Audit committee activity and agency costs

Menon and Williams indicate that many United States (US) over-the-counter (OTC) ®rms which form audit committees appear not to rely on them (cf. Menon, K., Williams, J.D. 1994. Journal of Accounting and Public Policy, 13(2), 121±139). Reliance on audit committees appears to depend upon board composition, while audit committee activity is associated with ®rm size. In this paper, we compare the US experience and evidence on audit committees and monitoring with the position in the United Kingdom (UK), where there has been a steady growth in the number of major companies voluntarily forming audit committees over the last 15 years (Collier, P.A. 1996. Accounting, Business and Financial History 6(2), 121±140). We contend that the dataset is best analyzed using the Heckman procedure (cf. Heckman, J.A. 1979. Econometrica 47(1), 153±161) which captures the two stages of the decision on audit committee activity. Our results show little support from the UK data for the ®ndings of Menon and Williams (cf. Menon and Williams, 1994. Journal of Accounting and Public Policy 13(2), 121±139). However, consistent with their agency theoretic perspective of monitoring, we found that high quality (Big Six) auditors, and to some degree leverage have a positive relationship with audit committee activity. Contrary to an agency theoretic expectation, we found that audit committee activity is reduced in ®rms that combine the role of chairman and chief executive. On the basis of this result we explored the impact of insiders (executive directors) and found that their presence on an audit committee had a signi®cant negative impact on audit committee activity. This result suggests that the emphasis placed by the US Securities and Exchange Commission (SEC) (Sta€ Report on Corporate Accountability, US Government Printing Oce, Washington, DC, 1980, p. 491) and the Cadbury Committee (Committee on the Financial Aspects of Corporate Governance. 1992. Report of the Committee on the Financial Aspects of Journal of Accounting and Public Policy 18 (1999) 311±332 * Corresponding author. Tel.: +44-1392-263220; fax: +44-1392-264425. E-mail address: [email protected] (A. Gregory) 0278-4254/99/$ see front matter Ó 1999 Elsevier Science Inc. All rights reserved. PII: S0 2 78 -4 2 54 (9 9 )0 00 1 50 Corporate Governance. Gee, London) on the independence of audit committee members may be well founded. The reduction in audit committee activity that arises from the combination of the role of chairman and chief executive ocer, and the presence of insiders on the audit committee, has important policy implications. Indeed, in the UK, both practices are the subject of recommendations in the Hampel Committee report Hampel Committee 1998. Committee on Corporate Governance. Gee, London. Ó 1999 Elsevier Science Inc. All rights reserved.