American Journal of Business Blog Archive Audit Committees Oversight Responsibilities Post Sarbanes-Oxley Act

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American Journal of Business Blog Archive Audit Committees Oversight Responsibilities Post Sarbanes-Oxley Act
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Audit Committees Oversight Responsibilities Post Sarbanes-Oxley Act

Hassan R. HassabElnaby, University of Toledo Amal Said, University of Toledo Glenn Wolfe, University of Toledo
Introduction
Based on the McKesson and Robbins, Inc. fraud in the 1930s, the SEC recommended in 1940 that publicly-held companies create audit committees to improve the integrity of corporate financial information; however, it was not until the 1960s and 1970s that audit committee oversight received widespread attention in the United States (DeZoort 1997).1 Since that time, audit committeescharacteristics of their membership, their responsibilities, and their effectivenessare of great interest to the accounting community, both academic researchers and practitioners. Recent accounting scandals raise questions about the oversight responsibilities of the audit committee. Regulators have responded with governance reforms that attempt to enhance the oversight responsibilities of audit committees. Although recent corporate scandals and the Sarbanes-Oxley Act of 2002 (SOX) caused the business community, corporate directors, investors, and others to focus their attention on corporate audit committees, the response of audit committees in reaction to the governance mandates introduced by SOX and stock exchanges is an issue of concern. Prior academic and practitioner research that examined audit committee responsibilities and how effectively these committees handle their responsibilities pre-SOX suggests the need for further reforms regarding audit committees (Carcello, Hermanson and Neal 2002; DeZoort 1997; Keinath and Walo 2004; Rezaee, Olibe and Minmier 2003). Despite the existence of a fair number of studies that examine audit committee oversight responsibilities before SOX, little direct evidence exists about such responsibilities post-SOX. Pandit, Subrahmanyam and Conway (2005) is the only study that examines the effect of SOX on audit committee disclosures. Using a sample of NYSE firms shortly after the passage of SOX and focusing only on the audit committee report, Pandit,Subrahmanyam and Conway (2005) find that many audit committees continue to provide only minimum required information in their report. The lack of significant impact of SOX on audit committee disclosures could be attributable to research-design-related factors (e.g., examine only one stock exchange, not allowing enough time for SOX to impact audit committees oversight responsibilities, and considering only audit committee reports) or could reflect the fact that SOX does not significantly impactaudit committee effectiveness. The objectives of this paper are twofold. First, we investigate the trends in audit committee activities in the periods preceding and following the passage of SOX. In particular,we test whether audit committee assigned and disclosed oversight responsibilities have been expanded following the passage of SOX.Second, we examine whether audit committees are effective in executing their assigned oversight responsibilities in the post-SOX era. Specifically,we compare the perceived oversight responsibilities of audit committee members and the oversight responsibilities actually assigned in the proxy. This study uses a hybrid methodology to investigate the research questions. We compare the disclosed oversight responsibilities in proxy statements to examine the trend in audit committee responsibilities pre-to post-SOX. In
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addition, we use a survey instrument to capture the perceived oversight responsibilities of audit committee members and to measure the effectiveness of the disclosed responsibilities. Based on archival data of proxy statements and survey data from audit committee members in 373 firms listed on NYSE, AMEX, and NASDAQ for the period 2001-2004, our results indicate that audit committees made a substantial commitment to increasing their assigned responsibilities examined in this study.The results also indicate that audit committee oversight responsibilities are expanding. Although the results suggest that the intent of SOX for audit committees to be more involved and active in the oversight role of an organization is becoming institutionalized (i.e., generally recognized as a vital part of a structured, well-established system of corporate oversight), audit committee members still do not recognize all the responsibilities assigned to them in their proxies. Without such recognition, it is doubtful that members of audit committees can effectively execute their responsibilities and provide sufficient assurance to restore confidence in capital markets. In addition, audit committee members in the current study believe that all examined responsibilities are appropriate duties for their committees and that internal control evaluation is their most important oversight responsibility. The remainder of this paper proceeds as follows. In the next section, we identify key provisions of the SarbanesOxley Act that pertain to audit committees and then review background information and literature on audit committee responsibilities and performance. The subsequent section describes the methodology used for this study and is followed by the results section. We conclude our study with a summary of our results,limitations of the study, and suggestions for future research.
Background
Sarbanes-Oxley Act of 2002 and Audit Committees
In response to many accounting scandals and irregularities in the period 2000-2002, the U.S. Congress passed the Sarbanes-Oxley Act of 2002. The Act changes corporate governance, including the authorities and responsibilities of audit committee members. Section 204 requires the accounting firm to report to the audit committee the following: (1) all critical accounting policies and practices that will be used, (2) all alternative treatments of financial information that is within GAAP that have been discussed with management, (3) the consequences or effects of using such alternative disclosures and/or treatment, and (4) the treatment preferred by the firm. Thus, the audit committee must discuss and help resolve auditor-management disagreements as required by Section 310 of the Act; however, it should be noted that this requirement is not a new audit committee responsibility. SAS 61 (1989) requires audit committees to help in resolving auditor-management disagreements. Section 301 requires the SEC to adopt regulations that prohibit stock exchanges from listing any company that does not have an audit committee meeting the requirements of SOX.3 Also, Section 301 contains several requirements specifically for audit committees. First, audit committee members must be independent, which means they may not receive any consulting, advisory, or other compensatory fee from the issuer (other than for service on the board), and may not be an affiliated person of the issuer or any subsidiary of the issuer. Second, the audit committee is responsible for the appointment, compensation, and oversight of the external auditor. Third, the committee is to establish procedures for the receipt, retention, and treatment of complaints (e.g., whistle-blower protection). Fourth, the committee has the authority to engage outside counsel or expert. Section 401 requires the audit committee to include at least one member who is considered a financial expert. Additionally, Section 407 requires each company to disclose whether it has a financial expert on the audit committee. If an audit committee does not have a financial expert, the company must disclose this fact along with
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an adequate explanation. The financial expert of the audit committee must possess adequate knowledge of GAAP,financial reporting complexity,internal control, and audit committee functions. The financial expert must also be capable of assessing different accounting issues related to accruals,reserves, valuations, and estimates.Further, the financial expert must possess high standards of personal and professional integrity.
Audit Committee Responsibilities and Effectiveness

