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Global Review of Accounting and Finance
Vol. 8. No. 1. March 2017 Issue. Pp. 1 – 9
Impact of Audit Committee Quality on Corporate Governance: The
Case of Select Indian Listed Firms
Kanukuntla Shankaraiah* and Seyed Masoud Sajjadian Amiri**
The study focuses on the association between audit committee
quality characteristics and corporate governance quality, so as to
improve the quality of corporate governance by understanding and
managing the audit committee characteristics. It is found in the study
that in most of the equity based listed companies at Bombay Stock
Exchange (BSE) under study, have complied with the legal
formalities like appointment of independent directors, number of
meetings, size of the audit committee, legal qualifications and
financial qualifications of the directors, as they were required for the
listing at a stock exchange in India. Further, the analysis and tests
stated that though the audit committee quality characteristics have
association with corporate governance quality, except the proportion
of independent directors on audit committee and number of audit
committee meetings, other attributes have shown no impact on later,
thus it may be suggested that the companies may improve the
corporate governance, by taking more independent directors and
conducting more number of audit committee meetings.
1. Introduction
The concept of corporate governance gained prominence in the 1980s, when stock market
crashed in different parts of the world, and corporations failed due to poor corporate governance
(Francis 2000). This forced for change to corporate governance codes, as there was a change
of attitude and much higher performance expectations were being placed on management
boards as they are expected to hold the responsibility to ensure that firms are run effectively and
in the right direction.
Mautz (1979) and Neary (1979) viewed the Audit Committee as a useful device that provided an
additional safeguard in corporate governance. In 1999, the Audit Committees gained significant
acceptance, with the formation of specialized committee like Blue Ribbon committee (BRC).
Jonas (1999) and Young (1999) pointed out that in today's corporate environment, concepts
such as board accountability and Audit Committee effectiveness are becoming increasingly
important topics of discussion, and they are also increasingly becoming subject of corporate
governance studies and surveys.
*Professor Kanukuntla Shankaraiah, Department of Commerce, Osmania University, Hyderabad, Telangana, India.
Email: kanukuntlas4@gmail.com
**Dr. Seyed Masoud Sajjadian Amiri, Research Scholar, Department of Commerce, Osmania University,
Hyderabad, Telangana, India. Email: m.sajjadianamiri@gmail.com
Shankaraiah & Amiri
2
Smith (2003) opined that Audit Committees would not only increase the level of assurance
against catastrophic failure and gross malfeasance, but would also help in offering
improvements on a wider front, and in raising the overall standard of corporate governance for
all companies that establish Audit Committees. Whereas, Turley (2004) and Zaman (2004),
pointed out that Audit Committees were promoted voluntarily as a part of corporate governance
reforms, as audit committees are one of the mechanisms which guide the board of directors into
adopting better corporate governance practices. Further, when presenting the importance of
Audit Committee as a mechanism for corporate governance, Millstein (1999) pointed out that it
was the US Securities and Exchange Commission’s (SEC) initiation which helped in focusing
on the financial reporting and structure of audit committees and helped the movement towards
progressive corporate governance, which included regulatory and voluntary measures to
improve overall board independence and oversight. It is, therefore, totally consistent that Good
Corporate Governance practice points to the Audit Committee as the focal point for
improvements in financial reporting.
After knowing the opinions of various academicians and practitioners regarding the association
of audit committee with corporate governance, an attempt is made, to present the literature
review in the following section 2 to understand the gap in the research and need for the study.
Further, the research methodology, expressed in terms of objectives, sample design, tools,
limitations and models adopted for testing the hypotheses, is presented in section 3, whereas,
the results of hypotheses testing are given in the 4th section, and the conclusions emerged from
the study along with the contribution to the knowledge and the aspects for the further study are
presented at the end.
