Overseeing the External Audit Function: Evidence from Audit Committees’ Reported Activities

Abstract

Although one of the most crucial responsibilities of audit committees is overseeing the audit process, we know very little about how audit committees fulfill this role and how their oversight is perceived by investors. In 2015 the Securities Exchange Commission (SEC) issued a concept release contemplating additional reporting requirements related to audit committee oversight. Recently, in response to calls for more transparency, many firms have begun reporting their audit committees’ oversight activities. We create a composite measure that captures the extent of audit committees’ reported oversight over the external audit. We find that firms with audit committees who report taking a more active role in overseeing the external audit have better financial reporting quality and pay higher audit fees. We also find that the market reacts positively to reports indicating strong oversight, consistent with perceptions of higher financial reporting quality. This study extends prior literature on the audit committees’ oversight role by introducing a new comprehensive measure of their reported activities and sheds light on how these activities map into financial reporting and audit quality. Our results have important implications for the issues raised in the SEC concept release.

Keywords: Audit Committee, Audit Quality, Discretionary Accruals, Market Reaction

JEL Classification: M41, M42, G18