Audit Committee Competence and Earnings Management in Europe

César Zarza Herranz,Nuria Reguera Alvarado,Felix J López Iturriaga

doi:10.6018/rcsar.385331

César Zarza Herranz, Nuria Reguera Alvarado + Show 1 more

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https://doi.org/10.6018/rcsar.385331

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Abstract

This study analyses the association between the competence of audit committee members and earnings management in a sample of 142 non-financial firms from France, Germany, Italy, Spain, and the United Kingdom over the 2006–2013 period. We measure members’ competence through their dedication and expertise. We find that outside directorships have a dual effect, such that a balanced level of dedication to the audit committee (roughly two outside directorships) reduces earnings management. We examine four types of expertise: audit, non-audit accounting, non-accounting financial, and supervisory expertise. We find a negative relation between earnings management and the audit experience of committee members, and that the other types of expertise play no relevant role. We also find that the contribution of audit experts to curbing earnings management proves particularly important in smaller and less active committees, as well as in smaller and busier boards. Este estudio analiza la asociación entre la competencia de los miembros del Comité de Auditoría y la gestión de los beneficios en una muestra de 142 empresas no financieras de Francia, Alemania, Italia, España y el Reino Unido durante el período 2006-2013. Se mide la competencia de los miembros a través de su dedicación y experiencia. Se descubre que el cargo de consejero externo tiene un efecto doble, de modo que un nivel equilibrado de dedicación al comité de auditoría (aproximadamente dos cargos de consejero externo) reduce la gestión de beneficios. Se examinan igualmente cuatro tipos de experiencia: de auditoría, contable no relacionada con la auditoría, financiera no contable y de supervision, encontrándose una relación negativa entre la gestión de beneficios y la experiencia en auditoría de los miembros del comité, y que los otros tipos de experiencia no desempeñan ningún papel relevante. También se descubre que la contribución de los expertos en auditoría para limitar la gestión de beneficios resulta especialmente importante en los comités más pequeños y menos activos, así como en los consejos más pequeños y más ocupados.

Highlights

The recent financial crisis and high-profile corporate financial scandals have renewed the concerns of policymakers, investors, and academia alike with regard to the quality of financial information Palazuelos Cobo et al, 2017)
Consistent with Baccouche & Omri (2014), our results suggest that when audit committee members belong to too many boards, they can become swamped and ineffectively mitigate earnings management
We explicitly show that accounting expertise, as it is broadly defined, is too vague and that only audit expertise is relevant in terms of reducing earnings management

Summary

Introduction

The recent financial crisis and high-profile corporate financial scandals have renewed the concerns of policymakers, investors, and academia alike with regard to the quality of financial information Palazuelos Cobo et al, 2017). The reaction of capital market authorities to these episodes has resulted in a more enforceable legal framework One example of this new framework is the European Union regulatory framework on statutory auditing (mainly, Recommendation 2005/162/EC and Directives 2006/43/EC and 2014/56/EU). This new legal setting focuses on the audit committee and on improving its function by ensuring directors’ competence. Research into these legal changes has shown that, more than the mere existence of audit committees, their monitoring effectiveness and competence are important vis-à-vis enhancing financial reporting quality (Bajra & Cadez, 2018). These results are in line with the evolution of studies exploring audit committees: whereas the first generation merely addressed the committee’s existence, subsequent studies have focused on certain characteristics of such audit committees, their independence, activity and their members’ expertise (Biedma López et al, 2011; Bilal et al, 2018; Ghafran & OSullivan, 2013; Inaam, 2016; Sultana et al, 2019; Zalata et al, 2018)

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