The Effect of Audit Committees on Earnings–Return Association: Evidence from Foreign Registrants in the United States

Abstract

Manuscript Type: EmpiricalResearch Question/Issue: This study examines whether foreign registrants that choose not to establish audit committees in the US have generally lower earnings-return associations. Research Findings/Insights: Our empirical results indicate that earnings-return associations for foreign registrants without audit committees are significantly lower compared with those of their US-matched firms which are required to establish audit committees. This result is even more pronounced after the introduction of new audit committee rules in 1999 aimed at increasing the responsibilities of audit committees. In addition, earnings-return associations of foreign registrants are found to increase following the establishment of audit committees. Overall, our results are consistent with the idea that the establishment of audit committees may be related to higher earnings-return associations. Theoretical/Academic Implications: Our empirical results suggest that foreign registrants that have chosen to establish audit committees have better earnings-return associations. This implies that the effectiveness of the audit committee in resolving agency problems is applicable to foreign companies, even though their home countries adopt non-AngloAmerican corporate governance systems. Practitioner/Policy Implications: This study offers important insights to foreign firms listed in the US. As the choice not to form an audit committee may increase the cost of capital in the US, but save the cost of establishment in home market, the managers of foreign registrants should weigh the costs and benefit of the options and make a choice accordingly.

The Governance Role of Audit Committees: Reviewing a Decade of Evidence

“…The inclusion of a finance trained director in an expert independent AC increases firm value significantly (roughly five times more than just having an independent AC). Chen et al (2008) Overseas and USA Earnings response coefficients are lower in foreign firms without ACs compared with matched US firms. Also shows an increase in earnings returns associations for foreign firms after establishing an AC.…”

Book‐Tax Differences, Corporate Governance Effectiveness and Audit Quality: An Interactive Effects

“…In her major study, Broye () claims that a positive association between the existence of an audit' committee and audit fees' level. Previous studies have reported a positive and significant association between audit committee independence and audit fees' level (Abbott, Parker, Peters, & Raghunandan, ; Chen, Duh, & Shiue, ; Goodwin‐Stewart & Kent, ).…”

Internal governance mechanisms and value relevance of accounting earnings: an empirical study in the French context

“…In the context of earnings management, many studies provide evidence that the presence of an audit committee affects negatively the level of discretionary accruals (Davidson et al, 2005;Piot and Janin, 2007;Baxter and Cotter, 2009). In the same vein, Chen et al (2008) find that foreign registrants listed in the United States that have opted for the establishment of audit committee have better earnings-returns associations. He shows a significant increase in stock returns variability for published earnings after the formation of audit committee, which confirms the important role of audit committee in ensuring a better earnings quality.…”

“…Some studies focus on the board of directors (Kamran et al, 2006;Petra, 2007), others on the audit committee (Bédard et al, 2004;Bryan et al, 2004;Zarai and Bettabai, 2007;Qin, 2007;Chen et al, 2008) and others on the ownership structure (Donnelly and Lynch, 2002;Fan and Wong, 2002;Gabrielsen et al, 2002;Yeo et al, 2002;Sánchez-Ballesta and García-Meca, 2007). Some studies focus on the board of directors (Kamran et al, 2006;Petra, 2007), others on the audit committee (Bédard et al, 2004;Bryan et al, 2004;Zarai and Bettabai, 2007;Qin, 2007;Chen et al, 2008) and others on the ownership structure (Donnelly and Lynch, 2002;Fan and Wong, 2002;Gabrielsen et al, 2002;Yeo et al, 2002;Sánchez-Ballesta and García-Meca, 2007).…”