Abstract:
The audit committee constitutes a fundamental element of a board ' s monitoring and control system and has traditionally been charged with overseeing the integrity of the financial reporting process. However, fuelled by high profile fraudulent cases such as Enron and WorldCom, the enactment of the Sarbanes-Oxley Act of 2002 has resulted in an expanded scope of duties and structural changes for audit committees. One new requirement is the need for publicly listed firms to possess at least one financial expert on their audit committee. In introducing this requirement, regulators believe that the presence of financial expertise will assist the audit committee in executing its monitoring role of the financial reporting process. This thesis consists of two essays that examine the nature of the relationship between financial reporting quality and a specific type of financial expertise, which prior literature suggests is most important for audit committee service, namely, accounting expertise. The first essay evaluates the association between accounting expertise in audit committees and accruals quality, a commonly-used proxy for financial reporting quality. After controlling for the other determinants of accruals quality, the results indicate a significant positive relation between accounting expertise in audit committees and accruals quality, but no significant association between accruals quality and the presence of non- accounting (finance or supervisory) financial expertise in audit committees. Further, this essay documents that the positive association between audit committee accounting expertise and accruals quality is more pronounced in the presence of strong audit committee governance. The results provide support for the notion that expertise obtained as a result of professional accounting certification or from other work experience that results in a better understanding of technical accounting issues contributes most significantly to audit committee effectiveness. The second essay evaluates whether firms with high financial reporting quality and accounting experts self-select each other. The results indicate that firms which already have high financial reporting quality are more likely to appoint accounting experts to their audit committee. Further, I find that the propensity of high quality firms to make such appointments is more pronounced when they are undervalued, underlining the use of accounting expert appointments as a signalling mechanism. Additional tests provide further support for the signalling motivation by documenting pronounced positive abnormal stock returns for undervalued firms with high financial reporting quality that appoint accounting experts.