Audit Committee Effectiveness and Financial Reporting Quality: Evidence from Low and Mid Tier Australian Firms

Wonsil Kang
Macquarie University
Australia

Alan Kilgore
Macquarie University
Australia

Sue Wright
Macquarie University
Australia

Abstract:
Recent corporate collapses and audit failures have undermined confidence in corporate governance, and have led to questions about the quality and integrity of corporate financial reporting practices. The intent of recent regulatory changes has been to restore confidence in corporate governance by improving the credibility and reliability of financial reporting. In this context, this study examines the relation between audit committee characteristic and financial reporting quality for non-top 300 (low and mid tier) listed firms on the Australian Stock Exchange (ASX) for the year 2006. In particular, in a setting in which audit committee formation is not mandatory, the study investigates the effectiveness of ASX Recommendations relating to audit committee formation, independence, technical expertise, size, number of meetings and charter, in terms of whether these recommendations have helped to improve financial reporting quality. In examining this issue, the study employs an advanced set of measures of earnings management as a proxy for financial reporting quality which have not been used before in Australian studies in this area. Based on a sample of 288 low and mid tier firms listed on the ASX, this study finds that independence and financial expertise are significantly associated with lower earnings management. The results provide support for the validity of ASX Recommendations in regard to audit committees and suggests that qualitative audit committee characteristics are important in improving financial reporting quality for low and mid tier firms.