2. Literature Review
Green (1994) concluded that Audit Committees have become a well-established part of
Corporate Governance with an expanding role in it. Wild (1994) indicated that audit
committee both enhances managerial accountability to shareholders and is an effective
component of corporate governance. Brierley (2002) and Gwilliam (2002) found that the
independence and expertise of Audit Committee was suspect and that Audit Committees had
failed to establish a close working association with either internal or external auditors. Cohen
(2002) and Krishnamoorthy (2002) indicated that Audit Committees are ineffective and lack
sufficient power to be a strong governance mechanism. Al-Mudhaki (2004) and Joshi (2004)
concluded that the formation of Audit Committee is slow and their composition lacks
independence, and that their functions are still concentrated in the traditional areas of accounting
and that their role is not changing fast enough to make the corporate governance more effective.
Turley (2004) and Zaman (2004) concluded that there was only limited and mixed effect of Audit
Committee on elements of governance and on organizational behavior.
Defond (2005), Hann (2005) and Hu (2005) found positive relation between financial expertise
on audit committees and corporate governance improvement. Flora (2006) concluded that
overall governance quality is negatively related to the level of abnormal accruals and positively
influences the return-earnings association. Bliss (2007), Muniandy (2007) and Majid (2007), and
Rahmat (2009), Iskandar (2009) and Saleh (2009) found that the financial distress of companies
has a significant negative association with financial literacy of the audit committee and the quality
of external audit. Puri (2010) and Trehan (2010) found that the dynamic nature of the role of
Shankaraiah & Amiri
3
the Audit Committees had a positive and effective impact on the corporate governance of Indian
companies. Liu and Zhuang (2011) found that the Audit Committees are composed exclusively
of independent directors, and include an accounting expert, and act with due diligence, leading
to the conclusion that a positive association exists between an effective Audit Committee and
Corporate Governance. Remblay (2011) and Gendron (2011) concluded that the mandatory
advice from regulatory bodies do not enhance the effective governance input of Audit
Committees.
The above review of literature may reveal that the studies were conducted by taking up one
issue at a time and in a different environment. No study is provided on the analysis of
effectiveness of select audit committee qualities on corporate governance quality in Indian
context, hence, the present study is taken up to fill up the gap with an objective to help the
management in improving the corporate governance through ensuring the audit committee
quality improvement.
3. Research Methodology
In order to attain the objectives of the study as, the examination of the association between Audit
committee quality and corporate governance quality; and measuring the effect of Audit
committee characteristics quality on corporate governance quality, from15,916 companies listed
at Bombay Stock Exchange as on 8.11.2012, 3,879 companies are considered based on equity
and listing, out of which 133 companies are selected randomly and information relating to
financial year 2002-03 to 2011-12 (10 Years) are considered. This research uses the formula
given by Bill Godden (2004), as the study uses descriptive statistics dealing with probability and
the population is finite, to justify the size of sample. As public limited companies having a paid-
up capital of at least Rs. 5 crore (50 Million), shall constitute a Committee of the Board known
as Audit Committee (As required by section 292A of the Companies Act.1956), only listed
companies which have Audit Committees are considered. The data, related to the select
characteristics and terms used in the models for analysis are collected from the annual reports
of the select companies and notes and statements given in them.
The study uses Pearson Correlation Coefficient, Regression analysis to establish the
association between the variables. t-test and ANOVA are used to test the effect of the
independent variable on the dependent variable and to test the stated hypotheses. Statistical
Software-SPSS is used for the purpose of processing data to arrive at relevant measures of
analysis. As study is limited to 133 equity based companies listed at Bombay Stock Exchange
(BSE) and selected on the basis of Bill Godden (2004) principle, the results may not represent
of the entire industry or the economy; The study is based on secondary data only and confined
to analyze the same for establishing the association to understand the impact of select factors
on audit committee quality; The study used the models developed by the various authors,
academicians, and researchers, after modifying them according to the need of the study, thus,
sometimes the process of modifications may not truly represent the desired phenomenon; There
may be various characteristics that determine the audit committee quality, but the study
considered only a few audit committee quality characteristics, such as, independency, size,
accounting and legal qualifications of members and number of audit committee meetings.
