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    Corporate Governance Research in Accounting and Auditing:...
    research summary posted October 27, 2014 by Jennifer M Mueller-Phillips, tagged 13.0 Governance, 13.01 Board/Audit Committee Composition, 13.03 Board/Audit Committee Tenure, 13.04 Board/Audit Committee Compensation, 13.05 Board/Audit Committee Oversight, 13.06 Board/Audit Committee Processes 
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    Title:
    Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions
    Practical Implications:

    First, the weight of evidence suggests that weak governance is associated with an increased likelihood of adverse financial reporting outcomes (in particular, fraud and restatements). Thus, perhaps the most fundamental practice implication is that the governance research findings to date are, on an overall basis, consistent with the focus on improved corporate governance (e.g., board independence, audit committee expertise) found in SOX and related regulatory reforms.

    Second, since the board and the audit committee are primary mechanisms for the internal monitoring of top management’s financial reporting behavior, and given that the CEO and/or CFO is involved in 89 percent of all public company accounting frauds (Beasley et al. 2010), external auditors need to very carefully examine corporate governance characteristics and processes in assessing the control environment.

    Third, research finds that auditor changes/dismissals are less problematic in the presence of good governance. That is, in the presence of good governance, the auditor change/dismissal may be justified by poor auditor performance or excessive fees. Since regulators do not have the resources to examine all auditor changes, even if limited to dismissals, regulators might want to consider the client firm’s governance characteristics when deciding whether to investigate an auditor dismissal.

    Fourth, research indicates that external auditors assess risk higher and plan more audit hours for firms with weak governance. However, whether auditors adequately adjust for weak governance has not been examined. In other words, adjustments of risk assessments and audit hours occur, but is there enough adjustment in light of the higher risk?

    Fifth, strong governance and strong auditing appear to be complements rather than substitutes—stronger boards and audit committees are associated with stronger auditing. Therefore, monitoring (both internal monitoring by the board and audit committee, and external monitoring by the auditor) is likely to be especially weak in firms with weak governance, for the quality of auditing is likely to be lower in the presence of weak governance.

    Sixth, a number of studies have demonstrated the importance of audit committee accounting expertise, as well as auditing expertise and industry expertise. Firms should strive to appoint audit committee members with specific accounting and auditing expertise given their apparently greater effectiveness and the positive stock market reaction to the appointment of accounting experts.

    Seventh, a growing line of research indicates that audit committee compensation methods can influence audit committee members’ judgments, and audit committee compensation methods are associated with the risk of restatement and with the handling of auditor adjustments. We encourage auditors, analysts, and shareholders to be cognizant of the potential risks involved if audit committee members are compensated primarily with short-term, incentive-based pay.

    Eighth, some audit committees appear to take their monitoring roles seriously, while others appear to be primarily ceremonial in nature. Auditors are in a unique position to evaluate the effectiveness of the audit committee process. Auditors should explicitly evaluate the effectiveness of the audit committee’s processes, and adjust their risk assessments, budgeted hours, and the nature, extent, and timing of audit testing, especially if effective audit committee processes seem to be attenuated by the intervention of a dominant CEO.

    Finally, given the severe reputational damage experienced by directors, especially audit committee members, in cases of financial reporting failures, and given the difficulty of monitoring a large entity on a part-time basis, audit committees might want to consider retaining permanent staff or consultants to the audit committee.

    For more information on this study, please contact Dana Hermanson.

    Citation:

    Carcello J. V., D. R. Hermanson, and Z. Ye. 2011. Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions. Auditing: A Journal of Practice & Theory 30 (3): 1-31. 

    Keywords:
    Corporate governance; board; audit committee; literature review.
    Purpose of the Study:

    Over the past two decades, the corporate governance literature in accounting and auditing has grown rapidly. We review this literature, primarily focusing on corporate board and audit committee issues.

    Design/Method/ Approach:

    We discuss 12 recent literature review or meta-analysis papers and summarize selected results (i.e., clusters of papers with new and interesting results) from recent empirical research papers, after reviewing the findings of over 250 studies. 

    Findings:

    We discuss the major insights from this literature and the practice implications of these findings. In addition, we identify a number of opportunities for future research. In particular, we make suggestions for: (1) improved research paradigms in corporate governance, (2) extensions of existing research, and (3) new or emerging lines of research.

    Category:
    Governance
    Sub-category:
    Board/Audit Committee Compensation, Board/Audit Committee Composition, Board/Audit Committee Oversight, Board/Audit Committee Processes, Board/Audit Committee Tenure