The effectiveness of audit committees : an analysis of governance mechanisms as surrogates for effectiveness

• Main Author: Dafinone, Daphne
• Published: City University London 2001
• Subjects: 338.6041; HB Economic Theory
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.393685

Current recommendations in the UK identify the audit committee as a key component of effective corporate governance. These recommendations emphasise the importance of structure and processes in an effective audit committee. It is therefore important to consider if these structures and processes are effective in promoting corporate accountability and control. This thesis therefore considers the extent to which the composition and structure of the audit committee is associated with the ability of the audit committee to fulfil its roles and objectives effectively in UK listed companies. It is reasonable to assume that an audit committee may be considered effective where it achieves its stated roles. The audit committee is not required to report to the shareholders within the financial statements on the extent to which they have achieved their roles. Thus, actual audit committee effectiveness cannot be externally observed. It is possible to measure audit committee effectiveness indirectly if it is considered that the absence of financial reporting problems indicates an audit committee has been effective in achieving their financial reporting oversight role. I.e. the extent to which the audit committees discharge their functional roles could be used as a surrogate for an external indication of audit committee effectiveness. This thesis therefore considers if the key governance mechanisms thought to impinge on audit committee effectiveness are present in companies in which the audit committee is considered to have failed in their financial reporting oversight role. The key governance mechanisms examined were: • The presence of the joint role of the CEO and the chairman; • Board Balance; • Existence of an audit committee; • Independence of the audit committee; • No. of audit committee members; • Existence of charter/terms of reference; • No. of meetings held by the audit committee per year; • Evidence of Interaction with / existence of Internal audit; • Financial literacy of members; • Technical competency of members; • Additional directorships of members. The results, based on comparing the above governance mechanisms in companies with no financial reporting problems ("CNFRP") to companies that have financial reporting problems (CFRP), indicate that "CNFRP's" have audit committees with significantly higher percentages of financially literate and technically competent members. This thesis provides insight into the effectiveness of governance mechanisms in UK audit committees during the period 1995-1999. This thesis contributes by updating our understanding of the factors that influence the effectiveness of the audit committee. It highlights that current recommendations in the United Kingdom, with their focus on audit committee composition and structure, should also consider the competency of audit committee members and determine a benchmark by which competency may be measured.