Audit Committee Characteristics and Audit Report Lag

• Author: J‐L. W. Mitchell Van der Zahn,Nigar Sultana,Harjinder Singh
• Published date: 01 July 2015
• DOI: http://doi.org/10.1111/ijau.12033
• Date: 01 July 2015

Audit Committee Characteristics and Audit Report Lag

Nigar Sultana, Harjinder Singh and J-L. W. Mitchell Van der Zahn

School of Accounting,Curtin University

This study seeks to determine whether audit committee compositional features are associated with the timeliness

of financial reporting by Australian firms. Timeliness of financial reporting by firms, of which the length of an

audit is a fundamental component, adds information content and impacts firm value, making an examination of

audit report lag determinants important. Results indicate that audit committee members with financial expertise,

prior audit committee experience and those who are independent are associated with shorter audit report lag.

Results suggest that legislationmandating audit committee financial expertise and independence are effective also

in improving the timeliness of financial reporting. More importantly, our resultssuggest that there may be benefits

in constituting audit committees with other compositional features such as prior committee experience in overall

efforts to improve the timeliness, and therefore quality, of financial reporting by firms.

Key words: Audit report lag, audit committee, financial reporting quality

INTRODUCTION

A double-edged information relevance-reliability

dilemma has long plagued external auditors. Prior

literature suggests that delays in the timely reporting

of accounting information significantly undermine the

quality of earnings, increase information asymmetry,

critically affect the chances of investors’ being defrauded,

enable ‘well-informed’ investors to further utilise private

information to exploit ‘less-informed’ investors and

increase uncertainty regarding investment evaluations

and expected payoffs (Hakansson, 1977; Bushman &

Smith, 2001). Provision of unverified financial accounting

statements and associated information, however,

automatically undermines the value of timely

information. There is, therefore, pressure on the external

auditor to complete the audit, and issue the audit report

without undue delay.

Emerging technology and new media forums only

serve to amplify the external auditor’s information

relevance-reliability dilemma in today’s highly

reactionary news-driven society. Reductions in capital

flow barriers, increased market integration and the

development of high-frequency trading platforms enable

investors to participate in a broader set of investment

markets. However, these developments may also

contribute to greater market volatility. Consequently, the

demand for auditor-verified financial statements and

associated financial accounting information is ever more

essential. Understanding factors influencing the time

taken by the external auditor to issue the audit report

(termed ‘audit report lag’) is therefore an important area

of investigation. Such understanding can enhance the

development of effective corporate governance and

reporting protocols and procedures within firms that

enhance the delivery of timely, reliable financial

information to capital market participants.

Timeliness of financial reporting by firms is a

fundamental component of quality general purpose

reporting. Prior research has shown that timely financial

reporting adds information content and consequently

affects firm value (Beaver, Lambert & Morse, 1980;

Schwartz & Soo, 1996; Blankley, Hurtt & MacGregor,

2014). The length of the annual audit has been identified

as the single most important determinant of timely

financial reporting by firms (Whittred, 1980b; Givoly &

Palmon, 1982; Knechel & Sharma, 2012). Therefore, the

timely disclosure of financial reporting through audited

financial statements plays an important role in firm

value and in reducing the information asymmetry of

financial information (Jaggi & Tsui, 1999; Lee, Mande &

Son, 2009). Due to recent high-profile accounting

disasters, legislators and investors have both become

increasingly concerned with the timeliness as well as the

quality of financial reporting. As such, research into the

factors that reduce audit report lag merit scholarly

attention and provide the motivation for this study.

Furthermore, given the clamour for information in the

timeliest period possible by demanding users of financial

information in the current decade, auditreport lag and its

determinants certainly require in-depth investigation.

Although there is a rich and lengthy history of research

into determinants of audit report lag, the bulk of the

prior literature focuses on client qualities (e.g., size,

profitability, internal control, industry type), audit

function features (e.g., risk and complexity of the audit)

or external auditor characteristics (e.g., audit firm size,

expertise, specialisation, non-audit services). Research

examining the influence of a firm’s corporate governance

structure on audit report lag has been less forthcoming

with the overwhelming focus on the board of directors.

The underlying corporate governance structure of many

firms worldwide has shifted dramatically during the

past two decades. Whilstthe board of directors maintains

overall responsibility for financial statements and

information issued, reformists, regulators, investors and

scholars alike continuously emphasise and reinforce

the need to delegate central oversight, accountability

and monitoring of the financial reporting process to an

audit committee. Corporate governance reforms, new

legislation and best practice guidelines introduced

globally during the past several decades have bolstered

the audit committee’s role and responsibilities in the

financial reporting process. Emergence of the audit

committee’s importance is likely to directly influence the

actions and activities of the external auditor, including

time taken to issue the audit report. Nonetheless, despite

such importance, Bedard and Gendron (2010) conclude

Correspondence to: Harjinder Singh, Curtin University, GPO Box

U1987, Bentley 6845, Perth, Western Australia, Australia. Email:

h.singh@curtin.edu.au

International Journal of Auditing doi:10.1111/ijau.12033

Int. J. Audit. 19: 72–87 (2015)

© 2014 John Wiley & Sons Ltd ISSN 1090-6738

(based on a comprehensive literature review) that

empirical analysis of any association is virtually

non-existent.

