65
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0268-6902.htm
Characteristics of audit
committee financial experts:
an empirical study
Characteristics of
audit committee
Venkataraman M. Iyer
Department of Accounting and Finance,
The University of North Carolina at Greensboro, Greensboro,
North Carolina, USA
E. Michael Bamber
J.M. Tull School of Accounting, The University of Georgia,
Athens, Georgia, USA, and
Jeremy Griffin
Department of Accountancy, University of Notre Dame,
South Bend, Indiana, USA
Abstract
Purpose – The purpose of this paper is to examine the characteristics and qualifications of audit
committee financial experts. Specifically, the paper examines if the majority of the financial experts
possess accounting or general management experience.
Design/methodology/approach – The authors collected the data through survey and use cross
tabulation (univariate) and logistic regression to analyze the data.
Findings – The results show that accounting certification and audit committee experience are valued
positively by the Board of Directors when designating an audit committee member as a financial expert.
Prior experience as a CEO results in a lower probability of being designated as a financial expert.
Research limitations/implications – Non-response bias may be a factor which should be
considered. There are other factors such as stock exchange affiliation of the company that have not
been included due to the anonymous nature of the survey.
Practical implications – It provides useful information and benchmark to the Board of Directors
with respect to the characteristics of designated audit committee financial experts.
Originality/value – This is the first paper to examine the characteristics of audit committee
financial experts through survey. The paper presents a richer array of factors compared to what is
available in proxy statements. Audit committees, financial statement users, policy makers, and
researchers will find the results interesting and useful.
Keywords Audit committees, Financial expert, Sarbanes-Oxley, Corporate governance, Auditing
Paper type Research paper
1. Introduction
Section 407 of the Sarbanes-Oxley Act of 2002 (the “Act”) requires public companies to
disclose whether or not they have at least one “financial expert” serving on their audit
committees. Companies that do not have an audit committee financial expert serving on
their audit committee must disclose that fact and explain why they have no such expert.
The SEC noted that the term “financial” extends beyond accounting and auditing to other
aspects of the company, such as its capital structure, valuation, risk analysis and
Managerial Auditing Journal
Vol. 28 No. 1, 2013
pp. 65-78
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686901311282506
www.emeraldinsight.com/0268-6902.htm
66
MAJ
28,1
capital-raising activities. The .
65 The current issue and full text archive of this journal.docx
1. 65
The current issue and full text archive of this journal is
available at
www.emeraldinsight.com/0268-6902.htm
Characteristics of audit
committee financial experts:
an empirical study
Characteristics of
audit committee
Venkataraman M. Iyer
Department of Accounting and Finance,
The University of North Carolina at Greensboro, Greensboro,
North Carolina, USA
E. Michael Bamber
J.M. Tull School of Accounting, The University of Georgia,
Athens, Georgia, USA, and
Jeremy Griffin
Department of Accountancy, University of Notre Dame,
South Bend, Indiana, USA
Abstract
Purpose – The purpose of this paper is to examine the
2. characteristics and qualifications of audit
committee financial experts. Specifically, the paper examines if
the majority of the financial experts
possess accounting or general management experience.
Design/methodology/approach – The authors collected the data
through survey and use cross
tabulation (univariate) and logistic regression to analyze the
data.
Findings – The results show that accounting certification and
audit committee experience are valued
positively by the Board of Directors when designating an audit
committee member as a financial expert.
Prior experience as a CEO results in a lower probability of
being designated as a financial expert.
Research limitations/implications – Non-response bias may be a
factor which should be
considered. There are other factors such as stock exchange
affiliation of the company that have not
been included due to the anonymous nature of the survey.
Practical implications – It provides useful information and
benchmark to the Board of Directors
with respect to the characteristics of designated audit committee
financial experts.
Originality/value – This is the first paper to examine the
characteristics of audit committee
financial experts through survey. The paper presents a richer
array of factors compared to what is
available in proxy statements. Audit committees, financial
statement users, policy makers, and
researchers will find the results interesting and useful.
Keywords Audit committees, Financial expert, Sarbanes-Oxley,
Corporate governance, Auditing
Paper type Research paper
3. 1. Introduction
Section 407 of the Sarbanes-Oxley Act of 2002 (the “Act”)
requires public companies to
disclose whether or not they have at least one “financial expert”
serving on their audit
committees. Companies that do not have an audit committee
financial expert serving on
their audit committee must disclose that fact and explain why
they have no such expert.
The SEC noted that the term “financial” extends beyond
accounting and auditing to other
aspects of the company, such as its capital structure, valuation,
risk analysis and
Managerial Auditing Journal
Vol. 28 No. 1, 2013
pp. 65-78
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686901311282506
www.emeraldinsight.com/0268-6902.htm
66
MAJ
28,1
capital-raising activities. The SEC chose the phrase “audit
committee financial expert”
because it more accurately reflects the characteristics
particularly relevant to the functions
of the audit committee oversight, such as expertise in
4. accounting matters as well as an
understanding of financial statements and the capacity to ask
insightful questions to
determine the completeness and accuracy of the company’s
financial statements.
The Final Rules (Securities and Exchange Commission, 2003)
define an “audit
committee financial expert ” as a person with all of the five
following attributes:
(1) an understanding of generally accepted accounting
principles and financial
statements;
(2) the ability to assess the general application of such
principles in connection
with the accounting for estimates, accruals and reserves;
(3) experience preparing, auditing, analyzing or evaluating
financial statements
that present a breadth and level of complexity of accounting
issues that are
generally comparable to the breadth and complexity of issues
that can
reasonably be expected to be raised by the registrant’s financial
statements, or
experience actively supervising one or more persons engaged in
such activities;
(4) an understanding of internal controls and procedures for
financial reporting; and
(5) an understanding of audit committee functions.
Under the Final Rules, in order to qualify as an “audit
5. committee financial expert” a
person can acquire the above listed attributes through any one
or more of the following:
. education and experience as a principal financial officer,
principal accounting
officer, controller, public accountant or auditor or experience in
one or more
positions that involve the performance of similar functions;
. experience actively supervising a principal financial officer,
principal accounting
officer, controller, public accountant, auditor or person
performing similar functions;
. experience overseeing or assessing the performance of
companies or public
accountants with respect to the preparation, auditing or
evaluation of financial
statements; or
. other relevant experience.
The board of directors (BOD) of every company subject to the
Final Rules is now
required to determine whether or not it has at least one audit
committee financial
expert serving on its audit committee. The directors can
conclude that a person is an
audit committee financial expert based on “other relevant
experience,” even if that
person did not obtain the required attributes through one of the
specific roles identified.
If the board makes such a determination, it is required to briefly
list that person’s
experience. Given the ability of the BOD to designate an audit
6. committee member as a
financial expert based on a wide range of characteristics, it is
important to examine the
characteristics and qualifications of audit committee financial
experts. Specifically, of
interest is the role of financial experts’ experience and, in
particular, the relative roles of
accounting and auditing experience, general managerial
experience, and prior BOD
and audit committee experience. Similarly of interest is whether
a prior relationship
with the company influences designation as a financial expert,
as it can influence
appointment to the BOD.
