Evaluating Financial Reporting Quality: The Effects of Financial Expertise vs. Financial Literacy

Abstract

Audit committees evaluate financial reporting quality as part of their corporate oversight responsibilities. Given this responsibility, the national stock exchanges now require all audit committee members to be financially literate and at least one member to have financial expertise. In light of recent debates over this requirement, we provide evidence on how experts and literates differ in their evaluations of financial reporting quality. Results suggest that experts' evaluations of financial reporting quality are more strongly associated with their assessments of characteristics underlying reporting quality (e.g., relevance) espoused in Statement of Financial Accounting Concepts No. 2's framework than literates' evaluations. Additionally, literates are more likely than experts to identify concerns about reporting treatments for business activities that are prominent in the business press or are distinguished by their nonrecurring nature, while experts are more likely to raise concerns about reporting treatments for less prominent, recurring activities. This same pattern occurs in the ratings of the quality of the reporting treatments for specific financial statement items with respect to elements underlying reporting quality (e.g., neutrality); literates (experts) assess the quality elements for the reporting treatments of prominent and nonrecurring items (less prominent and recurring items) comparatively lower than experts (literates). These results suggest that including financial experts on audit committees is likely to change the structure and focus of audit committee discussions about financial reporting quality, and may affect the committee's overall assessment of the quality of a company's financial reports.

Financial literacy, financial advice, and financial behavior

“…In this spirit, the research of Bodnaruk and Simonov (2015) is an interesting example for simultaneously analyzing individuals' financial behavior in the private and in the professional domain. To us, it appears that financial literacy in the business context is an interesting and still largely under-researched subject: as can be inferred from Table 1, 19 out of the 20 most cited papers focus on financial decisions of households, the only exception being McDaniel et al (2002), who discuss financial literacy in the context of audit committees.…”

Audit Committee Effectiveness and Company Performance: Evidence from Jordan

“…Several studies argue that audit committee members' knowledge or experience is directly associated with the committee's effectiveness (McDaniel et al 2002;Bedard et al 2004). For example, Jun Lin et al (2008) argue that the audit committee's main task is to supervise corporate financial reporting and auditing processes, therefore, its members should have the capability to understand the issues being examined or discussed.…”

Corporate Governance and Non-Jordanian Share Ownership: the Case of Amman Stock Exchange

“…The existence of audit committee can be seen as a mechanism for reducing information asymmetry between managers and owners and also for protecting investors (McMullen, 1996;McDaniel et al, 2002). Klein (2002) indicated that the existence of independent audit committee tends to reduce the possibility of earnings management, thus improving transparency.…”