Prior research investigates the impact of the inclusion of outside members and financial expertise on audit committees. Independent boards increase financial reporting quality by playing a crucial role in monitoring senior management (Lee, Mande and Ortman 2004). Prior research suggests that as the proportion of independent board members increases, earnings overstatement is less frequent (Dechow, Sloan and Sweeney 1996;McMullen and Raghunandan 1996); earnings management is lower (Klein 2002; Bdard, Chtourou and Courteau 2004); the external audit fee is greater (Carcello, Hermanson and Neal 2002); occurrence of financial restatement is less (Abbott, Parker and Peters 2004); and the likelihood of financial fraud in a firm decreases (Beasley et al. 2000). Carcello and Neal (2000) find that the greater the percentage of affiliated directors on the audit committee,the lower the probability the auditor will issue a going-concern report.Carcello and Neals (2003) findings suggest that audit committees with greater independence are more effective in shielding auditors from dismissal after the issuance of new going-concern reports. Lee, Mande and Ortman (2004) find that when audit committees and boards of directors are independent, auditors are less likely to resign. Another line of research examines the association between audit committee composition and internal control. Raghunandan, Read and Rama (2001) find that independent audit committees with at least one member having an accounting or finance background are more likely to have longer meetings with the chief internal auditor, more likely to provide private access to the chief internal auditor, and more likely to review internal audit proposals and results of internal auditing. Krishnan (2005) observes that audit committees who are independent and have financial expertise are significantly less likely to be associated with internal control problems. Several accounting studies examine audit committee responsibilities disclosed in audit committee charters and reports contained in proxy statements. Keinath and Walo (2004) examine the audit committees assigned responsibilities before the passage of Sarbanes-Oxley using a sample of proxy statements for ninety-eight domestic companies listed on NASDAQ as of August 2002. Their analysis indicates that only 63 percent of the audit committees monitor the choice of accounting policies and principles;54 percent review the quality of accounting principles with their auditors; 63 percent have the authority and funding to use outside experts;10 percent are solely responsible for hiring and firing the auditor; only one percent indicated that they both discuss and resolve disagreements between management and the external auditors; and none acknowledged procedures to handle complaints. In general, their analysis indicates that audit committees are not fulfilling the oversight responsibilities that would lead to an effective and proactive oversight role. Their findings also suggest that audit committees must make significant improvements in their disclosures to shareholders, and they also must disclose the extent to which they have fulfilled these responsibilities. Rezaee, Olibe and Minmier (2003) examine the content of audit committee reports for ninety-four of the Fortune 100 companies in the United States to determine the information content of these reports and the extent to which these reports conform to the requirements of the SEC, NASDAQ, and NYSE. Their results indicate that the majority of audit committee reporting satisfies the mandatory requirements of the SEC, NASDAQ, and NYSE. Although Rezaee, Olibe and Minmiers (2003) sample is before the passage of SOX, they indicate that more
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disclosures will be necessary to comply with SOX requirements. Carcello, Hermanson and Neal (2002) use a random sample of 150 proxy statements from the NYSE,AMEX, and NASDAQ to compare the assigned duties of the audit committee (charter) with the actual duties that the committee performs (reports). The authors find a gap between the information in charters and reports, suggesting the need for further reforms regarding audit committee disclosures (e.g., number of meetings and oversight of internal audit). Pandit, Subrahmanyam and Conway (2005) examine the effect of SOX on the audit committee disclosure in the 2002 audit committee reports (before SOX) and 2003 (after SOX) proxy statements for a sample of 100 companies listed on the NYSE. While the overall results indicate that some audit committees treat their report as more than just a regulatory requirement and provide more voluntary disclosure, many others continue to provide only the minimum required information in their report. These results may be explained by limitations in the study methodology. The study restricted its focus to the actual audit committee report text rather than including information disclosed in charters, as well as other venues within the proxy statement (e.g. description of the board committees and audit fees). Moreover, the authors examined the audit committee reports for a sample of NYSElisted companies. Examining a sample from the three major exchanges allows better understanding of the SEC and stock exchange reactions to SOX. Finally and most importantly, the authors scrutinize proxy statements shortly after the passage of SOX (only one year). Allowing a longer window after the enactment of SOX is needed to permit more time for SOX and SEC rule changes to impact audit committee performance.Pandit, Subrahmanyam and Conway (2005) concludes that with the significant burdens that SOX imposed on audit committees, it is imperative that audit committees be cautious in fulfilling their responsibilities and reporting to the shareholders. The future should see an increase in the amount of the voluntary disclosure made in the audit committee reports (Pandit,Subrahmanyam and Conway 2005).Based on the discussion above we ask the following research question: Are audit committee oversight responsibilities disclosed in proxy statements expanded post-SOX compared to pre-SOX? The audit committee participants in DeZoorts (1997) study responded to survey questions about their proxy statements assigned duties and theirperceptions of key tasks. The survey instrument includes a list of seventeen audit committee responsibilities identified by Wolnizer (1995) such as financial reporting oversight,appointing the external auditor, and other governance duties (DeZoort 1997). DeZoort finds a significant gap between the assigned duties of the audit committee members and their perceptions of their assignedresponsibilities. DeZoort (1997) suggests the need to evaluate the quality of the audit committee disclosures and their effectiveness. Scandals and governance mandates introduced by SOX increased pressure on audit committees to enhance their performance, to improve financial reporting transparency, and to provide higher levels of audit scrutiny. Whether audit committees have adequately responded is a matter of empirical investigation. Therefore, we formulate the following research question: Are audit committees effective in fufilling their oversight responsibilities?
Method
To investigate our first research question of whether audit committees assigned duties have been expanded as a
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result of the passage of SOX, we compare audit committees assigned responsibilities disclosed in proxy statements before and after the passage of SOX. Specifically, we examine financial reporting, auditing, corporate governance and other responsibilities for the audit committees (DeZoort 1997). We search proxies where responsibilities assigned for audit committee members could potentially be reported (e.g., charters, reports, and description of the board committees).6 We compare the duties assigned to audit committee members disclosed in proxy statements to audit committee members perceptions of their assigned responsibilities to test our second research question of whether audit committees are effective in executing their assigned responsibilities. Although the proxies may identify certain tasks as the responsibility of the audit committee, the members of the committee might actually believe that their tasks differ from those identified in the proxies. Audit committees are effective when their perceptions of what they are doing meet or exceed what the proxy says they should be doing.
Participants
We randomly selected 681 firms with December 31, 2004 year-end that filed proxy statements during January and February of 2005. To control for stock exchange bias, we examine proxy statements of an equal number of firms (227) listed on the three major stock exchanges in the U.S.: NYSE, AMEX, and NASDAQ.7 To be included in the sample,the firm must have proxy statements filed with the SEC for year-end 2001 (pre-SOX) through 2004 (post-SOX). We use year 2004 to represent post-SOX to allow enough time for SOX to impact audit committees. We search proxy statements on LEXIS/NEXIS to collect company and audit committee member information for the sample. We administered the survey in 2004 by mailing 1,052 questionnaires to audit committee members in 681 firms identified from LEXIS/NEXIS along with a stamped, return addressed envelope. The respondents were directed to make their answers relevant to the company mentioned on the enclosed envelope if they serve on more than one audit committee. We made a follow-up telephone call to those participants who did not respond to the initial mailing. Of the 588 individuals who did not return a completed survey instrument, forty-seven indicated that they were no longer a member of an audit committee and the remaining 541 non-respondents gave no reason for not returning the questionnaire.As a result, we have 464 useable instruments, for a response rate of 44 percent. The 464 respondents represent a total of 373 firms (one person from 310 firms, two individuals from 35 firms, and three from 28 firms).To address the possibility of firm policy response bias, we randomly choose one respondent from each firm with multiple responses. Thus,our final sample consists of 373 audit committee members from 373 different firms; 129 from NYSE, 124 from AMEX, and 120 from NASDAQ.We report the results of our survey mailings in Table 1.
Survey Instrument
Our instrument has four sections: (1) demographic information; (2) audit committee expertise and composition; (3) audit committee effectiveness; and (4) audit committee issues.The audit committee expertise and composition section of the survey consists of eight 5-point Likert-type questions. Three of the Likert-type questions focus on various types of expertise the audit committee members deem important (accounting expertise, auditing expertise,and industry expertise), and those they personally possess (familiarity with GAAP, familiarity with auditing standards, and familiarity with legal issues). The last two Likert-type questions concern the proper funding of the committee and the extent of the committee independence. The audit committee effectiveness section of our instrument contains questions concerning nineteen audit committee responsibilities. The first seventeen audit committee responsibilities are the same as those originally
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identified by Wolnizer (1995) and later used by DeZoort (1997). Upon further examination of the proxy statements of our sample firms, we note that several additional items were repeatedly mentioned in these statements as being important to audit committees; therefore, we add two additional audit committee responsibilities regarding reviewing the nature and magnitude of fees paid to independent professional advisers/counsels and reviewing the use of other auditors or counsels for second opinions. The respondents are asked to identify three questions related to the aforementioned nineteen assigned audit committee responsibilities. First, is the duty formally assigned to your committee? This question relates audit committee members perceptions of their assigned responsibilities and those disclosures in the proxy statement. Second, is the duty performed, but not assigned, to your committee? This question addresses the possibility that audit committees may perform some functions that are not formally assigned to them. Third, is the duty appropriate for audit committees? This question provides an opportunity for audit committee members to express their opinion about the list of proposed oversight responsibilities. To explore additional issues of interest facing audit committees, we ask them to list the most significant issue(s) currently facing their audit committees, to rank the five most important responsibilities for their committees, and any other comments they would like to add.
Results
The demographic information for the sample is presented in Table 2. The demographic profile of our respondents is a mean age of 53.4 with 10.9 years of work experience in their current industry. Most of the audit committee members are men (81.2 percent) and well educated (66.6 percent have an advanced degree).Approximately 64 percent hold at least an undergraduate degree in a business discipline (48. 3 percent are accounting and finance majors, and the remaining 15.8 percent hold management and marketing degrees).Their experience is equally divided among the three industry classifications (33.7 percent retail, 31.2 percent service, and 35.1 percent manufacturing), and only 20.3 percent consider themselves financial experts.
Audit Committee Expertise and Composition