67
We conducted a survey of audit committee members of public
companies in the
USA that are subject to these SEC requirements, to obtain
information about their
qualifications and characteristics. The survey, which was
conducted in 2009, resulted
in 167 responses, of which 118 were from audit committee
financial experts and 49 from
audit committee members who were not designated as financial
experts. To our
knowledge, our study is the first to use a survey method to
gather information about
audit committee financial experts. We also use the information
to construct a logistic
regression model to predict the factors related to the probability
of an audit committee
member being designated as a financial expert.
7. In contrast to prior studies (Carcello et al., 2002, 2006) that use
publicly available
information about designated financial experts, we examine a
richer array of survey data
to list the characteristics and qualifications preferred by the
BOD to designate an audit
committee member as a financial expert. While prior studies
examine the qualifications of
designated financial experts listed in the proxy statements, our
sample includes all the
audit committee members who are qualified to be a financial
expert. This unique dataset
enables us to provide the characteristics of a more desirable
audit committee financial
expert. Specifically, we examine if the BOD prefers certain
qualifications over others in a
financial expert. Contrary to the findings by Carcello et al.
(2002) that accounting or
financial management experience is the definition used by most
companies for financial
expertise, we find that professional accounting certification is
considered more valuable
by companies when designating a financial expert. This may be
due to the impact of
Sarbanes-Oxley Act (2002) and the related SEC requirements.
The rest of the paper is organized as follows. The next section
presents a brief
discussion of the prior research pertaining to the importance of
audit committee
financial experts. Research method including the description of
the sample is given
next. We continue with the results of the univariate and
regression analyses of audit
committee member characteristics that are associated with the
8. designation of financial
experts. The conclusion summarizes our findings, discusses the
paper’s limitations,
and identifies possible directions for future research.
2. Prior research
Recent research has focused on the impact of audit committee
financial experts on
various factors such as corporate governance, internal control
weaknesses,
restatements and market reaction to the appointment. For
example, Defond et al.
(2005) find a positive market reaction to the appointment of
financial experts
having accounting skills to audit committees but no market
reaction to the
appointment of financial experts who have broader financial
skills but no specific
accounting skills.
Zhang et al. (2007) find that internal control weaknesses are
related to a company’s
audit committee having less financial expertise or, more
specifically, having less
accounting financial expertise and non-accounting financial
expertise. Bedard et al.
(2004), Krishnan (2005) and Dhaliwal et al. (2006) report that
financial expertise,
measured using a strict definition based on accounting/auditing
experience, is
associated with less earnings management and better internal
control. On the other
hand, Anderson et al. (2004) do not find any relation between
debt costs and financial
experts serving on the audit committee. They attribute this to
the fact that the creditors
9. focus on audit committee independence and not necessarily on
its expertise.
Characteristics of
audit committee
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Carcello et al. (2006) examined the disclosures related to audit
committee financial experts
in the first year that this disclosure requirement was in effect.
They found that virtually all
companies disclose if there is a financial expert on the audit
committee but the disclosure
regarding his or her qualification was limited. They also found
that most financial experts
did not have a background in accounting or finance and the
stock exchange affiliation
moderated this factor. Carcello et al. (2002) studied the
disclosures in audit committee
charters and reports by examining a random sample of 150
proxy statements filed in 2001,
prior to the SEC rules requiring designation of financial experts
in audit committees. They
found that most companies define “financial expertise” as
having accounting or related
financial management expertise. Professional certification or
employment experience in
accounting was less commonly employed definition of financial
expertise.
10. Qualifications and characteristics of the financial experts thus
impact various outcomes
such as control weaknesses, restatements, earnings management,
etc. Most of the prior
studies obtain information about the financial experts from the
disclosures made by
companies in their proxy statements. On the other hand, our
study uses a survey instrument
to gather information from the audit committee members. Some
information such as prior
relationship of the audit committee member with someone on
the management team can
only be obtained using survey. To that extent, our research is
different and provides a richer
array of information about the financial experts. This is a purely
descriptive study as our
goal is to find the characteristics and qualifications deemed
important in a financial expert
by the BOD. Accordingly, we pose our research question:
RQ1. What characteristics and qualifications distinguish an
audit committee
financial expert from an audit committee member who has not
been
designated as a financial expert?
3. Research method
3.1 Sample
We collected our data on the characteristics of audit committee
financial experts
through a survey. A survey instrument was mailed to 1,000
audit committee members
in the fall of 2009. Their names were selected randomly from
OneSource Global, a
database comprising of audit committee members in public
companies in the USA, and
11. only one audit committee member was selected from each
company. We received
responses from 167 audit committee members for a response
rate of 16.7 percent[1].
The two-page survey instrument contained questions seeking to
obtain information on
the characteristics and background of audit committee
members[2].
3.2 Analysis
We use univariate and multivariate tests to analyze the data.
Specifically, we examine
if there are any specific characteristics that distinguish a
designated financial expert
from an audit committee member who is not so designated by
the companies. We also
performed logistic regression analysis to find the factors related
to an audit committee
member being designated as a financial expert. Logistic
regression is appropriate when
the dependent variable is dichotomous, e.g. if an audit
committee member is designated
as a financial expert or not.
Our choice of independent variables is based on the
qualifications listed by the SEC
for an audit committee financial expert. These qualifications
include accounting
or auditing knowledge and experience as a CEO of a company.
The SEC’s requirements
69
are quite broad and it even includes a category “other relevant
12. experience” which Characteristics of
audit committee provides latitude for the BOD to consider
qualifications other than the ones that are
listed. Given the exploratory nature of this study, we use a
broad array of qualifications
and characteristics that might be used by the BOD to designate
an audit committee
financial expert. For example, a company may consider
experience serving on other
audit committees and on other BODs to be “relevant
experience”. Moreover, the BOD
may use certain qualifications such as prior professional or
informal relationship when
choosing between two equally qualified audit committee
members.
Our logistic regression model and the variables used are given
below:
Fin Exp ¼ b0 þ b1 Other AC þ b2 Other Comm þ b3 Prior Mgr
Exp
þ b4 Prior BOD Exp þ b5 Prior Prof Rel þ b6 Prior Inf Rel
þ b7 More than one BOD þ b8 Senior Mgmt þ b9 Certification
þ b10 Audit Exp þ b11 Prior AC Exp þ b12 CEO Exp þ e
where:
Fin Exp ¼ 1 if the respondent is designated as a financial
expert, else 0.
Other AC ¼ 1 if the respondent is serving on the audit
committee of more
than one company, else 0.
Other Comm ¼ 1 if the respondent is serving on any other
13. committees of the
board, else 0.
