Effective association between audit committees and the internal audit function and its impact on financial reporting quality: Empirical evidence from Omani listed firms

Abstract

The role of the audit committee in oversight of the internal control and internal audit function has grown in the last decades as corporate governance mechanisms after the dramatic scandals and failures. This paper examines the impact of the audit committee and the presence of internal audit function on a company's financial reporting quality. Moreover, this study focus on the association between the audit committee and internal audit function and company's financial reporting quality measured as accruals quality and absolute discretionary accruals. It is hypothesized that the financial reporting quality is related to the strength of internal corporate governance mechanisms, including audit committee and internal audit and its association. Different mechanisms are being examined: audit committee size and independence, frequency of meeting, financial literacy, existence of internal audit function and its meeting independently. To test our hypothesis, we employ panel data analysis for 71 nonfinancial firms through 139 observations listed on the Muscat Securities Market during the period of 2013 and 2014. The data used in the analysis were collected from the companies' annual reports published by the Muscat Securities Market. Ordinary least squares is used to regress financial reporting quality linear variables on audit committee and internal audit. The findings suggest that audit committee meetings frequency and the presence of internal audit function positively affect a company's financial reporting quality. Hence, an audit committee that meets more frequently provides effective monitoring of financial reporting and increases the likelihood of discussing and following up any problems and findings in the financial statements and audit reports. Thus, frequent audit committee meetings provide better oversight of the annual accounts. Likewise, the internal audit function is considered an important corporate governance mechanism to safeguard the quality of financial reporting by monitoring organizational risks, assessing internal controls and detecting possible manipulation because the internal auditor evaluates financial procedures. However, results suggest that the relationship between other corporate governance mechanisms and financial reporting quality is not significant.

Disclosure quality vis-à-vis disclosure quantity: Does audit committee matter in Omani financial institutions?

“…Based on social capital theory and resource-dependence theory, which argue that due to the business connections, AC members could gain valuable experience (including governance experience) from serving on other boards, which provides them with the skills and motivations to seek greater assurances in the area of FRQ (Sultana et al 2019). The results are in line with the agency and resource-dependence arguments as well as Yang and Krishnan (2005), Eulaiwi et al (2016), Gebrayel et al (2018 and Al Lawati and Hussainey (2020). Furthermore, Abdelbadie and Salama (2019), Trinh et al (2020a) and Elnahass et al (2020) provide evidence that interlocked directors are very beneficial to companies in terms of the extended knowledge, wider channel networks and broader experience that these members gain from serving on different companies.…”

“…Extant evidence on the association between AC meetings and monitoring effectiveness is mixed. On the one hand, based on agency perspective, some studies find that the number of AC meetings is associated with higher FRQ (proxied by different measures, such as auditor selection and auditor quality, fewer restatements and less aggressive earnings management) (Abbott and Parker 2000;Xie et al 2003;Abbott et al 2004;Bédard et al 2004;Gebrayel et al, 2018). In line with this, a positive relationship is found between AC meeting frequency and the voluntary disclosure level (Li et al 2012;Allegrini and Greco 2013;Haji 2015;Al-Maghzom et al 2016;Buallay and Al-Ajmi 2019;Raimo et al 2020).…”

“…Therefore, this reputational benefit will lead these members to improve the quality of long-term decision making, which could positively affect the disclosures (Muravyev et al 2016;Chou and Feng 2019). In the same vein, Gebrayel et al (2018) and Bloch et al (2020) find that better CG practices and efficient FRQ operations are seen in interlocked organisations. Al Lawati and Hussainey (2020) find that interlocked AC members are positively enhancing the quantity level of FLD.…”

“…A number of studies use AC meetings frequency as a measure of the diligence of the AC in carrying out their responsibilities (Raghunandan and Rama 2007;Bedard and Gendron 2010). ACs need to meet regularly to ensure that the financial reporting process is functioning properly (Vafeas 2005) and to increase the likelihood of discussing and following up any financial problems (Gebrayel et al 2018). Extant evidence on the association between AC meetings and monitoring effectiveness is mixed.…”

Internal Auditing Quality and Earnings Management: Evidence from Sultanate of Oman

“…This study found a big positive relationship between internal audits and effective company governance. Gebrayel, Jarrar, Salloum, and Lefebvre, (2018) examined the impact of the audit committee and also the presence of internal audit operate on a company's money coverage quality. They mentioned that the inner audit operation is taken into account as a crucial company governance mechanism to safeguard the standard of economic coverage.…”