Table 3 provides results on audit committee perceptions of the importance of expertise (accounting, auditing, and industry), possession of the expertise, and the formation of the audit committee.The audit committee members who participated in our study generally believe that it is equally important for all audit committee members to have a sufficient level of expertise related to technical accounting issues, technical auditing issues, and industry (mean responses of 4.2). To a moderate extent, the audit committee members believe that they possess a sufficient level of expertise related to technical accounting standards (mean response of 3.9), technical auditing standards (mean response of 3.9), and to a lesser extent, legal issues (mean response of 3.8). Despite the high importance of the three types of expertise, it does not appear that these same committee members possess high levels of such expertise.There is a significant difference between the importance of the three types of expertise and the selfreported perceptions of expertise levels of the committee members in these three areas (p < .05 for the three types of the expertise). In addition, the participants believe that their audit committee is properly funded to effectively carry out their duties (mean response of 3.8), and that their committee is composed of independent members (mean response of 4.1). While audit committee members generally agree that expertise in accounting, auditing, and the companys industry is important, of the 373 participants (31.9 percent) seventy-six members nad forty-three chairs consider themselves financial experts, but approximately one-third of the committee members in our sample indicate that
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they possess a very limited level of familiarity with GAAP (mean response of 2.7) or GAAS (mean response of 2.8), and are only somewhat aware of the legal issues facing their firm (mean response of 3.1). Comparing the audit committee chairs and the audit committee members,we find significant differences (p < .05) between their self-reported perceptions of their expertise levels.Moreover, the results, not reported,show no significant differences in members' opinions (chair, financial experts, and committee members) of the importance of areas of expertise or of audit committee composition.
Audit Committee Assigned Responsibilities

