The impact of audit committee, CEO, and external auditor quality on the quality of financial reporting

• Pages: 263-279
• DOI: https://doi.org/10.1108/CG-07-2019-0204
• Date: 25 November 2019
• Published date: 25 November 2019
• Author: Abdulaziz Alzeban
• Subject Matter: Corporate governance,Strategy

The impact of audit committee, CEO, and

external auditor quality on the quality of

f‌inancial reporting

Abdulaziz Alzeban

Abstract

Purpose –This paper aims to explore theinfluence of corporate governance (CG) componentson the

quality of financial reporting (QFR). The components investigated are the Audit Committee (AC), CEO

and external auditor quality. The study also examines whether the AC mediates the effects of other

componentsof CG on the QFR.

Design/methodology/approach –Data were collected from 386 listed companies in four European

countries for the period 2015-2017. The QFR was measured using two proxies, discretionary accruals

and accruals quality.Firstly, an OLS regression model was estimatedto measure the effects of the three

variables investigatedon the QFR, and to determine which of these variables had the greatestinfluence

in this relationship. Secondly, several mediation analyses were performed to test whether the AC

mediatesthe effects of the CEO, and external auditor quality on the QFR.

Findings –The findings reveal that each of these threecomponents has a positive impact on the QFR,

but that the AChas the greatest effect in this respect.The findings also indicate that the AC mediatesthe

effect of the CEO on the QFR. Alternative tests and different measures for the variables confirm the

robustnessof the results obtained.

Practical implications –Significant implications are provided for regulators and policy-makers.

Findings of the presentstudy help regulators and policymakers to pay moreattention to the enforcement

of AC policies, and the appointment of AC members. Further, the results are helpful to policy-makers

concernedwith improving CG, and who need evidenceof the role of high QFR in this matter.

Originality/value –The findings provide insights into the effect of CG on QFR, and into the most

influential componentin this relationship; hence, they make a valuablecontribution to the literature. They

also contribute to thetopic of mediations analysis in CG research, providingadditional evidence that the

AC mediatesthe effects of the CEO, and externalauditor quality on the QFR.

Keywords CEO, Corporate governance, External audit, Audit quality, Audit committee,

Quality of f‌inancial reporting

Paper type Research paper

1. Introduction

According to Cohen et al. (2004), one of the most vital functions that corporate governance

(CG) can perform is the assurance of the quality of financial reporting (QFR) process. As

noted by the Institute of Internal Auditors (IIA), (2005), the principal components of CG are

the audit committee (AC), executive management, the external auditor quality (EXQ) and

the internal audit function (IAF). Specifically, the AC is seen as adoptinga key oversight role

through its monitoring of the work of the IAF, and through the provision of advice to

managements in respect of the implementation of internal accounting control systems and

the production of financial statements (Arun et al.,2015;Zalata et al., 2018). Additionally,

the effects of the CEO on earnings management are explored by some scholars (Almadi

and Lazic, 2016;Yasser and Al Mamun, 2015), as is the influence of EXQ on the QFR

Abdulaziz Alzeban is based

at Department of Business,

Community College, King

Abdulaziz University,

Jeddah, Saudi Arabia.

Received 8 July 2019

Revised 10 September 2019

2 November 2019

Accepted 5 November 2019

DOI 10.1108/CG-07-2019-0204 VOL. 20 NO. 2 2020, pp. 263-279, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 263

(Inaam and Khamoussi, 2016). Further, other studies have provided evidence of the link

between corporate governance and firm performance (Afrifa and Tauringana, 2015;

Assenga et al.,2018;Bhat et al.,2018;Dalwai et al.,2015;Kao et al., 2019;Merendino and

Melville, 2019). However, although these studies highlight the impact of CG on the QFR,

there has been limited effort, if any, directed towardsexploring which of these CG elements

has the greatest impact on the QFR, and whether the AC mediates the effects of other

components of CG on the QFR.

The study is motivated by this shortcoming in the literature, and intends to explore the key

driver within these different CG elements (the AC, CEO and EXQ), that secures improved

QFR. It uses data obtained from four European countries (the UK, France, Italy and Spain).

Additionally, the study investigates whether the AC mediates the effects of the CEO, and

EXQ on the QFR.

Data were collected from 386 listed companies in the four mentioned countries for the

period 2015-2017. The QFR was measured using two proxies, discretionary accruals and

accruals quality. Firstly, a regression model was estimated to measure the effect of these

variables (AC, CEO and EXQ)[1] on the QFR, andto determine which of these variables had

the greatest effect in this relationship. Secondly, several mediation analyses were

performed to test whether the AC mediates the effects of the CEO, and EXQ on the QFR.

Two proxies were used as indicators ofAC effectiveness, these being independence of the

AC, and experience of its members. CEO was measured using CEO tenure and expertise,

and Big 4 was used as a measure of EXQ. The key findings show that while the AC, CEO

and EXQ all have significantimpacts on the QFR, the two AC variables –independence and

experience of its members –are the most influential in this respect. Moreover, the findings

reveal that the AC mediates the effects of the CEO and EXQ on the QFR. Additionalanalysis

provides more support for themain results obtained and their robustness.

The limited research effort thus far on the influence of the AC, CEO, and EXQ on the QFR

provides the motivation for this study. Hence, the study makes a welcome addition to the

literature, doing so in several ways. Firstly, most prior research focuses on the US (Prawitt

et al., 2009), with only a few studies having been conducted in other developed countries

(Alzeban, 2018;Gutie

´rrez, 2006;Piot and Janin, 2007;Rainsbury et al., 2009). This study

differs from those studies by concentrating on four European countries, therefore

expanding the literature. Furthermore, it includes the governance components (AC, CEO

and EXQ) in one model in those four countries to examine which variable has the most

effect on the QFR. Contrary to other studies (Piot and Janin, 2007;Rainsbury et al., 2009)

that found no significant relationship between the AC and QFR, and no difference in the

effects of the big audit firms and other audit firms on earnings management, this paper

provides evidence that AC independence and expertise havea strong positive influence on

the QFR. Hence, the present research contributes to the expandingliterature that testifies to

the role of ACs as key, among the other elements, in the enhancement of the QFR.

Secondly, the study findings also contribute to the topic of mediations analysis in CG

research, providing additional evidence that the AC mediates the effects of the CEO, and

EXQ on the QFR. Furthermore, these findings have implications for regulators and

policymakers. For example,the results that AC independence and expertise of its members

are the most influential on the QFR imply that AC characteristics are more valuable than

other variables (CEO, and EXQ) in improving the QFR. Consequently, regulators and

policymakers need to pay more attention to the enforcement of AC policies, and the

appointment of AC members. In other words, a high QFR might result only from the

presence of an effective AC, determined by reference to its independence and expertise.

Simultaneously, the results are helpful to policy-makers concerned with improving CG, and

who need evidence of the role of high QFR in this matter. By acknowledging the AC as a

critical ingredient in CG, corporate codes or regulations have the means to place pressure

on ACs to be effective.

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