Prior Mgr Exp ¼ 1 if the respondent has a prior experience in
the company’s
industry in a management position, else 0.
Prior BOD Exp ¼ 1 if the respondent has a prior experience as
an independent
board member, else 0.
Prior Prof Rel ¼ 1 if the respondent has a prior professional
relationship with any
member of the management, else 0.
Prior Inf Rel ¼ 1 if the respondent has a prior informal
relationship with any
member of the management, else 0.
More than ¼ 1 if the respondent is currently serving on the
board of more than
one company, one BOD else 0.
Senior Mgmt ¼ 1 if the respondent is currently serving in a
senior management
position, else 0.
Certification ¼ 1 if the respondent has a CPA, CMA, or CIA
certification, else 0.
Audit Exp ¼ 1 if the respondent has auditing experience, else 0.
Prior AC Exp ¼ 1 if the respondent has a prior audit committee
experience, else 0.
CEO Exp ¼ 1 if the respondent has been a CEO of a company,
14. else 0.
4. Results
4.1 Distribution of responses
Figure 1 shows the distribution of responses among the sample
companies. The overall
response rate is 16.7 percent. The responses are approximately
uniformly distributed
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Figure 1.
Distribution of responses
among sample companies
Note: Revenue is measured in $ million
among various size organizations measured using revenues, with
the highest
percentage of responses (9.5 percent) from organizations with
the revenue of
approximately $1 billion. The average size of the companies
was $3.13 billion and the
standard deviation was $11.5 billion.
4.2 Descriptive results
Table I provides descriptive statistics about the audit committee
members. It shows
that a majority of audit committee members are serving
concurrently on other audit
committees, other BODs, and on other committees of the BOD,
15. and have prior
experience as a BOD member and as an audit committee
member. Approximately
53 percent of the respondents have CPA, CMA, or CIA
certification and 54 percent
have prior auditing experience. Close to 36 percent of the audit
committee
members have a prior informal relationship with a member of
the management and
30 percent have a prior professional relationship. About 70
percent of the respondents
have been designated as financial experts. Exactly half the audit
committee members
have prior experience as a CEO of an organization.
Table II provides additional information about the audit
committee members
who responded to the survey. An overwhelming majority of
respondents were male
(.80 percent) and the average age of respondents was 62. They
served on the audit
committee on an average of about six years and on the BOD for
about seven and a half years.
Table III provides descriptive statistics about the financial
experts on the audit
committee. It shows that a majority of the financial experts are
serving concurrently on
71
Characteristics of
audit committee Variable Legend No Yes Missing Total
16. Currently serving on other audit committees Other AC 69 92 6
167
Currently serving on other committees of the Other committees
28 139 0 167
board
Prior experience as manager in the industry Prior Mgr Exp 118
49 0 167
Prior experience as independent BOD member Prior Exp on
BOD 56 111 0 167
Prior professional relationship with the Prior Prof Rel 115 51 1
167
management
Prior informal relationship with the Prior Inf Rel 98 57 12 167
management
Financial expert Fin Exp 49 118 167
Serving on more than one BOD More than one 41 125 1 167
BOD
Currently in a senior management position Senior Mgmt 102 57
8 167
Certification (CPA, CMA, or CIA) Certification 79 88 167
Audit experience Audit Exp 72 90 5 167
Prior audit committee experience Prior AC Exp 46 120 1 167
Ever been a CEO CEO Exp 82 83 2 167 Table I.
Gender 152 14 1 Descriptive statistics of
(male) (female) audit committee members
Variable n Mean SD Min Max
Company revenues ($ millions) 158 3,129.36 11,520.96 1
100,000 Table II.
Years on AC 166 6.21 5.17 1 35 Descriptive statistics of
Years on BOD 164 7.43 6.24 1 35 companies and audit
Age 135 62.80 8.98 41 99 committee members
17. Variable Legend No Yes Missing Total
Currently serving on other audit committees Other AC 43 70 5
118
Currently serving on other committees of the Other committees
22 96 0 118
board
Prior experience as manager in the industry Prior Mgr Exp 84
34 0 118
Prior experience as independent BOD member Prior Exp on
BOD 39 79 0 118
Prior professional relationship with the Prior Prof Rel 76 42 0
118
management
Prior informal relationship with the Prior Inf Rel 72 38 8 118
management
Serving on more than one BOD More than one 23 95 0 118
BOD
Currently in a senior management position Senior Mgmt 73 38 7
118
Certification (CPA, CMA, or CIA) Certification 43 75 0 118
Audit experience Audit Exp 42 73 3 118
Prior audit committee experience Prior AC Exp 27 91 0 118
Table III.
Ever been a CEO CEO Exp 66 51 1 118 Descriptive statistics of
Gender 108 10 financial experts on the
(male) (female) audit committee
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18. other audit committees, other BODs, and on other committees of
the BOD, and have prior
experience as a BOD member and as an audit committee
member. About 63 percent of
the financial experts have a professional accounting
certification and about 62 percent
have prior auditing experience. Approximately 32 percent of the
financial experts have
a prior informal relationship with a member of the management
and 35 percent have a
prior professional relationship. Only about 32 percent of the
financial experts
are currently employed in a senior management position. Less
than half (42 percent) of
the financial experts have prior experience as CEOs of
organizations.
Table IV provides information about the designated financial
experts on the
audit committee. Among the financial experts who responded to
the question, 107
were males and only ten were females[3]. The average age of
the respondents was 62.
They served on the audit committee on an average of about six
years and on the BOD
for about six and a half years.
It is important to know the characteristics and qualifications of
audit committee
members not designated as financial experts, to ascertain if they
are indeed qualified to
be designated as financial experts. Table V provides descriptive
statistics about the
audit committee members not designated as financial experts. It
shows that a majority of
19. the members in this group are serving on other committees of
the Board, other BODs,
and have prior experience as a BOD member and as an audit
committee member.
As expected, only about 26 percent of them have a professional
accounting certification
Variable n Mean SD Min Max
Table IV.
Descriptive statistics of
financial experts on the
audit committee
Company revenues ($ millions)
Years on AC
Years on BOD
Age
113
118
117
97
3,585.79
6.00
6.50
62.3
13,429.02
4.83
5.53
9.4
1
1
20. 1
41
100,000
35
35
99
Variable Legend No Yes Missing Total
Currently serving on other audit committees Other AC 26 22 1
49
Currently serving on other committees of the Other committees
6 43 0 49
board
Prior experience as manager in the industry Prior Mgr Exp 34
15 0 49
Prior experience as independent BOD member Prior Exp on
BOD 17 32 0 49
Prior professional relationship with the Prior Prof Rel 39 9 1 49
management
Prior informal relationship with the Prior Inf Rel 26 19 4 49
management
Serving on more than one BOD More than one 18 31 0 49
BOD
Currently in a senior management position Senior Mgmt 29 19 1
49
Certification (CPA, CMA, or CIA) Certification 36 13 0 49
Table V. Audit experience Audit Exp 30 17 2 49
Descriptive statistics of Prior audit committee experience Prior
AC Exp 19 29 1 49
audit committee members Ever been a CEO CEO Exp 16 32 1 49
not designated as Gender 44 4 1
financial experts (male) (female)
21. 73
and about 35percent have prior auditing experience.