Table 4 reports the results of audit committee members responsibilities that are reported in the proxy statements for years 2001 pre-SOX and 2004 post-SOX. Comparing pre- and post-SOX financial reporting responsibilities, we find a significant upward trend (p < .01) in all financial reporting responsibilities. For example, only 79 percent of the proxies include the responsibility of reviewing all financial statements in 2001 and by 2004 that responsibility is included in 99 percent of the proxies.SOX is the result of a series of very costly business frauds and the subsequent failure of many of those firms;therefore, the results regarding the impact of SOX on the audit committees' financial reporting responsibilities are not surprising. Similarly, the proxies indicate that all of the audit committees increased their commitment to reviewing all existing accounting policies (71 percent compared to 89 percent), reviewing systems of internal control (82 percent to 96 percent), evaluating exposure to fraud (55 percent to 83 percent),reviewing all significant transactions (63 percent to 77 percent), and appraising key management estimates,judgments and valuations (48 percent to 70 percent). The results of comparing years 2001 to 2004 regarding audit oversight responsibilities indicate significant improvement in all responsibilities (p < .01) except reviewing the external auditor's management letter. Specifically, audit committees now assume a very prominent role in the auditing area, specifically with regard to the appointment and fees of external auditors. There is significant improvement in reviewing plans for effectiveness of internal and external auditors. Audit committees significantly increase their emphasis on reviewing the coordination of internal and external auditor work (55 percent to 77 percent), determining whether auditors are free from undue managerial influence (70 percent to 91 percent), requesting they be informed in cases of auditormanagement dispute (47 percent to 81 percent), and reviewing non-audit service fees paid to the auditor (79 percent to 96 percent). Regarding corporate governance responsibilities, audit committees significantly increased emphasis on facilitating communication between external auditors and the board of directors (p =.028) and monitoring compliance with companys code of conduct (p =.025). However, we find no significant improvement in the area of reviewing corporate policies and practices related to ethical issues. Although audit committees are not improving in the area of assessing and updating the appropriateness and the sufficiency of its ethical policies, they are improving in the area of mentoring compliance with such policies. The results of reviewing fees paid to independent advisers and the use of other auditors for second opinions (the two additional responsibilities), presented in Table 4. These results indicate significant increase in these two responsibilities (p < .01). Only 4 percent of the proxies include the review of the nature and magnitude of fees paid to independent professional advisers/counsels as a responsibility of the audit committee in 2001 compared to 45 percent in 2004. Finally, 30 percent of the 2001 proxies include the duty of reviewing the use of other auditors or counsels for second opinions, and by 2004 that increases to 68 percent. In general, the results of comparing audit committee assigned responsibility pre- and post-SOX reveals that these responsibilities expanded following the passage of SOX.
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Effectiveness of Audit Commitee Oversight Responsibilities

