having a high level of expertise. The other studies did not support the hypothesis that leverage is a significant determinant of audit committee formation and independence.

The mixed results of the association between leverage and audit committee variables are displayed in Table 2-4.

Table 2-4: Post SOX(2000) studies on the relationship between leverage and audit committee attributes

Cotter &

Silvester (2003) Piot (2004) Dey (2008)

Rainsbury

et al (2008)

Country Australia France U.S.A. New

Zealand

Audit committee variables

Formation --- Weak positive

association --- No association Independence Negative association Weak positive association Positive association No association Expertise --- --- Positive association ---

Thirdly, audit committees’ formation and composition are also associated with firms’ industrial contexts, in particular their litigious risk, but this is not consistent across industries (Ashbaugh, LaFond & Mayhew, 2003). Firms with high litigious risk tended to emphasise more formal corporate governance settings, including audit committees (Ashbaugh-Skaife, Collins & LaFond, 2006b). Piot (2004) provided evidence that in the generally less litigious environment of France, the formation of audit committees was associated with the firms’ operating

diversification. However, in New Zealand, where the corporate governance rules are also considered relatively less rigid, the formation and independence of audit committees was not associated with the firms’ growth opportunities (Goodwin, 2003). Carcello, Hollingsworth and Neal (2006) observed that subsequent to initial public offerings, firms were more likely to designate financial experts on their audit committees. Charitou, Louca and Panayides (2007)

28

confirmed that firms listed on both the Canadian and USA share markets tended to have more independent audit committees.

(4) Gaps in the existing qualitative research on the determinants of audit committee formation and composition

When observing audit committee establishment, (independence and financial expertise) and their determinants, some propositions regarding an audit committee’s nature can be

discussed (Tsui, Subramaniam, & Hoy, 2006). Firstly, the audit committee, as a sub-structure of the board of directors, carries out its function through board delegation. Therefore, audit

committee members are obliged to understand and represent the board’s expectations and report to the board about the outcome of its delegation. Little research has been done about the

interaction between the audit committee and the board.

Secondly, the agency problem, ownership structure, and litigious/industrial risks are key issues of corporate governance. To perform their role in corporate governance efficiently, audit committee members need to interpret their delegated duties according to their specific

organisational setting; such interpretation involves subjective and professional judgement. Little has been documented about how audit committee members reflectively interpret their role, their attributes, and their efforts in relating to their particular organisations. It is questionable

whether financial or accounting expertise is the only desirable characteristic contributing to the performance of the audit committee role. This research study aims to address the above gaps by providing qualitative evidence about how individual audit committee members justify the

existence of their committee and identify the contributing factors which help them perform their daily audit committee tasks.