Audit Committee Characteristics and Auditor Reporting

Abstract

We examine the relationship between the independence of the audit committee (from management) and auditor reporting behavior. More specifically, we consider the relationship between the percentage of audit committee members who are either insiders or ?grey? directors and the likelihood that the auditor issues a going- concern-modified report to firms experiencing financial distress. An insider is an officer, employee, or an officer of an affiliate company. A grey director includes: former officers or employees, relatives of management, professional advisers to the firm (e.g., consultants, bank officers, legal counsel), officers of significant suppliers or customers of the firm, and interlocking directors. This paper represents the first study to consider the relation between audit committee characteristics and going-concern reporting. We find evidence that the composition of the audit committee is associated with the type of audit report issued to companies experiencing financial distress. There is a significant negative relationship between the percentage of audit committee members who are either insiders or grey directors and the likelihood of receiving a going-concern-modified report. Additional analysis indicates that these results are driven by the composition of the audit committee not by the composition of the entire board of directors.

JEL Classification: M49