Table 5 provides the results of comparing the assigned and disclosed responsibilities in proxy statements and the perceived responsibilities of audit committee members. We find significant differences in four of the six areas of financial reporting:reviewing all financial statements,evaluating exposure to fraud, reviewing all significant transactions, and appraising key management estimates, judgments, and valuations.While in each of these four areas the responsibility is specifically assigned to the audit committee in the proxy,some of the members do not perceive it as an assigned responsibility. We also find this to be the case with three of the auditing responsibilities. Although the task is assigned to the audit committee members,some members do not acknowledge the following as a task: reviewing coordination of internal and external auditor work, requesting to be informed if there is an auditor-management dispute, and monitoring the resources allocated to the internal audit function. Similarly, a significant gap exists between the disclosed and perceived responsibilities regarding two of the three corporate governance responsibilitiesfacilitating communication between the external auditors and the board and monitoring compliance with the companys code of conduct. Finally, for one of the two additional responsibilities that we added, we find significant differences between assigned and perceived responsibilities regarding reviewing the use of other auditors or counsels for second opinions. DeZoort (1997) compares the assigned and perceived responsibilities of audit committee members using the first seventeen responsibilities employed in this study. He finds that audit committee members only recognize two of the seventeen audit responsibilities as assigned responsibilities. The comparison of our results to those of DeZoort (1997) implies that audit committee member perceive that they are engaging in more activities post-SOX than pre-SOX.Specifically, audit committee members in our study recognize six more of the original seventeen responsibilities requirements than audit committee members in the DeZoort (1997) sample, representing a 300 percent post-SOX improvement. In addition, audit committee members in our study recognize one of the two additional responsibilities;12 however,it appears that audit committees still do not consistently perform all of the functions assigned to them in their proxies. These are surprising results considering the significant events affecting audit committees that took place after DeZoorts (1997) study:The National Association of Corporate Directors 2000, Blue Ribbon Commission on Audit Committees 1999, SEC rule changes related to audit committee disclosures 1999,and the passage of SOX. Our results indicate that audit committees still have much room for improvement in the performance of their oversight responsibilities. Consequently, they must do more in order to meet the many additional challenges facing them in a post-SOX environment. Overall, there are significant differences (47% or 9 out of 19) between the assigned and perceivedresponsibilities. In every instance where we find significant differences between the proxy-assigned responsibilities and the members perceivedresponsibilities, the perceived responsibilities lag the assigned ones. The results show that audit committee perception of what they are doing is less than what they should be doing,according to their assigned responsibilities in proxies. This result provides strong evidence that audit committees are not yet effective in executing their assigned responsibilities. One explanation for the results above could be that the audit committee members do not believe that the responsibility assigned to them is an appropriate responsibility. To explore this possibility, we ask the audit committee members the following question, Is this duty appropriate for audit committees? Table 6 shows that the majority of the respondents believe that seventeen of the nineteen responsibilities are appropriate oversight responsibilities for their audit committees. For example, 99 percent believe that reviewing all financial statements is
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an appropriate task for audit committee members. Similarly, 97 percent of the audit committee members consider reviewing all existing accounting policies to be an appropriate responsibility. Except for recommend appointment and fee for external auditor and review plans for effectiveness of internal and external auditors, a significant gap exists between audit committee perceptions of the appropriateness of their oversight responsibilities and their perception of performing these responsibilities.This rules out the possibility that audit committees are not effective because they do not consider the responsibility to be appropriate.
Other Audit Committee Issues