Approximately 39 percent of the
respondents in this group have a prior informal relationship
with a member of the
management and 18 percent have a prior professional
relationship. Only 39 percent of
the members are currently employed in a senior management
position and more than
half (65 percent) have prior experience as CEOs of
organizations.
Table VI provides additional information about the members not
designated as
financial experts on the audit committee. Among those who
responded to the question,
44 were males and only four were females. The average age of
the respondents was 64.
They served on the audit committee on an average of about six
years and on the BOD for
about nine and a half years. There was no significant difference
between the size of the
companies of the financial experts and the companies of other
audit committee members.
A further analysis of this group of audit committee members
shows that seven
members did not possess the accounting knowledge
(certification or auditing
experience) or background as a CEO of a company which would
meet the requirement
to be designated as a financial expert.
22. 4.3 Cross tabulation results
Table VII provides the results of the cross tabulation analysis.
Cross tabulation shows
the joint distribution of two or more variables and can be used
to examine the
relationships between the variables. x 2 statistics is used to
determine if the relationship
between the variables is significant.
Characteristics of
audit committee
Variable n Mean SD Min Max
Table VI.
Company revenues ($ millions) 45 1,983.22 3,562.59 0 18,000
Descriptive statistics of
Years on AC 48 6.708 5.95 1 33 audit committee members
Years on BOD 47 9.745 7.31 1 33 not designated as
Age 38 64.1 7.79 48 86 financial experts
Expected number of financial Actual number of financial x 2
Variable expertsb experts p-valuea
Other AC 64.6 70 0.059
Other Committees 98.2 96 0.313
Prior Mgr Exp 34.6 34 0.816
Prior Exp on BOD 78.4 79 0.838
Prior Prof Rel 36.3 42 0.033
Prior Inf Rel 40.5 38 0.368
More than one BOD 89 95 0.018
Senior Mgmt 39.8 38 0.518
Certification 62 75 0.000
Audit Exp 63.9 73 0.002
23. Prior AC Exp 85.3 91 0.029
CEO Exp 58.9 51 0.007
Notes: a x 2 p-values are calculated using two-tail tests;
bexpected value in a cross tabulation is the
number of objects one would expect to find after multiplying
the probabilities of the row and the
column in the table
Table VII.
Cross tabulation of
financial expert with
other variables
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Our results show that designation of financial expert is
significantly related to a
variety of experiences and current activities. Having a
professional accounting
certification and auditing experience are positively associated
with financial expert
designation, so is prior audit committee experience. CEO
experience is a factor in
appointment to a BOD, and approximately half of our financial
experts have this
experience, but it is negatively associated with designation of
financial expert. While
the majority of audit committee members currently serve on
other BOD and audit
24. committees, audit committee members designated financial
experts are even more
likely to currently serve on other BODs and audit committees.
4.4 Regression results
Cross tabulation examines each variable at a time. Hence
logistic regression is used to
determine the impact of each variable in the presence of other
variables. As explained
before, of the 167 respondents, 160 were deemed to have the
necessary qualifications to
be designated as financial experts. Hence, we use only these
160 cases in our analysis.
Results of the logistic regression are given in Table VIII. These
results are discussed in
the following paragraphs.
The regression model is significant ( p , 0.001) with a pseudo R
2 of 0.40. It has a
classification accuracy of 82.1 percent. Table VIII shows that
the following factors are
significantly related to the probability of an audit committee
member being designated
as a financial expert:
. currently serving on other audit committees ( p ¼ 0.072);
. prior experience on BOD ( p ¼ 0.029); and
. CPA, CMA, or CIA Certification ( p ¼ 0.074), and prior CEO
experience ( p ¼ 0.002).
Dependent variable Financial experts
Parameter Coeff. Exp(B) (odds ratio) Wald x 2 P a
Intercept 1.822 6.186 1.56 0.211
25. Other AC 21.277 0.279 3.23 0.072
Other Committees 0.222 1.249 0.08 0.783
Prior Mgr Exp 0.423 1.526 0.49 0.482
Prior Exp on BOD 1.902 6.702 4.76 0.029
Prior Prof Rel 20.979 0.376 1.67 0.196
Prior Inf Rel 0.448 1.565 0.58 0.445
More than one BOD 0.229 1.257 0.11 0.738
Senior Mgmt 20.470 0.625 0.60 0.437
Certification 21.089 0.337 3.19 0.074
Audit Exp 20.633 0.531 1.00 0.317
Prior AC Exp 20.419 0.658 0.30 0.582
CEO Exp 2.150 8.584 9.74 0.002
Ln Revenue 0.028 1.029 0.04 0.845
x 2 ¼ 38.47
Table VIII. p ¼ 0.000
Logistic regression model Classification
for factors related to audit accuracy ¼ 82.1%
committee members Nagelkerke R 2 ¼ 0.40
designated as financial
experts Note: a p-values for independent variables are
calculated using two-tail tests
75
The table also reports the odds ratio (Exp (B)) which is the
natural log base, e, to the
exponent, b, where b ¼ the parameter estimate. When b ¼ 0,
Exp(b) ¼ 1, so therefore
an odds ratio of 1 corresponds to an explanatory variable, which
does not affect the
dependent variable. An Exp(b) . 1 means the independent
variable increases the logit
and therefore increases odds(event). If Exp(b) is less than 1.0,
26. then the independent
variable decreases the logit and decreases odds(event). In binary
logistic regression, the
higher category of the dependent (1 – financial expert) is
predicted and the lower
category (0 – not a financial expert) is the comparison reference
by default. Also, when
there are categorical independent variables (e.g. having a
professional certification or
not), the prediction is for the lower category and the higher
category (professional
certification ¼ 1) is the reference. Hence, for certification, we
can say that the odds of
being designated as a financial expert are decreased by a factor
of 0.337 by not having
a professional certification[4].
Results show that the factors that improve the odds of being
designated as a financial
expert are largely consistent with the earlier cross tabulation
results. A professional
accounting certification and serving on other audit committees
increase the odds of
being designated a financial expert. However, prior experience
on BOD joins prior CEO
experience in decreasing the odds of being designated as a
financial expert.
5. Conclusions
To our knowledge, this is the first study which uses a survey
method to gather data
from the audit committee members to examine the
characteristics of designated
financial experts. We present the results of the responses
received from audit
committee members in 167 companies.
27. Our results show that professional accounting certification and
audit committee
experience are valued positively by the BOD when designating
an audit committee
member as a financial expert. Prior experience as a CEO results
in a lower probability of
being designated as a financial expert. These results are positive
findings given that prior
research shows that accounting knowledge and audit experience
are valuable and they
result in less earnings management and better internal control.