Shankaraiah & Amiri
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4. Test of Hypothesis
The corporate governance practices do often get influenced by various factors as suggested by
many academicians and professional as mentioned below in brief:
As mentioned by Public Oversight Board (1994) that corporate governance needs to be
concerned with the duties and responsibilities of the board of directors to successfully head the
company. Thus, the prime factor influencing the corporate governance may be the
independence of board of directors as the character assumes a greater role in decision making.
Tricker (2009) and Bob (2009) mentioned that some continental European countries, including
Germany and the Netherlands, require a two-third Board of Directors as a means of improving
corporate governance. In the two-tiered board, the Executive Board, made up of company
executives, generally runs day-to-day operations, while the supervisory board, made up entirely
of non-executive directors who represent shareholders and employees, hires and fires the
members of the executive board, determines their compensation, and reviews major business
decisions (Hopt 2011 and Klaus 2011). Further their owning of ownership funds may influence
the corporate governance.
The financial institutions, who participate in the capital contribution by owning equity shares or
lending loans and advances, may have an important role in making the policies relating to the
corporate governance. The inclusion of which in measuring the corporate governance quotient
may be justified in the context of their importance in ensuring the corporate governance.
According to Weill (2003), who carried out new empirical evidence on a major corporate
governance issue “the association between leverage and corporate performance”, found mixed
evidence. In his study, he found that the firms in Italy found negative association, whereas
positive association was found for firms in France and Germany. Further, Majumdar (1999) and
Chhibber (1999) tested the association between leverage and corporate performance on a
sample of Indian companies and found negative link between them. As these studies established
the association between leverage of corporate governance, they are considered for the purpose
of computation of corporate governance quotient. Khurana (2007) stated that with the rise of the
manager-run corporation, the problem of managerial responsibility rose to prominence. Thus,
the extending complexity theory to the notion of corporate governance is meaningful. After
knowing the influence of the terms related to corporate governance, Field (2000) formed the
equation to examine the association between audit quality and corporate governance and the
same may be used to measure the corporate governance quotient as,
Corporate Governance = (BODINDEP, EDOWN, NEDOWN, FINOWN, NFINOWN,
LEVERAGE, COMPLEXITY, SIZE) / 8
The null hypothesis i.e. “there is no association between the audit committee characteristics
quality and corporate governance Quality” is tested by using the following equation, formed in
the lines of equation suggested by Field:
CORP GOV = β0 +β1ACIND + β2ACLEGEX + β3ACACCEX + β4ACMEET + β5ACSIZE + εi,t
The notation of the terms of the above equations is as,
ACIND is proportion of independent directors on audit committee.
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ACLEGEX is proportion of directors on audit committee with legal qualifications.
ACACCEX is proportion of directors on audit committee with accounting qualifications.
ACMEET is number of audit committee meetings for the year.
ACSIZE is number of audit committee members.
β is the slope (also called the regression coefficient).
The mean and standard deviations of the various terms of the above equation are presented in
table-1, which may reveal the following:
i) The corporate governance measured in terms of the mean value of the averages of eight
variables, such as, independence board director (BODINDEP), executive directors’ ownership
(EDOWN), non-executive directors’ ownership (NEDOWN),Financial institution ownership
(FINOWN) and Non-financial institution ownership (NFINOWN), are measured using percentage
of shares owned in relation to the issued capital of the company, total debts divided by total
assets (LEVERAGE), the summation of total accounts receivable and total inventory divided by
total asset (COMPLEXITY), total asset (SIZE) is 0.60 million and the Standard Deviation is 0.23
million, which indicate the corporate governance of firms under study is similar among the select
firms.