Our survey instrument includes a ranking question and an open-ended question to obtain additional insights regarding audit committee membersbeliefs concerning their most important oversight responsibilities. One of these questions asks each member to list the most important issues facing his audit committee. Committee members in our sample identify thefollowing five responsibilities as their most important concerns in the following order: (1) reviewing systems of internal control; (2) reviewing all financial statements; (3) reviewing fees paid to the auditor for non-audit services; (4) reviewing the external auditors management letter; and (5) determining that auditors are free from undue managerial influence. We also ask the respondents to rank the five most important responsibilities for their committees. The results of this question strongly support our earlier finding that audit committee members view the internal control evaluation task as their most important responsibility. Following this task, the respondents believe that their next most important duty is to focus on the quality of financial reporting,followed by the work of the internal and external auditors. Prior research finds a significant association between quality of financial reporting systems and quality of governance mechanisms, including audit committee (Farber 2005; Bdard, Chtourou and Courteau 2004; Xie, Davidson and DaDalt 2003). The audit committee has a significant role in improving the quality of financial information. In particular, audit committees recognize that they are the core de-cision-making body that is expected to monitor financial reporting practices. The provision of non-audit fees can strengthen the auditors economic relationship with the client, thus increasing the auditors incentive to submit to client pressure,which may jeopardize the auditors independence (Simunic 1984; Beck,Frecka and Solomon 1998). Frankel,Johnson and Nelson (2002) find that non-audit fees are positively associated with earnings surprises and the magnitude of discretionary accruals. Klein (2002) finds a negative relation between audit committee independence and abnormal accruals. It is not surprising, considering the findings of prior research, to observe that the most important five duties before audit committees in our sample are related to internal control and external auditors. All these duties should lead to better financial reporting systems. Good internal control is considered to be an important factor in achieving good quality financial reporting. There is increased pressure to improve financial reporting transparency and provide higher levels of audit scrutiny from audit committees and auditors (Hannon 2005). The Treadway Commissions report recommended:To be effective, audit committees should exercise vigilant and informed oversight of the financial reporting process, including the companys internal controls. (NCFFR 1987, 12). A primary function of the audit committee should be the oversight of internal control, although it is not mandated by SEC rules (Krishnan 2005).The SEC (2003) has mandated that all material written communications between management and the external auditor be provided to the audit committee,including reports on observations and recommendations on internal controls.
Summary and Conclusions

