Audit committee versus other governance mechanisms and the effect of investment opportunities: evidence from Palestine

• Pages: 527-544
• DOI: https://doi.org/10.1108/CG-06-2019-0185
• Date: 30 March 2020
• Published date: 30 March 2020
• Author: Islam Abdeljawad,Ghassan A.I. Oweidat,Norman Mohd Saleh
• Subject Matter: Corporate governance,Strategy

Audit committee versus other governance

mechanisms and the effect of investment

opportunities: evidence from Palestine

Islam Abdeljawad, Ghassan A.I. Oweidat and Norman Mohd Saleh

Abstract

Purpose –This paper aims to explore how thepresence of an audit committee is associated with other

corporate governance mechanisms, i.e. board structure, ownership structure and quality of external

audit. The present study evaluated whether the presence of the audit committee complements or

substitutes other governancemechanisms in Palestinian companies. Moreover,the effect of investment

opportunities on the relationship between the formation of the audit committee and the quality of the

auditorwas addressed.

Design/methodology/approach –The association between the formation of the audit committee and

other governance variables was modelled as a binary logistic model. The sample comprising 44 firms

listed on Palestine exchange for the period between 2013 and 2017, amounting to 220 firm-year

observations.

Findings –Based on the investigation, the results have indicated that board independence, the

distinctionbetween the chairman and chief executiveofficer function, ownership concentrationand audit

quality enhance thechance of audit committee formation, implying complementaryeffect. Contrastingly,

board size and board ownership serve as a substitute to audit committee formation. It has also been

found thatinvestment opportunities act as an effectivemoderating factor that strengthens the relationship

betweenaudit quality and the formation of the audit committee.

Originality/value –The study provides valuable insight into the interactionbetween multiple corporate

governance mechanisms within the economy of Palestine where the external uncertainty is high and

investment opportunitiesare constrained by the decisions of the occupyingauthority. The findings may

help regulators and policymakers in Palestine alongside those of other countries with similar

environmental features to reviseand update their corporate governance codes to ensure that the best

controlcan be achieved, subsequently attractingmore foreign and domestic investments.

Keywords Audit committee, Palestine, Corporate governance, Investment opportunities,

Substitution versus complementary effects

Paper type Research paper

1. Introduction

Corporate governance is the bundle of rules and measures, which outlines the

responsibilities of a firm’s management and provides assurance that the best interests of

shareholders are pursued. Corporate governance has been a prominent material of

investigation following the numerous events of financial scandal across the globe, which

implied how weak governance can lead management to exploit the shareholders (Naser

et al.,2013

). Consequently, corporate governance regulations and codes have been

introduced by many countries to diminish the agency problemand simultaneously preserve

the shareholders’ rights. A corporate governance system incorporates different internal and

external mechanisms that are interconnected in achieving the goal of monitoring

management. Although existing literature has shown how each mechanism manages the

Islam Abdeljawad is based

at the Department of

Finance and Banking,

Al-Najah National

University, Nablus,

Palestine.

Ghassan A.I. Oweidat is

based at the Department of

Accounting, Palestine

Polytechnic University,

Hebron, Palestine.

Norman Mohd Saleh is

based at the Department of

Accounting, Faculty of

Economics and

Management, Universiti

Kebangsaan Malaysia,

Bangi, Malaysia.

Received 23 June 2019

Revised 5 November 2019

Accepted 13 February 2020

DOI 10.1108/CG-06-2019-0185 VOL. 20 NO. 3 2020, pp. 527-544, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 527

agency problem, the degree of control that each mechanism adds to the overall firm

governance has not been extensively addressed in light of the other mechanisms applied.

This gap suggests that further investigation should be directed to study how each

mechanism interacts with and affectsthe work of other mechanisms used in the governance

system of the firm. Hence, governance mechanisms should not be examined individually,

rather, they should be considered as a group that provides a certain level of control (Ward

et al., 2009). It is believed that the interaction of different governance mechanisms in a

certain economy is crucial in determining the most advantageous mix of mechanisms

that provides the highest level of control over management with the lowest cost possible in

that economy (Aguilera and Crespi-Cladera, 2012). Past research has also revealed that

different governance mechanisms can either function as complements or substitutes to

each other (Hassan et al.,2017). When a mechanism acts as a substitute, an increase in the

first mechanism will replace part of the control provided by the second mechanism without

increasing the overall level of control exerted by the whole governance system (Ward et al.,

2009). Contrastingly, when a mechanism functions as a compliment, an increase in the first

mechanism will also increase the control exerted by the second mechanism, and

consequently, lead to a higher level of overall control. Therefore, it can be deducedthat the

governance system is a continuum with weak governance on one end and strong

governance on the other; the addition of more monitoring mechanisms increases the

strength of the governance system (Hassanet al.,2017).

The audit committee is a vital internal governance technique, which provides assistance to

the board of directors in supervising the system of financial reporting and facilitating the

external audit function. Hence, it can be argued that besides reducing the agency costs,

the implementation of an audit committee can diminish the information gap between

management and owners (Sharma et al.,2009). It should be highlighted that the way in

which the audit committee impacts other governance mechanismshas not been thoroughly

addressed in past research, especially in developing countries and particularly countries

with unstable political and economic environments such as Palestine (Hassan and Hijazi,

2015;Hassan et al.,2017). Also, while there have been limited studies (Hassan and Hijazi,

2015) that evaluated the factors of the voluntary establishment of the audit committee in

Palestine, no empirical research has examined the interaction between the voluntary

creation of audit committee and other governance mechanisms, as well as the effect of

investment opportunities on this interaction. Accordingly, the current paper intends to

examine the association between the existence of an audit committee and other corporate

governance instruments, namely, board structure, ownership structure and quality of

external audit. This paper will investigate whether the audit committee works as a

complement or as a substitute in relation to other governance mechanisms in Palestinian

companies. In contrast to prior literature, this study also evaluates the effect of an

investment opportunity on the establishment of an audit committee and the substitution/

complementary role of audit committeevis-a

`-vis audit quality mechanisms.

There are several justifications in relation to the significance of analysing the nature of the

interconnection between the existence of audit committee and other corporate governance

tools in Palestine. This country proves to be a good choice for investigating distinctive

reasons for audit committee formation as its establishment is arbitrary –apart from banks.

Moreover, the ownership structure in the Palestinian business environment is based on

concentrated ownership by family investors. Differences in the ownership structurebetween

countries have caused discrepancies in the nature of conflicts between management and

shareholders, resulting in variations of the corporate governance systems (Hassan and

Hijazi, 2015). Palestine also suffers from economic and political instability, weak law

enforcement and inefficient fiscal and monetary policies to operate and monitor the

economic activities. Though Palestine possesses a certain degree of autonomy in handling

interior daily aspects of Palestinians’ life since 1994, most resources includinglands, water,

power and even radio waves are still subjectedto the occupation control. Foreign trade also

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