Our results do not support
the finding of Carcello et al. (2002) that the financial experts
designated by the companies
typically do not possess an accounting or finance background
but have experience serving
as a CEO. The different results are likely due to the Sarbanes-
Oxley Act. While many of
our designated financial experts have experience serving as a
CEO, this is a typical
characteristic of BOD members but it does not increase the
chance of being designated a
financial expert. Rather, a financial expert designation is
significantly improved with a
professional accounting certification and audit committee
experience. Contrary to
assertions in the popular press, a prior informal or professional
relationship with members
of the management team does not seem to influence the
designation as a financial expert.
We do not find significant differences in age or experience
levels between the financial
experts and other members of the audit committee.
There are several limitations to our study. Caution is required
28. when interpreting
results due to the limitations associated with administering the
materials by mail.
Non-response bias is a factor which should be considered. There
are other factors such
as stock exchange affiliation of the company may impact the
characteristics of
financial experts (Carcello et al., 2006). Given the anonymous
nature of the survey,
Characteristics of
audit committee
76
MAJ
28,1
we were unable to supplement publicly available information
with the information
provided by the respondents.
Future studies may examine the process the companies use to
choose the financial
expert to serve on the audit committee. Studies have typically
used the
accounting/non-accounting background of financial experts to
examine the outcomes
such as internal control weaknesses, fraud, etc. Another avenue
for future research is to
use a richer set of characteristics such as CEO experience, audit
experience, etc. of
financial experts to examine these outcomes.
29. Notes
1. Most of these responses were received after our first mailing.
We did send out a reminder
and a copy of the survey to the non-respondents but there were
only 18 responses to our
second mailing.
2. Relevant questions from the questionnaire are provided in the
Appendix.
3. The proportion of males and females in the sample is similar
to the proportion of males and
females in the population surveyed.
4. The results are similar even if we use just the CPA
certification instead of CPA, CMA, or CIA
certification. About 68 audit committee members had CPA
certification out of which 62 were
designated as financial experts.
References
Anderson, R.C., Mansi, S.A. and Reeb, D.M. (2004), “Board
characteristics, accounting report
integrity, and the cost of debt”, Journal of Accounting and
Economics, Vol. 37 No. 2,
pp. 315-42.
Bedard, J., Chtourou, S.M. and Courteau, L. (2004), “The effect
of audit committee expertise,
independence, and activity on aggressive earnings
management”, Auditing: A Journal of
Practice & Theory, Vol. 23 No. 2, pp. 13-35.
Carcello, J.V., Hermanson, D.R. and Neal, T.L. (2002),
30. “Disclosures in audit committee charters
and reports”, Accounting Horizons, Vol. 16 No. 4, pp. 291-304.
Carcello, J.V., Hollingsworth, C.W. and Neal, T.L. (2006),
“Audit committee financial experts:
a closer examination using firm designations”, Accounting
Horizons, Vol. 20 No. 4,
pp. 351-73.
Defond, M.L., Hann, N. and Hu, X. (2005), “Does the market
value financial expertise on audit
committees of boards of directors?”, Journal of Accounting
Research, Vol. 32, pp. 153-93.
Dhaliwal, D., Naiker, V. and Navissi, F. (2006), “Audit
committee financial expertise, corporate
governance and accruals quality: an empirical analysis”,
working paper, University of
Arizona, Tucson, AZ.
Krishnan, J. (2005), “Audit committee quality and internal
control: an empirical analysis”,
The Accounting Review, Vol. 80 No. 2, pp. 649-75.
Securities and Exchange Commission (2003), Final Rule:
Disclosure Required by Sections 406 and
407 of the Sarbanes-Oxley Act of 2002, Government Printing
Office, Washington, DC.
Zhang, Y., Zhou, J. and Zhou, N. (2007), “Audit committee
quality, auditor independence, and
internal control weaknesses”, Journal of Accounting & Public
Policy, Vol. 26 No. 3,
pp. 300-27.
31. 77
Further reading Characteristics of
audit committee DeZoort, T. and Salterio, S. (2001), “The
effects of corporate governance experience and financial
reporting and audit knowledge on audit committee members’
judgments”, Auditing:
A Journal of Practice & Theory, Vol. 20 No. 2, pp. 31-47.
Appendix. Questionnaire
Are you currently on the audit committee of more than one
company ? Yes No
Please answer the following questions pertaining to your
relationship with the company that you serve as
an audit committee member (use the largest company if serving
on more than one):
1. How long have you been on the audit committee? Number of
years _____
2. How long have you been on the BOD of this company?
Number of years _____
3. Are you serving on any other committees of the board? Yes
No
4. What is the approximate revenue of this company?
________________
5. Does this company have a Big 4 auditor? Yes No
Please answer the following questions:
32. 1. Before being appointed to the board of directors, did you
have prior experience in the company’s
industry in a management position? Yes No
2. Before being appointed to the board of directors, did you
have prior experience as an independent
BOD member? Yes No
3. Did you have (a) a professional relationship with any
members of this company’s management before
serving on the BOD? Yes No
or (b) an informal relationship with any member of this
company’s management before serving on
the BOD? Yes No
4. Approximately how many days per year do you spend as an
audit committee member on the
company’s affairs? days
5. Are you deemed to be the financial expert on the audit
committee? Yes No
6. Do you currently serve on more than one company’s BOD?
Yes No
7. Other than your work as a BOD member, which of the
following best describes your current
employment status?
Employed (full-time) Employed (part-time) Retired Other
_______________
Are you currently serving in a senior management position ?
Yes No
33. 8a. Gender: Male Female 8b. Age years
9. Do you have any accounting certification? CPA CMA CIA
Other _____________
10. Do you have any auditing experience? Yes No
11. Do you have any prior audit committee experience (in
another company)? Yes No
12. Were you ever a CEO? Yes No
Thank you
78
MAJ
28,1
About the authors
Venkataraman M. Iyer is a Professor. His research has appeared
in several journals including
Accounting, Organizations, and Society; Auditing: A Journal of
Practice and Theory; and
Managerial Auditing Journal. Venkataraman M. Iyer is the
corresponding author and can be
contacted at: [email protected]
E. Michael Bamber is Harold M. Heckman Chair of Public
Accounting. He has published in
many journals including The Accounting Review; Accounting,
Organizations, and Society; and
Auditing: A Journal of Practice and Theory.
34. Jeremy Griffin is an Assistant Professor. His research is in
behavioral auditing.
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Audit Committee Financial Expert Rule
SOX Section 407
… In this release, we adopt rules to implement the following
two provisions of the Sarbanes-Oxley Act: Section 407, which
directs us to adopt rules: (1) requiring a company to disclose
whether its audit committee includes at least one member who is
a financial expert; and (2) defining the term "financial expert";
…
What term to use for “expert”?