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The study examines whether audit committee assigned duties have been expanded after the passage of SOX and whether audit committees are effective in executing their assigned responsibilities. The results indicate that assigned audit committee duties expanded after the passage of SOX with noticeable increases in the percentage of proxies assigning responsibility to the audit committee in the areas of reviewing all financial statements, reviewing all existing accounting policies,reviewing systems of internal control, reviewing all significant transactions, and appraising key management estimates, judgments, and valuations. Also, the results show a greater emphasis on audit committee responsibilities pertaining to external auditors. Specifically, a pronounced increase in the percentage of proxies assigned responsibility to the audit committee in the areas of reviewing coordination of internal and external auditor work, determining whether auditors are free from undue managerial influence, requesting to be informed of auditor-management disputes, and reviewing fees paid to the auditor for non-audit services. The results indicate that audit committee members perceive they are doing more post-SOX than pre-SOX. The results show a significant gap between perceived and assigned responsibilities in four of the six areas of financial reporting, three of the auditing responsibilities,and two of the three corporate governance responsibilities.In addition, the results imply significant reduction in the gap between perceived audit committee responsibilities and assignedaudit committee responsibilities post-SOX as compared to that which existed in the pre-SOX environment. Nevertheless, the oversight role of the audit committee in corporate America is a vital responsibility that will require an ever more vigilant and conscientious group of individuals in the future. Our study suggests that most audit committees have seriously considered the many mandates contained in the Sar-banes-Oxley Act of 2002 and have incorporated most of the seventeen responsibilities in their assigned oversight responsibilities. However,they still need to do more to meet the many additional challenges facing them in a post-SOX environment. Further, our results suggest that these same individuals take a much more involved stance with respect to the internal control evaluation of the firm and their role as the primary point of contact between the firm and the external auditors. Although the findings of the study show that the governance mandates introduced by SOX were effective in increasing the audit committee perceptions of their assigned duties compared to DeZoort (1997), we cannot attribute these results solely to SOX due to a number of significant audit-committee events that took place prior to SOX and after the data collected in DeZoort in the mid 1990s (e.g. the National Association of Corporate Directors NACD of 2000,Blue Ribbon Commission on Audit Committees of 1999, and SEC rule changes related to audit committee disclosures of 1999). It is difficult to attribute changes in audit committee assigned responsibilities from 2001 through 2004 to SOX only because of many other concurrent major corporate scandals. For instance, the period following the scandals is likely to be marked by greater investor alertness and increased scrutiny by auditors and regulators. Moreover, the results regarding the increase of the audit committee responsibilities post-SOX reflect a more general voluntary disclosure phenomenon. Pre-SOX firms chose whether to assign many of the responsibilities to the audit committee and whether to disclose these assigned responsibilities. So, it is possible that many firms assigned the responsibility but did not disclose these responsibilities in their proxies. Post-SOX there is evidence of an increase in the disclosure behavior relative to pre-SOX (Pandit, Subrahmanyam and Conway 2005; Keinath and Walo 2004). Therefore, the results may be due to an increase in audit committees disclosure requirements rather than an increase in the audit committee assigned responsibilities. As pointed out in Core
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(2001), the simultaneous choice of disclosure and corporate governance structure is an interesting question for future research. Survey studies such as this have a number of limitations,and therefore,the results should be interpreted within this context. Although we did not find any significant differences in the early and late responders who participated in our study, there is always the risk that the individuals who did not respond differed significantly in their views than those who participated in the survey.Also,we had no control over the environment in which the members responded to the survey instrument. Finally, 310 firms in our sample were represented only by one respondent of the audit committee. It is possible that such a respondent may not be a prototypicalmember of a given audit committee and that the respondents perceptions may not necessarily represent the perceptions of the entire audit committee. While the results of this study are encouraging, future research is still warranted on several of the issues examined in the current study.As accounting and auditing issues become increasingly complex in the future, and based on the obfuscation of accounting data and financial reports that transpired in many well-publicized frauds, the technical accounting and auditing expertise of audit committee members should be a critical topic of interest to policy-makers at all levels. This suggests several issues for future research. First, there is a need for more in-depth studies that examine the expertise possessed by audit committee members. Second, should audit committees be required to include at least one senior-level certified public accountants and/or partners of public accounting firms? If yes,where are the potential conflicts of interest? Third, should audit committee members become more aggressive about attaining the required expertise? Perhaps studies should focus on both the quantity and quality of ongoing education for audit committee members from internal sources (such as the internal audit staff ) and outside sources (such as specialized training programs). Another avenue for investigation is whether audit committees are engaging in self-assessment and, if so, what tools are they using and who is conducting the self-assessment for the committee. Rossiter (2004) notes that only the NYSE requires audit committees to conduct an annual self-assessment. He claims that this can be a valuable undertaking if a committee uses the assessment for continuous self-improvement. This also offers an opportunity for audit committees to develop best practices that might be used as standards for world-class committees. Based on the increasing requirements and expectations of audit committees under SOX, this might also be an important defense for audit committee members in the event of litigation.
Notes
