Audit committee adoption and firm value: evidence from UK financial institutions

• Pages: 205-226
• Published date: 05 March 2018
• Date: 05 March 2018
• DOI: https://doi.org/10.1108/IJAIM-04-2017-0048
• Author: Peter Agyemang-Mintah,Hannu Schadewitz
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Audit committee adoption and

f‌irm value: evidence from UK

f‌inancial institutions

Peter Agyemang-Mintah and Hannu Schadewitz

Department of Accounting and Finance,

Turun Kauppakorkeakoulu, Turku, Finland

Abstract

Purpose –This paper aims to examine theimpact of audit committee (AC) adoption on the f‌inancial value

of f‌inancial institutionsin the UK and also to examine the impact of the establishment of an AC on f‌irm value

during the pre/post-globalf‌inancial crisis era.

Design/methodology/approach –The paper embarks on a theoreticaland empirical literature review

on AC adoption and its impact on a f‌irm’sf‌inancialvalue. The paper uses data from 63 f‌inancial institutions

and covers a 12-yearperiod.

Findings –The empirical resultsindicate that the adoption of an AC by f‌inancial institutions has a positive

and statistically signif‌icantimpact on f‌irm value. The results from the pre-crisis period also indicate that the

adoption of an AC makesa positive and signif‌icant contribution to f‌irm value. However,there is no impact on

f‌irm value during the post-crisis period. The results suggest that the entire UK economy experienced an

economicdownturn after the f‌inancial crisis (2009-2011), and f‌inancialf‌irms were no exception.

Research limitations/implications –This study helps to f‌ill research gaps on the relationships

between ACs and f‌irm value as they exist in UK f‌inancial institutions. These f‌indings are important for

policymakersand regulators.

Practical implications –This researchwill encourage f‌irms to establish ACs.

Social implications –This new f‌inding aboutthe importance of f‌irms having an AC in place is important

for policymakersand regulators.

Originality/value –To the best of the authors’knowledge,this research is the f‌irst to conduct an empirical

study of the effect of AC adoption on UK f‌inancial institutionsand f‌irm value. Second, no single study has

been conducted on theeffects of AC adoption and its impact on either the pre- or post-f‌inancialcrisis periods.

This is the f‌irstpaper to provide such empirical evidence.

Keywords UK, Financial institutions, Audit committee adoption, Firm’s value,

Pre and post f‌inancial crisis

Paper type Research paper

1. Introduction

Shareholders appoint a board of directorsto scrutinise the highest decisions made within a

f‌irm (Fama, 1980;Vefeas and Theodorous, 1998). The appointment is required by state or

country incorporation laws. Boards also provide solutions to organisational problems by

monitoring and advising executives on important decisions concerning the f‌irm (Bozec,

2005;Baldenius et al., 2014). The monitoring or advising of the board is intended to protect

shareholder interestsby providing an objective and independent review of the actionstaken

by corporate executivesto reduce agency conf‌licts (Klein, 1998;Fama and Jensen, 1983). The

directors on the board form part of the f‌irm’s internal governance mechanism, which

ensures that the interests of shareholders and managers are closely aligned (Kang et al.,

2007).

Audit

committee

adoption

205

Received13 April 2017

Revised29 June 2017

Accepted4 July 2017

InternationalJournal of

Accounting& Information

Management

Vol.26 No. 1, 2018

pp. 205-226

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-04-2017-0048

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/1834-7649.htm

According to the Cadbury Committee Report, 1992, the Combined Code,2003, 2006 and

the Financial Reporting Council (FRC), 2016, a board of directors should establish board

committees for auditing, remuneration nomination, etc. to help improve eff‌iciency. These

committees are classif‌ied as key committeesbecause of their contribution to organisational

success as they help to assist in the dispatch of business activities by considering more

detail than would be convenient for the whole board. Also, these committees enhance a

f‌irm’s corporate governancepolicies and improve investor conf‌idence, eventuallyimproving

f‌inancial performance (Charkham, 2005;Financial Reporting Council (FRC),2014, 2016;

Cadbury Committee Report, 1992;Combined Code,2003, 2006). All such committees

scrutinise decisions and solveorganisational problems. This research aims to narrowdown

and focus on the adoption or the establishment of an audit committee (AC) as being one of

the most important functionsof the board of directors.

Generally, there should be at least three AC members, or in the case of smaller

companies, it can be two non-executive directors. The members should be independent and

have experience and ethical repute for making the right decisions and ensuring that the

interests of shareholders areprotected in relation to f‌inancial reporting and internal control.

The requirements for the establishment of AC in the UK are consistent with that of India,

another Commonwealthcountry (Financial Reporting Council (FRC), 2016;Khosa,2017).

In the same vein, the functions of an AC are to monitor and review the integrity of their

f‌irm’sf‌inancial statements and audit process and risk management systems. Further

functions include the following: to ensure professional judgement and help meet audit

standards and make recommendations to the board and shareholders regarding the

appointment, and re-appointmentand removal of an external auditor. Also, the functions of

the AC are to approve the remuneration and terms of engagement of the external auditor

and review audit fees and fees paid for any non-audit work. The AC implements policy on

the engagement of the external auditor concerningthe supply of non-audit services, serving

as a bridge between the internal auditors, externalauditors and the board of directors. The

AC is involved in whistle blowing, reviewing and monitoring the external auditor’s

independence and objectivity, ensuring the timely release of unbiased accounting

information by managers to shareholders, as well as helping to avoid f‌inancial fraud and

increase f‌irm performance (Smith, 2003;Klein, 1998;Financial Reporting Council (FRC),

2014, 2016;Mallin,2006;Walker review, 2009;Chong, 2015).

Based on these AC functions, we empirically examine whether their adoption in UK

f‌inancial institutionscan have an impact on the f‌inancial value of f‌irms.

The f‌irst motivation for conducting this research is that the AC is the only committee

that requires at least one of its members to have recent and relevant f‌inancial experience,

and that their duties should follow relevant UK professional and regulatory requirements

(Financial Reporting Council (FRC),2014, 2016;Khosa, 2017). However, there is no strict

regulatory requirementfor the adoption of a nomination process or remuneration committee

by the board. This makes the establishment of an AC crucial to the board’s success and

creates an avenue by which to ascertain empirically if its establishment has a signif‌icant

impact on f‌irm value.

The second motivation for embarkingon this research is that there have been numerous

corporate governance reforms in the UK (Cadbury Committee Report, 1992;Greenbury,

1995;Hampel, 1998;Combined Code,2003, 2006;Turnbull,1999, 2005;Myners, 2001;

Financial Service Authority Review (FSA review), 2002;Higgs, 2003;Tyson, 2003;Smith,

2003;Turner review, 2009;Walker review, 2009;Financial Services Bill, 2010; and the

Financial Reporting Council (FRC),2014, 2016)tohelpf‌irms improve their corporate

governance policies. However, the adoption of these codes by f‌irms is on a voluntary basis;

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