Table 1: Mean and Standard Deviation of Audit Committee Quality and Corporate
Governance
No
Variables
N
Mean
Std. Deviation
1
Corporate Governance
1330
0.60
0.23
2
ACIND
1330
0.795
0.202
3
ACLEGEX
1330
0.286
0.059
4
ACACCEX
1330
0.601
0.076
5
ACMEET
1330
4.55
1.435
6
ACSIZE
1330
3.73
0.956
7
Valid N
1330
Source: Data extracted from Annual reports
ii) The mean and standard deviation values of the other terms, related to audit committee
characteristics, of the equation such as, ACIND, ACLEGEX, ACACCEX, ACMEET and ACSIZE
may reveal that the most of the equity based listed companies at BSE under study, have
complied with the legal formalities like appointment of independent directors, meetings, size of
the audit committee, legal qualifications and financial qualifications of the directors, without
which companies may not be listed at any stock exchange in India.
After understanding the nature of corporate governance and audit committee quality,
characteristics, the association matrix between them is presented table-2, which reveals the
following association between audit committee quality characteristics and corporate governance
quality:
i) Corporate Governance is positively and significantly correlated with some of the select audit
committee characteristics such as, independence of audit committee members (ACIND), audit
committee meetings (ACMEET) and size of the audit committee members (ACSIZE), implying
that with the increase in the ACIND, ACMEET and ACSIZE of the firms, Corporate Governance
Shankaraiah & Amiri
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quality increases or vice versa. Thus, it may be concluded that the independence, number of
audit committee meetings and size of audit committee improve the corporate governance
quality. Whereas, corporate governance quality is negatively and significantly correlated with
audit committee with legal qualification (ACLEGEX) and accounting qualification (ACACCEX),
showing that with the improvement in the Corporate Governance, the auditors with legal and
accounting qualifications may be less required, as good quality of corporate governance may
minimize the requirement of expert audit committee members.
Table 2: Correlation between Corporate Governance and Audit Committee Quality
No
Corporate
Governance
ACIND
ACLEGEX
ACACCEX
ACMEET
ACSIZE
1
Corporate
Governance
Pearson
Correlation
1
0.144**
-0.097**
-0.075**
0.188**
0.094**
Sig. (2-tailed)
0.000
0.000
0.006
0.000
0.001
N
1330
1330
1330
1330
1330
1330
2
ACIND
Pearson
Correlation
0.144**
1
0.170**
0.026
0.056*
-0.214**
Sig. (2-tailed)
0.000
0.000
0.345
0.041
0.000
N
1330
1330
1330
1330
1330
1330
3
ACLEGEX
Pearson
Correlation
-0.097**
0.170**
1
0.450**
-0.087**
-0.776**
Sig. (2-tailed)
0.000
0.000
0.000
0.001
0.000
N
1330
1330
1330
1330
1330
1330
4
ACACCEX
Pearson
Correlation
-0.075**
0.026
0.450**
1
-0.086**
-0.402**
Sig. (2-tailed)
0.006
0.345
0.000
0.002
0.000
N
1330
1330
1330
1330
1330
1330
5
ACMEET
Pearson
Correlation
0.188**
0.056*
-0.087**
-0.086**
1
0.129**
Sig. (2-tailed)
0.000
0.041
0.001
0.002
0.000
N
1330
1330
1330
1330
1330
1330
6
ACSIZE
Pearson
Correlation
0.094**
-0.214**
-0.776**
-0.402**
0.129**
1
Sig. (2-tailed)
0.001
0.000
0.000
0.000
0.000
N
1330
1330
1330
1330
1330
1330
**. Correlation is significant at the 0.01 level (2-tailed).
*. Correlation is significant at the 0.05 level (2-tailed).
Source: Data extracted from Annual reports shown in appendix-C
ii) Audit committee independence (ACIND) has positive and significant relation with Audit
committee members with legal qualification (ACLEGEX) and Audit committee meeting
(ACMEET). This infers that the independence of audit committee members increases with an
increase in the members with legal qualifications and number of meetings of audit committee.