The primary objective of this study, therefore, is to

address the imbalance in the literature by examining

the association between audit report lag and key audit

committee characteristics found in the past literature

to most significantly influence audit committee

effectiveness. The six audit committee characteristics/

features examined in this study are audit committee

member financial expertise, prior audit committee

experience, gender diversity, audit committee size, audit

committee member independence and audit committee

diligence. Results from our examination will assist

regulators and reform advocates develop and re-focus

audit committee guidelines that yield greater benefits to

all capital market participants.

Data is hand-collected using a final pooled-sample of

494 firm-year observations from Australian Securities

Exchange (ASX) listed and incorporated firms (selected

using a stratified-random selection approach to control

for firm size bias) across the period 1 January 2004 to

31 December 2008. Aside from using contemporaneous

audit committee data, analysis is extended to the

influence of lagged audit committee features on audit

report lag. Our analysis is further extended to determine

if the six audit committee composition features are also

associated with a change in audit report lag.

Consistent with expectations, our analysis supports a

significant negative association between auditcommittee

financial expertise, prior audit committee experience and

audit committee independence with auditreport lag. Our

results therefore suggest that audit committee members

with financial expertise, prior committee experience and

who are independent of management are most likely to

increase audit committee effectiveness and, in turn, may

be able to significantly reduce the time taken for the

auditor to issue the audit report. Contrary to predictions,

we find no evidence of a relation between auditreport lag

and audit committee gender diversity, size and meeting

frequency.

Australia provides an interesting setting for examining

the audit committee determinants of audit report lag. For

instance, audit committees have a relatively new history

in Australia but have been a prime focus in the past

decades with the introduction of key corporate

governance reforms (i.e.,ASX Corporate Governance and

Recommendations, Common Law Economic Reform

Program ((CLERP) 9). The limited history of audit

committees in Australia may assist in identifying more

clearly the reforms introduced recently that were likely

to have been of greaterbenefit to the market. Also, studies

suggest greater diversity of audit firms participating

in the Australian audit market and such diversity may

provide unique insights into the audit committee/

audit report lag linkage. Finally, litigation risk is more

subdued in Australia than other institutional settings

such as the United States (US). Consequently, the audit

committee’s importance in ensuring that disclosed

financial information is timely and reliable is heightened

given that litigationis not ordinarily used as a mechanism

to influence the quality of reported financial information

by firms, as users tend to look instead towards the audit

committee to ensure the quality of financial reporting.

Overall, this study makes several key contributions.

Findings highlight to regulators and reform advocatesthe

impact of enforcingspecific composition requirements on

an audit committee from an information timeliness

perspective and this has direct resourcing implicationsfor

the management of firms. Results lend credence to the

belief that effective corporate governance mechanisms

increase the timeliness and, therefore, the quality of

financial reporting by firms. Our analysis also fills a gap

in the extant literature where empirical evidence of

how the audit committee influences audit report lag is

scant. This is particularly important as regulators and

reform advocates continue to promote the role and

responsibilities of the audit committee in improving

the quality of financial reporting, including its timeliness.

This study also introduces improvements to the prior

literature by collectively examining six key audit

committee features found to dominate audit committee

effectiveness. Finally, results further enhance an

understanding of audit report lag determinants and raise

implications for the potential introduction of regulations

governing such factors.

The remainder of the paperis organised as follows. The

next section reviews the literature on audit committees

and audit report lag and is followed by the development

of this study’s hypotheses. The data and research

methodology is then outlined, before we go on to report

descriptive statistics, correlations, main results and

sensitivity tests. The final section concludes by

summarising findings, discussing implications from our

results, identifying limitations and making suggestions

for future research.

LITERATURE REVIEW

Timely release of financial information by firms is an

important aspect of financial reporting playing a

fundamental role in the information marketplace and in

the investment decisions made by users. Audit report lag

jeopardises the quality of financial information by not

providing timely information to key stakeholders. In

principle, it is argued that there is an inverse relationship

between information valueand the time taken to prepare

financial statements,specifically the longer the time taken

by the auditor to complete the audit, as reflected in the

audit report lag, the stronger the signal to the market as

there may be negative issues arising from the audit.

Acknowledging the theoretical and practical importance

of timely financial information to the decision-making

process of capital market participants, regulators such

as the Securities and Exchange Commission (SEC) and

the ASX have established mandatory time periods within

which firms are required to provide audited financial

statements to shareholders and other key stakeholders

via statutory filing requirements. Past studies have

determined that delays in the timely release of financial

reports can adversely impact firm value (Givoly &

Palmon, 1982; Blankley et al., 2014). Specifically, Beaver

et al. (1980) pointed out that investors postponed

transactional activity of securities until earnings

announcements were made. Similarly, Givoly and

Palmon (1982) determined thatthe share price reaction to

early earnings announcements wasmore significant than

the reaction to late announcements, suggesting that the

early release of financial performance data was viewed

more favourably. Blankley et al. (2014) found that,

compared to non-restating firms, firms that eventually

restate their financial statements have longer abnormal

audit report lags. The corporate governance framework

within firms, particularly audit committees, should

Audit Committee Characteristics and Audit Report Lag 73

Int. J. Audit. 19: 72–87 (2015)© 2014 John Wiley & Sons Ltd