A Proposed Framework For Studying The Effects of Independent Audit Committee Member Characteristics on Financial Restatements

Abstract

Background This paper addresses the effects of independent audit committee member characteristics on financial restatements. I investigate certain characteristics of independent audit committee members as important elements of the corporate governance process. I argue that certain characteristics of independent audit committee members will determine the effectiveness of their oversight role in the financial reporting and auditing processes and influence the likelihood of financial restatements. I identify and analyze five independent audit committee member characteristics (expertise, diligence, reputation, tenure and compensation) and two determinants of auditor independence (non-audit services fees and audit-firm tenure) as potential factors hypothesized to influence the effectiveness of the audit committee and the auditor in the context of financial restatements. I provide theoretical bases for these relationships, through which, I examine and empirically document the evidence on the effectiveness of independent audit committee members and auditor independence on the likelihood of financial restatements. Contributions to be Made by the Study This study makes the following contributions: • it provides feedback to the regulators on the effectiveness of audit committees in reducing financial restatements; • it provides evidence of conditions under which restatements take place. Knowledge of such conditions will aid regulators improve the financial reporting process and corporate governance such that market losses due to restatements could be minimized; • it adds to the sparse but growing body of literature related to financial restatements and corporate governance, and extends our understanding of the effectiveness of governance mechanisms in reducing financial restatements; • it further contributes to the literature by examining the interaction effects of effective (ineffective) audit committee characteristics on financial restatements; • it provides useful evidence to regulators, members of the accounting profession and financial statement users as they deliberate on the costs and benefits of mandatory auditor rotation; • finally, it opens avenues for future research by considering additional independent audit committee member variables and interactions. These additional variables include the reputation of the independent audit committee members, tenure of the independent audit committee members and the cash compensation paid to independent audit committee members.

Research Hypothesis Hi: As the proportion of independent audit committee members with expertise increases, the likelihood of financial restatements decreases. H2: As the proportion of independent audit committee members with expertise and diligence increases, the likelihood of financial restatements decreases. H3: As the reputation of independent audit committee members increases, the likelihood of financial restatements decreases. H4:As the proportion of independent audit committee members with expertise, diligence and reputation increases, the likelihood of financial restatements decreases. H5: There is no relationship between independent audit committee member tenure and the likelihood of financial restatements. H6: The cash compensation paid to independent audit committee members is not related to the likelihood of financial restatements.