36. In the Proposing Release, we solicited comment as to whether
we should use the term "financial expert" … or whether a
different term such as "audit committee financial expert" would
be more appropriate.
A number of commenters expressed a concern that neither the
term "financial expert" nor "audit committee financial expert"
accurately reflects the required experience and expertise of the
type of expert contemplated by Section 407 …
One commenter therefore recommended that we use the term
"audit committee accounting expert." Other suggested terms
included "accounting expert," "audit committee member
financial lead" and "financially proficient director."
“Audit Committee Financial Expert”
… We have decided to use the term "audit committee financial
expert" in our rules implementing Section 407 instead of the
term "financial expert.”
This term suggests more pointedly that the designated person
has characteristics that are particularly relevant to the functions
of the audit committee, such as: a thorough understanding of the
audit committee's oversight role, expertise in accounting
matters as well as understanding of financial statements, and the
ability to ask the right questions to determine whether the
company's financial statements are complete and accurate.
The new rules include a definition of the term "audit committee
financial expert."
Opposition to naming experts
37. A substantial number of commenters opposed our proposal to
require a company to disclose the number and names of the
persons that the company's board determined to be audit
committee financial experts. …
Much of the opposition stemmed from a fear that the
designation of an audit committee financial expert may
inappropriately suggest that the expert bears greater
responsibility, and therefore is subject to a higher degree of
liability, for audit committee decisions than other audit
committee members.
Some commenters thought that identification of the audit
committee financial expert in the company's annual report
would exacerbate that problem and discourage qualified persons
from serving as such experts.
AC Expert NOT mandatory! But disclosure is required
We have modified the proposals … . Under the rules that we are
adopting, a company must disclose that its board of directors
has determined that the company either: has at least one audit
committee financial expert serving on its audit committee; or
does not have an audit committee financial expert serving on its
audit committee.
A company disclosing that it does not have an audit committee
financial expert must explain why it does not have such an
expert.
… under the final rules, if a company discloses that it has an
audit committee financial expert, it also must disclose the
38. expert's name. …
We believe that, in general, omission of the expert's name
ultimately would not result in the expert's identity remaining
non-public. To the extent that there are liability concerns, we
believe that they are best addressed by our inclusion of a safe
harbor in our rules, as discussed below.
The final rules permit, but do not require, a company to disclose
that it has more than one audit committee financial expert on its
audit committee. …
Furthermore, if the company's board determines that at least one
of the audit committee members qualifies as an expert, the
company must accurately disclose this fact. It will not be
appropriate for a company to disclose that it does not have an
audit committee financial expert if its board has determined that
such an expert serves on the audit committee.
Initially Proposed Definition
a. Proposed Definition of the Term "Financial Expert"
(1) An understanding of GAAP and financial statements;
(2) Experience applying such GAAP in connection with the
accounting for estimates, accruals, and reserves …;
(3) Experience preparing or auditing financial statements …;
(4) Experience with internal controls and procedures for
financial reporting; and
(5) An understanding of audit committee functions.
39. “Too restrictive”
The proposed definition of the term "financial expert" proved to
be the most controversial aspect of the proposals - more
commenters remarked on it than on any other topic addressed by
the proposed rules. Most of the commenters thought that the
proposed definition was too restrictive.
Other objections
… Some of the corporate commenters were of the view that they
already have exemplary audit committees, despite the fact that
none of their current members would meet our proposed
definition of an expert. A few complained that companies may
have to sacrifice the diversity of their boards and nominate
directors who satisfy the audit committee financial expert
definition even if the company does not believe that these
directors are best-suited for the position.
… several commenters debated the merits of defining an audit
committee financial expert as a person with strong accounting
credentials, given that an audit committee member's role is one
of oversight, rather than direct involvement in the company's
accounting functions, and suggested that the emphasis on
technical accounting expertise in the definition was misplaced.
.…
Final Definition
c. Final Definition of "Audit Committee Financial Expert“
An understanding of GAAP;
The ability to assess the general application of such principles
in connection with the accounting for estimates, accruals and
40. reserves;
Experience preparing, auditing, analyzing or evaluating
financial statements … or experience actively supervising one
or more persons engaged in such activities;
An understanding of internal controls and procedures for
financial reporting; and
An understanding of audit committee functions
Acquiring expertise
Under the final rules, a person must have acquired such
attributes through any one or more of the following:
(1) Education and experience as a principal financial officer,
principal accounting officer, controller, public accountant or
auditor or experience in one or more positions that involve the
performance of similar functions;
(2) Experience actively supervising a principal financial
officer, principal accounting officer, controller, public
accountant, auditor or person performing similar functions;
(3) Experience overseeing or assessing the performance of
companies or public accountants with respect to the preparation,
auditing or evaluation of financial statements; or
(4) Other relevant experience.
Changed definition of expert
Effective audit committee members must have both the ability
and the determination to ask the right questions. Therefore, we
have broadened this attribute to include persons with experience
performing extensive financial statement analysis or evaluation.
41. We also are convinced by commenters that a potential audit
committee financial expert should be considered to possess this
attribute by virtue of his or her experience actively supervising
a person who prepares, audits, analyzes or evaluates financial
statements. …
Safe harbor for expert
… we are including a safe harbor in the new audit committee
disclosure item to clarify that: …
The designation or identification of a person as an audit
committee financial expert pursuant to the new disclosure item
does not impose on such person any duties, obligations or
liability that are greater than the duties, obligations and liability
imposed on such person as a member of the audit committee and
board of directors in the absence of such designation or
identification;
Audit Committee Director Independence Rule
(Release No. 33-8220. SEC 2003)
Audit Committee (AC) Member Independence
… An audit committee (AC) comprised of independent directors
is better situated to assess objectively the quality of the issuer's
financial disclosure and the adequacy of internal controls than a
committee that is affiliated with management.
Management may face market pressures for short-term
performance and corresponding pressures to satisfy market
expectations.
42. These pressures could be exacerbated by the use of
compensation or other incentives focused on short-term stock
appreciation, which can promote self-interest rather than the
promotion of long-term shareholder interest.
An independent AC with adequate resources helps to overcome
this problem and to align corporate interests with those of
shareholders.
These requirements standing alone do not, for example,
preclude independence on the basis of other commercial
relationships not specified in the final rule, and they do not
extend to the broad categories of family members that may be
reached by SRO listing standards.
Instead, as proposed, our requirements build and rely on SRO
standards of independence that cover additional relationships
not specified in Exchange Act Section 10A(m).
Our final rule allows SROs flexibility to adopt and administer
additional requirements of these sorts through SRO rulemaking
…
We will review the rules submitted by the SROs to implement
Exchange Act Rule 10A-3 so that they contain appropriate
overall standards for audit committee independence
Advising, Consulting or Compensatory Fees
As for the two criteria for independence in Exchange Act Rule
10A-3, the first is that audit committee members are barred
from accepting any consulting, advisory or other compensatory
fee from the issuer or any subsidiary thereof, other than in the
member's capacity as a member of the board of directors and
43. any board committee.
