Audit Committee Quality and Internal Control: An Empirical Analysis

TLDR

Information on internal control quality is scarce, but companies changing auditors must disclose any internal control problems identified by predecessor auditors. I examine the association between audit committee quality and the quality of corporate internal control. The study compares firms that disclose internal control problems with those that do not, measuring audit committee quality by size, independence, and expertise, and classifying problems as reportable conditions or material weaknesses, using data from before recent audit‑committee policy changes. Independent audit committees and those with financial expertise are significantly less likely to be associated with internal control problems at both reportable and material‑weakness levels, supporting recent policy emphasis on independence and expertise.

Abstract

I examine the association between audit committee quality and the quality of corporate internal control. While information on the quality of internal control is not generally available, companies changing auditors are required to disclose any internal control problems that were pointed out by their predecessor auditors. The empirical results are based on a comparison of companies disclosing such internal control problems with a control sample of companies changing auditors but not disclosing internal control problems. Audit committee quality is measured in three dimensions: its size, its independence, and its expertise. The internal control problems are observed at two levels of increasing seriousness: reportable conditions and material weaknesses. The sample time period precedes the effective dates of recent policy changes regarding audit committees. The results indicate that independent audit committees and audit committees with financial expertise are significantly less likely to be associated with the incidence of internal control problems. This is true for both levels of internal control problems. The results are consistent with recent policy emphasis on audit committee independence and expertise.