The Effect of Audit Committees on Earnings–Return Association: Evidence from Foreign Registrants in the United States

• Published date: 01 January 2008
• Date: 01 January 2008
• DOI: http://doi.org/10.1111/j.1467-8683.2008.00660.x
• Author: Fujiing N. Shiue,Rong‐Ruey Duh,Jengfang Chen

The Effect of Audit Committees on

Earnings–Return Association: Evidence from

Foreign Registrants in the United States

Jengfang Chen*, Rong-Ruey Duh and Fujiing N. Shiue

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines whether foreign registrants that choose not to establish audit committees in

the US have generally lower earnings–return associations.

Research Findings/Insights: Our empirical results indicate thatearnings–return associations for foreign registrants without

audit committees are signif‌icantly lower compared with those of their US-matched f‌irms which are required to establish

audit committees. This result is even more pronounced after the introduction of new audit committee rules in 1999 aimed

at increasing the responsibilities of audit committees. In addition, earnings–return associations of foreign registrants are

found to increase following the establishment of audit committees. Overall, our results are consistent with the idea that the

establishment of audit committees may be related to higher earnings–return associations.

Theoretical/Academic Implications: Our empirical results suggest that foreign registrants that have chosen to establish

audit committees have better earnings–return associations. This implies that the effectiveness of the audit committee in

resolving agency problems is applicable to foreign companies, even though their home countries adopt non-Anglo-

American corporate governance systems.

Practitioner/Policy Implications: This study offers important insights to foreign f‌irms listed in the US.As the choice not to

form an audit committee may increase the cost of capital in the US, but save the cost of establishment in home market, the

managers of foreign registrants should weigh the costs and benef‌it of the options and make a choice accordingly.

Keywords: Audit committee, United States, shareholder value

INTRODUCTION

Audit committees (ACs) were virtually unheard of in

the international arena in 1970s (Canadian Institute of

Chartered Accountants, 1981). However, in less than 20

years, the number of large capital markets that require a

public company to have an AC has increased (Vanasco,

1994). For example, the United States (US), Australia,

Canada, Hong Kong, Israel, Malaysia, Singapore and Thai-

land now mandate that public companies have anAC as part

of their corporate structure. Likewise, the United Kingdom

and Germany impose an AC requirement on a comply-or-

explain basis. In France, Japan, China and Taiwan, however,

the formation of an AC is voluntary (Tafara, 2006).Although

ACs have become a more common mechanism for ensuring

good corporate governance in some countries, they are still

far from universal. For example, there are virtually no ACs

around in South America and Continental Europe. This

inconsistency in the regulatory framework for ACs around

the world may pose a challenge to companies without ACs

listing on foreign exchanges where ACs are a regulatory

requirement. It could also have an impact on stock

exchanges in the design and enforcement of regulatory

requirements.

During the 1980s, American exchanges faced severe com-

petition from rivals around the world. To cope with f‌ierce

competition, the US Securities and Exchange Commission

(SEC) then promulgated Form 20-F, which applies to foreign

registrants. Form 20-F includes some exemptions from the

regulatory regime applicable to domestic American regis-

trants under Form 10-K. One conspicuous case is the exemp-

tion provided to foreign issuers regarding the establishment

*Address for correspondence: Department of Accountancy, National Cheng Kung

University, No 1, University Road, Tainan City 701,Taiwan. E-mail: jengfang@

yahoo.com

32 CORPORATE GOVERNANCE

Volume 16 Number 1 January 2008 © 2008 TheAuthors

Journal compilation © 2008 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00660.x