Audit committee responsibilities have consistently increased, and practitioners have raised concerns that audit committees may be overloaded with duties. For example, in a 2005 interview, one audit committee member noted, “It’s becoming almost excessive. We get press releases almost weekly to review. It’s becoming a burden on my email at home. Earnings releases, litigation information, and acquisition information — something seems to always be coming my way” (Beasley et al. 2009). These concerns continue today. For example, forty percent of audit committee members polled by KPMG (2015) report that it is increasingly difficult to adequately fulfill all of the audit committee’s responsibilities.
Concerns related to audit committee overload stand in sharp contrast to the belief held by regulators that assigning audit committees more monitoring responsibilities enhances oversight and the reliability of financial reporting. While financial reporting oversight is the core duty of audit committees (e.g., see the 1999 report of the Blue Ribbon Committee on Audit Committee Effectiveness), audit committees often undertake additional (non-core) oversight, not directly related to financial reporting. For example, beginning in 2004, the NYSE stock exchange required companies to expand audit committee oversight to areas related to financial risk management (including hedging programs and asset management). However, consistent with overload concerns, Deloitte cautions that “boards should take care not to overburden the audit committee with risk oversight responsibilities” (Deloitte 2018, pg. 1).
In our paper, The scope of audit committee oversight and financial reporting reliability: Are audit committees overloaded?, we investigate the following questions: Are audit committees in fact overloaded? How does expanding audit committee oversight to include non-core areas like financial risk management affect financial reporting reliability?
We address these questions through the use of audit committee charters. Audit committees often operate as a black box; investors typically have little insight into what duties and responsibilities audit committees actually execute. To provide shareholders with a better way to evaluate audit committee activities, the SEC requires that each audit committee adopt and disclose a charter that is tailored to each company’s specific circumstances and details the role and responsibilities of the audit committee (SEC 2000). From 2000 to 2006, the SEC required companies to include their audit committee charters in annual proxy statements. Our sample is restricted to this period, because after 2006 only the latest version of audit committee charters must be kept on each company’s website.
Despite concerns that audit committee charters may be boilerplate and uninformative, we find significant variation in their length and content from company to company. We use the length of the audit committee charter to capture the extent of audit committee responsibilities and find that audit committees with more comprehensive charters provide better oversight of financial reporting, resulting in a lower likelihood of misstating financial statements. Our analysis suggests that, on average, increasing the duties of the audit committee by one standard deviation is associated with an 8 percent decrease in the likelihood of a misstatement, relative to the overall incident rate of misstatements in our sample. Audit committee effectiveness does not appear to be impaired as responsibilities increase. To the contrary, we find that improved financial statement reliability occurs for companies with the longest of audit committee charters.
As suggested by Deloitte (2018) and other governance professionals, financial reporting reliability may more likely suffer when audit committee overload arises from extraneous, non-core responsibilities that distract from the audit committee’s core responsibility to monitor financial reporting. We find evidence consistent with such a distraction effect. Financial statement reliability decreases as audit committees are assigned greater oversight responsibilities related to financial risk management.
In summary, our evidence suggests that increasing audit committee responsibilities to high levels of financial reporting oversight can improve financial reporting reliability, but responsibilities unrelated to financial reporting can distract audit committees from their core oversight mandate and result in reduced financial reporting reliability.
Beasley, M. S., Carcello, J. V., Hermanson, D. R., & Neal, T. L. (2009). The audit committee oversight process. Contemporary Accounting Research, 26(1), 65-122.
Blue Ribbon Commission on Improving the Effectiveness of Corporate Audit Committees. (1999). Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. The Business Lawyer, 54(3), 1067–1095.
Deloitte. 2018. Risk Oversight and the Role of the Board. https://deloitte.wsj.com/riskandcompliance/2018/10/02/risk-oversight-and-the-role-of-the-board/.
KPMG. (2015). 2015 Global Audit Committee Survey. https://home.kpmg.com/us/en/home/insights/2015/03/2015-issue1-article2.html.
SEC (2000). Audit Committee Disclosure. Release No. 34-42266. Washington, D.C.
This post comes to us from Musaib Ashraf, a PhD candidate at the University of Arizona; Professor Preeti Choudhary at the University of Arizona; and Jacob Jaggi, a PhD candidate at the University of Arizona. It is based on their recent paper, “The Scope of Audit Committee Oversight and Financial Reporting Reliability: Are Audit Committees Overloaded?,” available here.