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 impacts audit quality. 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 when firms’ audit committees report exerting strong oversight, they have higher audit quality as proxied by discretionary accruals, audit fees, the likelihood of meeting or beating earnings benchmarks, and restatements. We also find that the market reacts positively to reports indicating strong oversight, consistent with perceptions of higher audit quality. This study extends prior literature on audit committees by introducing a new comprehensive measure of audit committees’ reported oversight activities and sheds light on how these activities map into audit quality.

Keywords: Audit Committees, Audit Quality, Financial Reporting

JEL Classification: M41, M42, G18