Abstract:
Concerns over aggressive earnings management and corporate scandals in the United States in the late 1990s and early 2000s focused attention on the roles that audit committees can play in monitoring the quality of financial reports and preserving the independence of external auditors, resulting in calls to improve their effectiveness. Such calls were similar to those made in the 1970s and 1980s in the United States and United Kingdom when investigations of corporate collapses were undertaken. By the mid-2000s, a number of government and overseas stock exchanges introduced regulations to strengthen audit committees. The United States took a legislative approach, while other countries introduced corporate governance best practice recommendations recognising that corporate governance mechanisms need to suit the needs of a firm. There were claims that strong audit committees would improve the integrity and reliability of financial statements. There was general support that the effectiveness of audit committees is dependent upon the members appointed. High quality audit committees were considered to be those that had independent directors and included at least one member with financial expertise. New Zealand was slower than some of its main trading partners, Australia, the United Kingdom and the United States, to make changes to audit committee membership. The period during which other countries implemented audit committee changes and New Zealand did not provides a distinctive setting to nvestigate the incentives for New Zealand firms to establish high quality audit committees and their effectiveness. Using an agency perspective, this study examines characteristics of firms and boards of directors that voluntarily formed high quality audit committees and also explores the effectiveness of high quality audit committees in monitoring the quality of financial reporting. Specifically, the thesis examines the following research questions: What are the characteristics of firms that have high quality audit committees? Are firms with high quality audit committees less likely to select aggressive accounting policies and estimates compared with other firms? Regulators in New Zealand realised that the country lagged behind other countries in promoting and regulating appropriate corporate governance practices. They recognised that if New Zealand's capital market was to remain internationally competitive, changes needed to be made. By the end of 2003, the national stock exchange made rule changes to introduce a corporate governance code. In 2004, the New Zealand Securities Commission published principles and practices of corporate governance for entities issuing securities to the public. This period, between the collapse of Enron in late December 2001 and the beginning of regulations for audit committees, is the setting for the third research question which examines if New Zealand entities changed their corporate governance practices in the aftermath of the Enron collapse. In relation to audit committees, the question is: (3) Did the quality of audit committees of New Zealand listed companies change subsequent to the Enron collapse? The research questions contribute to the literature in the following ways. Research on incentives to voluntarily form high quality audit committees to date has focused primarily on explaining differences in audit committee independence. This study extends prior research by examining the formation of audit committees that have members with financial expertise. Existing research on the effect of audit committees on the quality of financial reporting has focused predominantly on firms that have been subject to actions for fraudulent reporting. Where non-fraud firms are used, the empirical approach often used is to test the relationship between audit committees and the level and/or sign of discretionary (abnormal) accruals. This study uses an alternative empirical approach by examining specific accounting estimates and policy choices made by managers. This study also extends New Zealand research on audit committees. Previous research by Bradbury (1990) focused on factors explaining the voluntary formation of audit committees by New Zealand listed companies while Porter (1998) conducted a survey of the composition and role of audit committes.