This prohibition will preclude payments to a member as an
officer or employee, as well as other compensatory payments.
Indirect compensation
To prevent evasion of the requirement, disallowed payments to
an audit committee member includes payments made either
directly or indirectly. …
The final rules, therefore, mandate that indirect acceptance of
compensatory payments includes payments to spouses, minor
children or stepchildren or children or stepchildren sharing a
home with the member. In addition, indirect acceptance includes
payments accepted by an entity in which such member is a
partner, member, officer such as a managing director occupying
a comparable position or executive officer, or occupies a similar
position … and which provides accounting, consulting, legal,
investment banking or financial advisory services to the issuer
or any subsidiary.
… … the prohibitions … do not include non-advisory financial
services such as lending, check clearing, maintaining customer
accounts, stock brokerage services or custodial and cash
management services.
Only for AC directors
… the final rule relates only to requirements for audit
committee membership.
They do not affect the ability of a director associated with an
entity that provides such services to a listed issuer from
otherwise serving on that issuer's board of directors, again to
44. the extent other SRO rules permit such relationships. …
The final rule specifies that, unless an SRO's listing rules
provide otherwise, compensatory fees do not include the receipt
of fixed amounts of compensation under a retirement plan
(including deferred compensation) for prior service with the
listed issuer (provided that such compensation is not contingent
in any way on continued service)
New public company exception
… Before completion of a company's initial public offering, the
board of directors often will consist primarily, if not
exclusively, of representatives of venture capital investors and
insiders. …
to balance the concerns between the need for independence and
the ability to recruit qualified candidates, we are adopting a
revised exception … that requires at least one fully independent
member at the time of an issuer's initial listing, a majority of
independent members within 90 days, and a fully independent
committee within one year. …
AC Responsibilities towards the Auditor
… The auditing process may be compromised when a company's
outside auditors view their main responsibility as serving the
company's management rather than its full board of directors or
its audit committee.
This may occur if the auditor views management as its employer
with hiring, firing and compensatory powers. Under these
conditions, the auditor may not have the appropriate incentive
to raise concerns and conduct an objective review.
45. Further, if the auditor does not appear independent to the
public, then investor confidence is undermined and one purpose
of the audit is frustrated.
One way to help promote auditor independence, then, is for the
auditor to be hired, evaluated and, if necessary, terminated by
the audit committee. This would help to align the auditor's
interests with those of shareholders.
… we are adopting as proposed the requirement that the audit
committee … will need to be directly responsible for the
appointment, compensation, retention and oversight of the work
of any registered public accounting firm engaged (including
resolution of disagreements between management and the
auditor regarding financial reporting) for the purpose of
preparing or issuing an audit report or performing other audit,
review or attest services for the issuer, and the independent
auditor will have to report directly to the audit committee.
These oversight responsibilities include the authority to retain
the outside auditor, which includes the power not to retain (or
to terminate) the outside auditor. In addition, in connection with
these oversight responsibilities, the audit committee must have
ultimate authority to approve all audit engagement fees and
terms.
AC oversight of Internal Audit
… we requested comment on whether other responsibilities…
should be under the supervision of the audit committee, such as
the appointment, compensation, retention and oversight of an
issuer's internal auditor. Commenters were split … with the
majority not supporting action by the Commission at this time.
46. Given this split, we are not extending the responsibility
requirement to include such oversight.
Non-US jurisdictions
… none of the audit committee requirements in the final rule
conflicts with, nor do they affect the application of, any
requirement or ability under an issuer's governing law or
documents or other home country legal or listing provisions that
requires or permits shareholders to ultimately vote on, approve
or ratify such requirements.
… in some jurisdictions, the outside auditor can only be
removed by court order upon specified circumstances. Other
commenters noted that the government is required to select the
outside auditor for some foreign private issuers. …
we are providing an additional instruction to clarify that the
requirements in the final rule do not conflict with any legal or
listing requirement in an issuer's home jurisdiction vesting such
responsibilities with a government entity or tribunal.
AC role in receiving complaints
Since the audit committee is dependent to a degree on the
information provided to it by management and internal and
outside auditors, it is imperative for the committee to cultivate
open and effective channels of information.
Management may not have the appropriate incentives to self-
report all questionable practices. A company employee or other
individual may be reticent to report concerns regarding
questionable accounting or other matters for fear of
management reprisal.
47. The establishment of formal procedures for receiving and
handling complaints should serve to facilitate disclosures,
encourage proper individual conduct and alert the audit
committee to potential problems before they have serious
consequences.
Whistleblowing
Accordingly, under the listing standards called for by our final
rules, each audit committee must establish procedures for:
The receipt, retention and treatment of complaints received by
the issuer regarding accounting, internal accounting controls or
auditing matters, and
The confidential, anonymous submission by employees of the
issuer of concerns regarding questionable accounting or
auditing matters.
… we are not mandating specific procedures that the audit
committee must establish. …
Similarly, we are not adopting the suggestion that … the
requirement should be limited to only employees in the
financial reporting area.
Audit committee use of outside experts
To be effective, an audit committee must have the necessary
resources and authority to fulfill its function. …
To perform its role effectively, therefore, an audit committee
may need the authority to engage its own outside advisors,
including experts in particular areas of accounting, as it
determines necessary apart from counsel or advisors hired by
management, especially when potential conflicts of interest with
management may be apparent.
48. The advice of outside advisors may be necessary to identify
potential conflicts of interest and assess the company's
disclosure and other compliance obligations with an
independent and critical eye. … The assistance of outside
advisors also may be needed to independently investigate
questions that may arise regarding financial reporting and
compliance with the securities laws.
… the final rule specifically requires an issuer's audit
committee to have the authority to engage outside advisors,
including counsel, as it determines necessary to carry out its
duties.
Funding for outside experts
… the final rule requires the issuer to provide for appropriate
funding, as determined by the audit committee, in its capacity
as a committee of the board of directors, for payment of
compensation:
To any registered public accounting firm engaged for the
purpose of preparing or issuing an audit report or performing
other audit, review or attest services …; and
To any advisors employed by the audit committee.
Not only could an audit committee be hindered in its ability to
perform its duties objectively by not having control over the
ability to compensate these advisors, but the role of the advisors
also could be compromised if they are required to rely on
management for compensation. Thus, absent such a provision,
both the audit committee and the advisors could be less willing
to address disagreements or other issues with management.
49. Audit Committee expenses
Some commenters believed it would be appropriate to
supplement the funding requirements. … Specifically, these
commenters believed the final rule should also state that the
issuer must provide appropriate funding for ordinary
administrative expenses of the audit committee. We find merit
in this suggestion.
An audit committee's effectiveness may be compromised if it is
dependent on management's discretion to pay for the
committee's expenses, especially when potential conflicts of
interest with management may be apparent.
