Impact of audit committee characteristics and external audit quality on firm performance: evidence from India

• DOI: https://doi.org/10.1108/CG-09-2020-0420
• Published date: 11 October 2021
• Date: 11 October 2021
• Pages: 424-445
• Subject Matter: Strategy,Corporate governance
• Author: Waleed M. Al-ahdal,Hafiza Aishah Hashim

Impact of audit committee characteristics

and external audit quality on f‌irm

performance: evidence from India

Waleed M. Al-ahdal and Hafiza Aishah Hashim

Abstract

Purpose –The purpose of this paper is to analysethe influence of audit committee characteristics and

external audit qualityon the performance of non-financial publiclimited companies listed on the National

Stock Exchange100.

Design/methodology/approach –One-way random effect panel data regression was applied to 74

non-financial firms inthe Nifty 100 from 2014 until 2019. The overall auditcommittee index and external

audit index were builtbased on the new Indian Companies Act, 2013 and on a reviewof the literature to

capturethe impact of the new Act on firm financial performance.

Findings –The outcome of thestudy revealed that there is lack of evidence to show thataudit committee

characteristicsimprove the performance of top Indian non-financial listed firms.However, external audit

quality was foundto have a significant positive impact on the financialperformance of firms as measured

by Tobin’s Q, while firm size and leverage were found to have a significant impact on the financial

performanceof firms as measured by return on assetsand return on equity.

Practical implications –This paper will be greatlybeneficial for financial practitioners and policymakers

because it provides practicalsuggestions and recommendations about the types of external audit that

are indispensablefor the overall effectiveness andperformance of firms. The study findingsmay also aid

strategic policy formulation and execution for bettercorporate governance practices for the purposeof

profit andwealth maximisation.

Originality/value –To the best of the authors’ knowledge,to date, no previous research has evaluated

the effects of audit committeefeatures and external audit quality on the financial performance of firms in

India after the implementation of the new Companies Act, 2013. Hence, this study fills this void in the

present literature by examiningthe overall features of the audit committee and external audit and their

impacton firm performance in the setting of India.

Keywords India, Financial performance, Audit committee, External audit

Paper type Research paper

1. Introduction

The recent collapse of high-profile global corporations has triggered immense interest

among investors, regulators and academicians. As documented by Srivastava (2009),

weaknesses in corporate governance practices such as sub-standard external audit and

ineffective audit committees were largely responsible for such failures. The disastrous

failures and excessive losses of major firms, such as Enron Corporation, WorldCom and

Tyco International, all based in the USA, further reinforced the view that there is a critical

need to enhance the quality of corporate governance in developed and underdeveloped

nations. The recent collapse of corporate entities, coupled with financial scandals in Asian

countries, as in the cases of Satyam in India, Citic Pacific in China, and SK Networks in

South Korea, which represent perfectexamples of corporate governance failure.

Waleed M. Al-ahdal and

Hafiza Aishah Hashim are

both based at the Faculty of

Business, Economics and

Social Development,

Universiti Malaysia

Terengganu, Kuala Nerus,

Malaysia.

Received 18 September 2020

Revised 19 April 2021

3 August 2021

14 September 2021

Accepted 16 September 2021

PAGE 424 jCORPORATE GOVERNANCE jVOL. 22 NO. 2 2022, pp. 424-445, ©Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-09-2020-0420

Several countries reacted to these undesirable fiascos by enacting corporate governance-

oriented legislation aimed at improving corporate disclosure, procedures and practices

(Chhaochharia and Laeven, 2009), not least because corporate failures have severely

affected the confidence of stakeholders in terms of the truthfulness and reliability of

accounting reports. The transparency and disclosure of material facts in accounting

statements has led to a rise in “window dressing”, which is detrimental to the smooth

functioning of any business entity. In several cases of corporate fraud, it was discovered

that the external auditors were activelyinvolved in such activities (Mutasher, 2016). Yet, it is

the paramount duty of external auditors to provide an accurate and reliable assessment of

financial statements to prevent accounting malpractice and to unearth any deviations from

adopted accounting principlesand practices. Several researchers have pointed out that the

reputation of the brand name of the auditor and the size of the audit firm significantly affect

the strength and ability of auditors in monitoring the financial performance of their clients

(Mutasher, 2016). These attributes enable the auditor to produce quality assessments and

reports that ultimately enhance firm performance (Cheng et al., 2014). In contrast,

Scarbrough et al. (1998) noted that investorsfavour a decision to change the auditor from a

larger firm to a smaller one.

In this era of globalisation and the ever-increasing importance of corporate governance and

firm growth, the need for business governance to enhance firm value is recognised

worldwide (Haniffa and Hudaib, 2006). The performance measurement apparatus plays a

fundamental role as a source of information regarding financial output as presented in

financial statements. It offers a solid basis on which decision-making ideas and processes

are made, particularly with regard to planning and monitoring activities (Neely, 1999). The

recent financial crisis has directed significant attention towards business governance, as

revealed by Peni and Va

¨ha

¨maa (2012). Companies that have better corporate governance

practices have been shown to have higher corporate performance. Hence, all countries are

continuously working to improve their corporate governance codes and guidelines,

practices and procedures. Moreover, robust corporate governance practices mandated

and promoted by government and regulatory agencies are significant factors in attracting

both domestic and internationalinvestors.

The recently amended Indian Companies Act, 2013 has made the introduction of an audit

committee compulsory, and the committee is required to fulfil some conditions specified in

the regulations. For instance, the audit committee is required to assess and determine the

utilisation of investments of publiclytraded entities injected into unquoted subsidiaries, such

as offshore-based subsidiaries (Bansal and Sharma, 2016). The Act also requires that the

audit committee scrutinise the utilisation of capital in the event that the parent company has

extended funds such as corporate loans, endowments and other fund advances

(investments) that are above 100 crore rupees or constitute at least 10% of all the assets

owned by the subsidiary, whichever is lower. It also mandates that the audit committee

meet a minimum of five times per annum. In addition, it stipulates that other supplementary

committees convene a minimum of one time per year. The Act also requires that one

independent or unconnected director is present at these committee meetings (Shikha and

Mishra, 2019).

As regards the auditing of companies, the Companies Act of 2013 mandates that during its

first annual general meeting, every company appoints an auditor, who will serve from the

end of the fifth annual general meeting to the end of the sixth annual general meeting. It

further specifies that an individual or audit firm who has served as an auditor for a business

shall not be hired as an auditor for another company for a periodof five years after that term

has ended. Further, the Act stipulates that an audit firm thathas a common partner/partners

in another audit firm whose term of appointment with a company has expired immediately

preceding the current financial year cannot be appointed as auditor of that company for a

period of 5 years (KPMG, 2014).

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