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, whether this oversight impacts the financial reporting process and how it is perceived by investors. Recently, in response to calls for more transparency, many firms have begun reporting their audit committees’ activities related to overseeing the external audit process. Using a novel dataset that summarizes reported audit committee activities, we create a composite measure that captures the extent of the audit committee’s oversight over the external audit. We then examine whether the extent of audit committee oversight is related to financial reporting quality and audit fees, and whether it is informative to investors. Our results show that firms with audit committees who take a more active role in overseeing the external audit are associated with better financial reporting quality and pay higher audit fees. We also find evidence that the market reacts positively to reports indicating strong oversight, consistent with perceptions of higher financial reporting quality. Our results provide important insights about the oversight role of audit committees.

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

JEL Classification: M41, M42, G18