Whereas, audit committee independence (ACIND) and Audit committee size (ACSIZE) are
negatively and significantly correlated, which infers that the increase in ACSIZE, reduces the
ACIND or vice versa.
iii) Audit committee with legal qualification (ACLEGEX) is positively and significantly associated
with Audit committee with accounting qualification (ACACCEX), implying that members who
possess the ACLEGEX had expertise in accounting knowledge (ACACCEX). Whereas, Audit
committee with legal qualification (ACLEGEX) has significant negative association with audit
committee meetings (ACMEET) and audit committee members size (ACSIZE), showing that an
increase in ACLEGEX of the Audit Committee reduces the need of ACMEET and ACSIZE.
Shankaraiah & Amiri
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iv) Audit committee with accounting qualification (ACACEX) has significant inverse association
with audit committee meeting (ACMEET) and audit committee members size (ACSIZE), showing
that more audit committee members with accounting qualification, may reduce the number of
Audit Committee meetings.
v) Audit committee meeting (ACMEET) and audit committee size (ACSIZE) are positively and
significantly correlated, which may infer that the more meetings of audit committee are required,
when the size of audit committee is large.
After knowing the mean, variability of the characteristics and establishing the associations
among them, an attempt is made here to test the hypothesis by using ANOVA and t-Test to
know the significance of such associations. The result of the data collected and processed is
presented in the following table-3:
Table 3: ANOVA Table for Audit Committee Quality and Corporate Governance
Model
Sum of Squares
(SS)
DF (V)
Mean Square (MS)
F
Sig.
Regression
4.766
5
0.953
18.720
0.000
Residual
67.412
1324
0.051
Total
72.177
1329
Source: Data extracted from Annual reports
In the above table, the F-ratio 18.720 (0.953/0.051) is less than 0.05 level of significance, hence,
there is no difference in mean values of audit committee quality characteristics and corporate
governance quality measures, which may reject the null hypothesis, and conclude that the
alternative hypothesis accepted, i.e. there is association between audit committee
characteristics quality and corporate governance quality. Further, the impact of characteristics
of the audit committee quality on the corporate governance quality is measured by t-test, and
the values of which are presented in table-4.
Table 4:Coefficients Table for Audit Committee Quality and Corporate
Governance
Model
Unstandardized Coefficients
T
Sig.
B
Std. Error
(Constant)
0.389
0.100
3.888
0.000
ACIND
0.181
0.031
5.741
0.000
ACLEGEX
-0.241
0.170
-1.420
0.156
ACACCEX
-0.050
0.091
-0.555
0.579
ACMEET
0.027
0.004
6.167
0.000
ACSIZE
0.013
0.010
1.210
0.226
Source: Data extracted from Annual reports shown appendix-C
Table-4 indicates that except, CONSTANT, ACIND and ACMEET, the null hypotheses for all
other variables such as, ACLEGEX, ACACCEX and ACSIZE are accepted. In other words for
the CONSTANT, ACIND and ACMEET, H0 is rejected, from which it may be concluded that there
is a significant difference between corporate governance and some of the audit committee
characteristics, such as, ACIND and ACMEET.
Shankaraiah & Amiri
8
5. Conclusions
The prime conclusion emerged from the study is that in most of the equity based listed
companies at BSE under study, have complied with the legal formalities like appointment of
independent directors, number of meetings, size of the audit committee, legal qualifications and
financial qualifications of the directors, as they were required for the listing at a stock exchange
in India. Further, the analysis and tests stated that though the audit committee quality
characteristics have association with corporate governance quality, except the proportion of
independent directors on audit committee and number of audit committee meetings, others have
shown no impact on later, thus it may be suggested that the companies may improve the
corporate governance, by taking more independent directors and conducting more number of
audit committee meetings, which is contradicting with the results of earlier studies, where the
audit committee quality characteristics which have the relationship with corporate governance,
also shown the significant impact on the later. Considering limitations of the study stated under
the research methodology, the utility of the study would be improved if the other characteristics
of audit committee quality influencing the corporate governance are included and the
implications would be understood with the help of opinion survey.
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