Given the significance of the audit committee as a critical governance mechanism, it is important to understand what motivates audit committee members and what affects the functioning of the audit committee. A recent study by Eunice Khoo, Youngdeok Lim and Gary Monroe published in Abacus investigates how audit committee members’ reputation incentives may influence the way they allocate their time and effort in monitoring their corporations’ financial reporting processes. The authors argue that audit committee members are motivated to develop their reputations as effective monitors in order to increase their value to boards and to obtain other directorships. Therefore, those who already sit on more than one audit committee are likely to prioritize their work on more prestigious or influential boards, which can greater career payoffs, resulting in them being more effective in monitoring the financial reporting and audit processes of those corporations and less effective in relation to the less prestigious corporations.
Using data for U.S. corporations from 2007 to 2015, the study by Khoo, Lim and Monroe finds that corporations with more audit committee members for whom this is the most prestigious audit committee membership are associated with better financial reporting and audit quality. These corporations are less likely to have financial restatements, or internal control weaknesses, and more likely to remediate identified internal control weaknesses. Based on these results, it might be concluded that professional reputation is a powerful incentive for audit committee members, and this can enhance financial reporting quality and the effectiveness of the external audit function.
The study highlights the challenges arising from the increase in audit committee members’ workloads. According to KPMG’s 2015 Global Audit Committee Survey, the amount of time required by audit committee members to carry out their audit committee responsibilities has increased considerably. Further, according to the Institutional Shareholder Services’ 2015-2016 Global Policy Survey, investors and proxy advisors are concerned that audit committee members on multiple boards may be too busy to properly execute their duties for all their corporations. Regulators may consider restricting the number of committees audit committee members can sit on. With reduced busyness, there may be less need for audit committee members to prioritize their workload.
While there are benefits to having directors also sitting on the boards of other corporations, there may be costs associated with them becoming too busy, and this might have particular detriments in relation to busy audit committee members. Among the many factors boards need to consider in relation to the composition of audit committees, they may need to consider the relative prestige of their corporation compared to other corporations for which a director is also an audit committee member. If the position with the other corporation appears more prestigious or career advancing, then there is a significant risk that the director will devote more of the effort to that role, and so be less effective in monitoring the reporting and auditing of the less prestigious corporation.
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Further Reading
Khoo, E. S., Lim, Y., & Monroe, G. S. (2020). Audit committee members’ reputation incentives and their effectiveness in monitoring the financial reporting process. Abacus, 56(3), 348-406. https://doi.org/10.1111/abac.12201
Citation
Khoo, Eunice. (2022). How reputation incentives affect the effectiveness of busy audit committee members in monitoring the financial reporting process. ANCAAR Audit Discoveries, The Australian National Centre for Audit & Assurance Research, The Australian National University, Canberra, 17 October 2022, Available from: https://rsa.anu.edu.au/news/2022/how-reputation-incentives-affect-effectiveness-busy-audit-committee-members-monitoring
About the Author
Eunice Khoo is Lecturer of Accounting. Her research interests are in auditing, corporate social responsibility and corporate governance. Eunice has investigated audit quality, audit efficiency, corporate social responsibility, voluntary disclosures, and tax avoidance. Her work has been published in academic journals including Journal of Business Finance and Accounting, Abacus and International Journal of Auditing.
Eunice is a convenor of the Early Career Researchers Support Network (ECRSN), a network that helps early-career researchers and Ph.D. students to enhance their social wellbeing and academic performance. She is also a coordinator of the Australian National Centre for Audit & Assurance Research (ANCAAR) Audit Research Forum. Prior to commencing at ANU, Eunice worked as an external auditor for PricewaterhouseCoopers.
Contact Details
Website: https://cbe.anu.edu.au/about/staff-directory/dr-eunice-khoo
Disclaimer
This article includes reportage and opinion. The reportage and opinions are for general information only. The opinions expressed in articles are those of the individual authors and do not represent the opinions of the editors, ANCAAR, ANU or the institutions to which the authors are attached.