The effect of audit committee characteristics on earnings management: Evidence from the United Kingdom

Abstract

This study examines the impact of audit committee (AC) characteristics on earnings management (EM), of FTSE 350 companies, for the fiscal years 2006 and 2007. Characteristics such as number of members and meetings; independence; directors’ remuneration; outside directorships; various types of financial expertise; AC members’ ownership; regulated sector; and the listing on FTSE 100 are investigated. No significant association was found between absolute discretionary accruals and these characteristics, apart from in the regulated industry. The results for signed discretionary accruals show that some characteristics have an effect on either upward or downward EM. This reveals the importance of distinguishing between AC effectiveness on constraining upward and downward EM. This article explores some qualitative AC characteristics, which have not previously been examined. In addition, it is probably the first to examine the effect of several AC characteristics on EM in the UK context. The findings of this study provide useful insights for regulators in order to improve and reconsider the current regulations on AC mechanisms. The findings of generally ineffectual ACs in the United Kingdom, along with many similar findings from other countries (see Xie et al, 2003 and Baxter and Cotter, 2009), raise concerns about the current situation of the regulation and the composition of ACs. External auditors are warned against relying on the form rather than substance of ACs.