Audit committee characteristics and earnings management: is there link?

Pratheepkanth Puwanenthiren

doi:10.4038/ijabf.v4i2.32

Abstract

This study analyses the correlation between audit committee (AC) characteristics and earnings management in a sample of 100 Sri Lankan firms. The analysed AC characteristics include Size of AC, AC independence, AC knowledge and Frequency of AC meetings. The empirical evidence is provided by a sample of 100 Sri Lankan listed firms. Descriptive statistics and multivariate regression are performed. Evidence suggests that size of AC, AC independence and frequency of AC meetings are significant to reduce the earnings management. The remaining AC characteristics (i.e., AC knowledge) are not found to have a significant impact on the earnings management. Other than that, performance also found to be significant, a finding that is consistent with the previous literature on earnings management. This study provides further evidence on how AC characteristics affect their ability to oversee earnings management.

Highlights

An Audit committee (AC) represents a governance mechanism that needs to function effectively in order to limit potential agency conflict problems arising from the separation of corporate ownership and control (Abbott L. , Parker, Peters, & Raghunandan, 2003; Jensen & Meckling, 1976)
The results indicate that audit committee‟s meet about five times a year, the total number of meetings depends on the firm‟s terms of reference and the complesity of the firm‟s operation and a 63 percent of them have accounting knowledge
The study reveals that the interaction of the frequency of meeting is significantly related to earnings management practices

Summary

Introduction

An Audit committee (AC) represents a governance mechanism that needs to function effectively in order to limit potential agency conflict problems arising from the separation of corporate ownership and control (Abbott L. , Parker, Peters, & Raghunandan, 2003; Jensen & Meckling, 1976). Under the traditional view of good corporate governance where the focus is on the interests of shareholders, the equitable treatment of shareholders, and the disclosure and transparency by management – monitoring roles by the board, its committees and an independent auditor are central. Corporate boards are responsible for monitoring managerial performance in general, and financial reporting process in particular, a task that is delegated to audit committees. It is generally agreed that ACs play a significant role in corporate governance, in enhancing the board of directors‟ effectiveness in monitoring management (Klein, 2002; Li, Mangena, & Pike, 2012; Smith Report, 2003; Spira, 2003). The findings of corporate finance literture indicate that audit committee are important in financial reporting process (Li, Mangena, & Pike, 2012)

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Conclusion