Accordingly, the final rule provides that, in addition to funding
for advisors, the issuer must provide appropriate funding for
ordinary administrative expenses of the audit committee that are
necessary or appropriate in carrying out its duties.
Audit Committee Disclosure Rule (Release No. 34-42266 - SEC
1999)
Background
As discussed in the Proposing Release, given the changes in our
markets, such as the increasing number of investors entering our
markets and changes in the way and speed with which investors
receive information, it is vitally important for investors to
remain confident that they are receiving the highest quality
financial reporting. …
One challenge is that companies are under increasing pressure
50. to meet earnings expectations. We have become increasingly
concerned about inappropriate "earnings management," the
practice of distorting the true financial performance of the
company.
Role of Audit Committees
The changes in our markets and the increasing pressures on
companies to maintain positive earnings trends have highlighted
the importance of strong and effective audit committees.
Effective oversight of the financial reporting process is
fundamental to preserving the integrity of our markets.
Audit committees play a critical role in the financial reporting
system by overseeing and monitoring management's and the
independent auditors' participation in the financial reporting
process. Audit committees can, and should, be the corporate
participant best able to perform that oversight function.
Increased Liability to Directors?
While almost all of the commenters that provided comment
letters on the Proposing Release supported our goals of
improving disclosure about audit committees and enhancing the
reliability and credibility of financial statements, many
commenters suggested alternative approaches to achieving those
goals. …
the concern most frequently expressed was that as a result of the
new requirements to provide certain disclosures in a report,
audit committees may be exposed to additional liability, and
that consequently it may be difficult for companies to find
qualified people to serve on audit committees.
51. Safe Harbor
… As we discussed in the Proposing Release, we do not believe
that improved disclosure about the audit committee and
increased involvement by the audit committee should result in
increased exposure to liability.
Consequently, we believe that this modification, together with
the safe harbors, should further alleviate concerns about
increased liability exposure, while promoting our goal of
improving the financial reporting process.
Should rules be the same for all companies?
Some commenters expressed concern about applying the new
requirements to small businesses, particularly the interim
financial review requirement. We have considered those
comments carefully.
We think that improvements in the financial reporting process
for companies of all sizes is important for promoting investor
confidence in our markets.
In this regard, because we have seen instances of financial fraud
at small companies as well as at large companies, we think that
improving disclosures about the audit committees of small and
large companies is important. …
Reviews of Interim Financial Statements
We are adopting [amendments] … to require that a company's
interim financial statements be reviewed by an independent
public accountant prior to the company filing its Form 10-Q or
10-QSB ...
52. … the reviews required will facilitate early identification and
resolution of material accounting and reporting issues because
the auditors will be involved earlier in the year.
Early involvement of the auditors should reduce the likelihood
of restatements or other year-end adjustments and enhance the
reliability of financial information. In addition, as a result of
changes in the markets, companies may be experiencing
increasing pressure to "manage" interim financial results.
Inappropriate earnings management could be deterred by
imposing more discipline on the process of preparing interim
financial information ….
Big 5 already require quarterly reviews
… we understand that the five largest U.S. accounting firms and
other firms have policies to require that their clients have
reviews of quarterly financial statements as a condition to
acceptance of the audit.
Consequently, those firms already have implemented the new
requirement for the companies that are audited by those firms.
Independence Standards Board (ISB)
We are adopting new [rules] … that require the audit committee
to provide a report in the company's proxy statement. …
Audit committees must state whether:
the audit committee has reviewed and discussed the audited
financial statements with management; …
the audit committee has received the written disclosures and the
letter from the independent auditors required by ISB Standard
53. No. 1, as may be modified or supplemented, and has discussed
with the auditors the auditors' independence.
Disclosures in Proxy Statement
… The disclosures are required in the company's proxy
statement because they could have a direct bearing on
shareholders' voting decisions, and because the proxy statement
is actually delivered to shareholders and is accessible on the
SEC's web site. …
Audit Committee Charter
We are adopting, as proposed, the requirement that companies
disclose in their proxy statements whether their audit committee
is governed by a charter, and if so, include a copy of the charter
as an appendix to the proxy statement at least once every three
years. …
The new disclosure regarding audit committees' charters should
help shareholders assess the role and responsibilities of the
audit committee.
“Boilerplate”
We believe that audit committees that have their responsibilities
set forth in a written charter are more likely to play an effective
role in overseeing the company's financial reports.
The amendments, however, will not require companies to adopt
audit committee charters, or dictate the content of the charter if
one is adopted.
Several commenters expressed concern that the requirement to
54. attach the charter would result in boilerplate charters.
We believe that it is useful for shareholders to know about the
responsibilities and the duties of audit committees, and while it
is inevitable that some of the same provisions will appear in
charters of different audit committees, we encourage companies
to tailor the charters to their specific circumstances.
Audit Committee Director Independence
As early as 1940, the Commission encouraged the use of audit
committees composed of independent directors ...
Further, as the Blue Ribbon Committee noted, ". . . common
sense dictates that a director without any financial, family, or
other material personal ties to management is more likely to be
able to evaluate objectively the propriety of management's
accounting, internal control and reporting practices."
Exceptional situations
… Under the revised listing standards of the NYSE, AMEX, and
NASD, under exceptional and limited circumstances, companies
may appoint to their audit committee one director who is not
independent if the Board determines that membership on the
committee by the individual is required by the best interests of
the corporation and its shareholders, and the Board discloses, in
the next annual proxy statement subsequent to such
determination, the nature of the relationship and the reasons for
that determination.
We are adopting, as proposed, the requirement that companies
whose securities are listed on the NYSE or AMEX or quoted on
Nasdaq that have a non-independent audit committee member
55. disclose the nature of the relationship that makes that individual
not independent and the reasons for the Board's determination to
appoint the director to the audit committee. Small business
issuers are not required to comply with this requirement.
Different listing standards
… We are also adopting, as proposed, the requirement that
companies, including small business issuers, whose securities
are not listed on the NYSE or AMEX or quoted on Nasdaq,
disclose in their proxy statements whether, if they have an audit
committee, the members are independent as defined in the
NYSE's, AMEX's, or NASD's listing standards, and which
definition was used.
These companies would be able to choose which definition of
"independence" to apply to the audit committee members in
making the disclosure. Whichever definition is chosen must be
applied consistently to all members of the audit committee. …
Cost estimates
… We believe the costs associated with these amendments
would derive principally from the disclosure obligations – we
are not placing any substantive requirements on audit
committees or their members. At the proposing stage, we
estimated that the additional disclosure contemplated by the
amendments would, on average, require less than three-fourths
of a page in a company's proxy statement, based on the staff's
experience with proxy statements, and analogous cost estimates.
A financial printing company informed the staff that this
disclosure would not likely increase the printing cost because
up to three-fourths of a page can normally be incorporated
56. without increasing the page length by reformatting the
document. The printer reported that adding one more page could
increase costs by about $1,500 for an average sized company.