1. A comprehensive history of audit committees is included in DeZoort (1997). 2. For example, the revisions to NYSE governance rules is expected to drive different assessments of director independence, perhaps changing audit committee composition and charters as rules around their responsibilities and processes are clarified (PricewaterhouseCoopers LLP, 2005). 3. Subsequently, the SEC adopted Rule 10A-3 to implement Section 301 requirements concerning audit committees. 4. Keinath and Walo (2004) provide a brief summary of each of these provisions of SOX and identify each provision as either a new or an expanded duty for audit committees.
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5. Pandit, Subrahamanyam and Conway (2005) restricted their investigation to only nine requirements, while the current study uses a larger list of audit committee duties and authorities and covers more dimensions than Pandit, Subrahamanyam and Conway (2005). 6. Ninety-nine percent of the audit committees disclosed that they have charters that identify the committees purpose for the entire four year period of our sample of proxy statements. 7. During January and February of 2005 only 227 firms from NASDAQ filed their proxy statement (more from the other two stock exchanges). To eliminate any specific stock exchange impact on the results we included only 227 firms from each stock exchange. 8. We called 60 audit committee members to seek their agreement on participation in our pilot sample. Forty five audit committee members (15 each from the NYSE, AMEX, and NASDAQ) agreed to participate in our pilot sample. For those individuals who agreed to participate, we conducted telephone interviews to clarify the issues under investigation, to draw out new issues, and to explain the terminology used in our instrument. 9. Our analysis did not reveal any significant differences in the early and late responders. 10. We compared the results from the 464 respondent to the results from 310 firms on the descriptive component results. The results of the t-test comparison revealed no significant differences for any of the questions evaluated. 11. The 5-point Likert scale range (for the expertise questions) is 1 = strongly disagree, 2 = moderately disagree, 3 = neither agree nor disagree, 4 = moderately agree, and 5 = strongly agree. For the familiarity questions the 5-point Likert scale range is 1 = dont know, 2 = to small extent, 3 = to some extent, 4 = to moderate extent, and 5 = to great extent. 12. We recognize the imperfection in our method. Comparison to DeZoort (1997) does not provide a direct test of the audit committee perceptions post-and pre-SOX.The direct test requires pre-SOX and postSOX survey data from audit committee members serving similar types of public companies (e.g., 2001 survey data versus 2003 survey data from audit committee members serving similar companies).Therefore,we cannot attribute these results solely to SOX. 13. One-way ANOVA and Tukeys LSD confirms the ranking. We did not observe any differences (p < 0.05 level) across industry, stock exchanges, or audit committee members' experiences. 14. We did not find any differences across industry, stock exchanges, or audit committee members experience (p < 0.05 level).
References
Abbott, L., S. Parker and G. Peters. 2004.Audit committee characteristics and restatements. Auditing: A Journal of Practice & Theory 23(1): 69-87. Beasley, M. , J. Carcello, D. Hermanson and P. Lapides. 2000. Fraudulent financial reporting: Consideration of
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industry traits and corporate governance mechanisms. Accounting Horizons 14 (December): 441-454. Beck, P., T. Frecka and I. Solomon. 1998. A model of the market for MAS and audit services: Knowledge spillovers and auditor-auditee bonding. Journal of Accounting Literature 7:50-64. Bdard, J., S. Chtourou and L. Courteau.2004. The effect of audit committee expertise, independence, and activity on aggressive earnings management. Auditing: A Journal of Practice & Theory23(2): 13-35. Carcello, J. and T. Neal. 2003. Audit committee characteristics and auditor dismissals following new goingconcern reports. The Accounting Review 78(1):95-117. Carcello, J. and T. L. Neal. 2000. Audit committee composition and auditor reporting. The Accounting Review 75(October): 453-467. Carcello, J., D. Hermanson and T. Neal. 2002. Disclosures in audit committee charters and reports. Accounting Horizons 16(4): 291-304. Core, J.E. 2001. A review of the empirical disclosure literature: Discussion. Journal of Accounting and Economics 31(1-3):441-456. Dechow, P., R. Sloan and A. Sweeney. 1996.Causes and consequences of earnings manipulation: An analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research 13(Spring): 1-36. DeZoort, F. 1997. An investigation of audit committees oversight responsibilities. Abacus 33(2): 208-227. Farber, D.B. 2005. Restoring Trust after Fraud: Does Corporate Governance Matter? The Accounting Review 80(2):539-561. Frankel, R., M. Johnson and K. Nelson. 2002. The relation between auditors fees for nonaudit services and earnings management. The Accounting Review77(Sup.): 71-105. Hannon, N. 2005. Post Sarbanes-Oxley:Does XBRL hold the key? Strategic Finance 86(7): 57-59. Keinath, A. and J. Walo. 2004. Audit committee responsibilities: Focusing on oversight, open communication, and best practices. The CPA Journal 74(11):22-28. Klein, A. 2002. Earnings management and audit committees. Journal of Accounting & Economics 33(3) :375401. Krishnan, J. 2005. Audit committee quality and internal control: An empirical analysis. The Accounting Review 80(2):649-675. Lee, H., V. Mande and R. Ortman. 2004.The effect of audit committee and board of director independence on auditor resignation. Auditing: A Journal of Practice & Theory 23(2): 131-146. McMullen, D. and K. Raghunandan. 1996.Enhancing audit committee effectiveness. Journal of Accountancy
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182 (August): 79-81. National Commission on Fraudulent Financial Reporting (NCFFR, the Treadway Commission). 1987.Report ofthe National Commission on Fraudulent Financial Reporting. Washington, D.C.:Government Printing Office. Pandit, G., V. Subrahmanyam and G. Conway. 2005. Audit committee reports before and after Sarbanes-Oxley. The CPA Journal 75(10):42-44. PricewaterhouseCoopers. 2005. Current development for audit committee,Available at: http://www.pwc.com/extweb/pwcpublications.nsf/docid/5872EF7FE6D3DA8385256FA9006 BD6B1. Raghunandan, K., W. Read and D. Rama.2001. Audit committee composition,gray directors, and interaction with internal auditing. Accounting Horizons 15(2): 105-118. Rezaee, Z., K. Olibe and G. Minmier. 2003. Improving Corporate Governance: The Role of Audit Committee Disclosures. Managerial Accounting Journal 18(6/7):530-537. Back
American Journal of Business 2006 by Ball State University ISSN: 1935-5181 Produced at the Bureau of Business Reasearch, Ball State University.
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American Journal of Business Blog Archive Audit Committees Oversight Responsibilities Post Sarbanes-Oxley Act

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Audit Committees Oversight Responsibilities Post Sarbanes-Oxley Act

Audit Committee Responsibilities and Effectiveness

Audit Committee Expertise and Composition

Audit Committee Assigned Responsibilities

Effectiveness of Audit Commitee Oversight Responsibilities

Other Audit Committee Issues

Summary and Conclusions

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