The Role of the Audit Committee in Moderating the Negative Effect of Non-Audit Services on Earnings Quality

Abstract

This paper examines the effect of audit committee effectiveness on the relationship between non-audit services (NAS) and the quality of earnings. We hypothesize that audit committee effectiveness will mitigate the adverse effects of the provision of NAS on the quality of reported earnings. This study uses a sample of 455 firms listed on Bursa Malaysia in the year 2010. Audit committee effectiveness is measured using the Principal Component Method based on four audit committee variables: the size of the audit committee, the proportion of outsiders on the committee, the total number of audit committee meetings during the year, and the attendance rate for audit committee meetings. Examination on the dataset reveals that NAS adversely affects the quality of accounting information, in terms of the lower earnings response coefficient (ERC). The statistical tests also show that this negative relationship becomes weaker when the firms have a more effective audit committee. The results are robust even after controlling for firm growth, risk, earnings variability, earnings losses, and the likelihood of debt covenant violation. In short, this study provides evidence that investors did perceive NAS as impairing auditor independence, and that the inverse effect would be reduced by setting up a more effective audit committee.