Audit committee voluntary disclosure describing external auditor oversight: Does it reflect higher audit quality?

• Published date: 01 October 2022
• Author: Denise O'Shaughnessy,Najib Sahyoun,Wayne Tervo
• Date: 01 October 2022
• DOI: http://doi.org/10.1002/jcaf.22560

Received: February  Revised:  April  Accepted: April 

DOI: ./jcaf.

RESEARCH ARTICLE

Audit committee voluntary disclosure describing external

auditor oversight: Does it reflect higher audit quality?

Denise O’Shaughnessy Najib Sahyoun Wayn e Tervo

Arthur J. Bauernfeind College of

Business, Murray State University,

Murray, Kentucky, USA

Correspondence

Arthur J. Bauernfeind College of

Business, Murray State University,

Murray,Kentucky, USA.

Email: nsahyoun@murraystate.edu

Abstract

This study examines the association between audit committee voluntary disclo-

sures related to external auditor oversight and audit quality of the top US bank

holding companies for a period of  years. Using manual coding of the voluntary

disclosures that target audit committee oversight of the external auditor,we find

that audit committees with a higher level of voluntary disclosures delineating

activities of external auditor oversight tend to have a higher audit quality.These

results are consistent with the view that audit committees play a major role in

overseeing the external audit process as was emphasized by the Sarbanes-Oxley

(SOX) Act. In the case of negligence or wrongdoing, audit committees can be

sued for breaching due care; thus, voluntary disclosure is a reliable indicator of

the audit committee effectiveness and oversight of the audit process. Using vol-

untary disclosures in the audit committee report, this research provides useful

information to shareholders to evaluate the effectiveness of audit committees in

monitoring the external audit process while answering previous calls to inves-

tigate the audit committee oversight process (and corresponding effect on audit

quality) and not just focusing on audit committee characteristics such as size,

expertise, experience, meeting frequency, and audit fees.

KEYWORDS

audit committee report, audit quality, external auditor oversight, voluntary disclosure

1 INTRODUCTION

This paper analyzes the association between audit commit-

tee voluntary disclosure related to external auditor over-

sight and audit quality of bank holding companies. Mainly,

we are interested in knowing whether voluntary disclo-

sures related to external auditor oversight show higher

monitoring of the external audit process reflecting in

higher audit quality. Prior studies on this voluntary disclo-

sure have mixed results. Some studies describe voluntary

disclosure as real activities undertaken by audit commit-

tees to improve the financial reporting quality (Al-Shaer

& Zaman, ; Downes et al., ; Reidenbach, ;

Ye, ), while others suggest that those disclosures are

mainly impression management or tools to reinforce legit-

imacy (Al-Shaer et al., ; Draeger et al., ; Sahyoun&

Magnan, ). In this study,we analyze whether the activ-

ities described in the voluntary disclosures are real steps

taken by audit committees to monitor the external audit

process that lead to higher audit quality or are used for

impression management and legitimacy reinforcement.

Since , audit committees of public firms are

required to issue an annual report that identifies activ-

ities undertaken during the year to protect their share-

holders. The Securities Exchange Commission’s(SEC) goal

of requiring audit committees to issue this report is to

increase transparency and confidence in financial mar-

kets (SEC, ). There is an ongoing debate about the

22 ©  Wiley Periodicals LLC. J Corp Account Finance. ;:–.wileyonlinelibrary.com/journal/jcaf

O’SHAUGHNESSY  . 23

usefulness of the audit committee report. On one hand,

audit committees and auditors claim that voluntary dis-

closure has steadily increased and is useful to sharehold-

ers (Deloitte, ;EY,). On the other hand, institu-

tional investors solicit an increase in voluntary disclosures

as audit committee reports are not considered useful in

providing relevant information of audit committee activ-

ities (CAQ, ).

As a result of this debate, the Audit Committee Collabo-

ration (ACC), a partnership of corporate governance orga-

nizations, was formed in . The ACC issued a report

encouraging audit committees to increase voluntary dis-

closure in order to enhance audit committee report useful-

ness (ACC, ). Furthermore, the SEC issued a concept

release in  requesting different stakeholders to provide

comments regarding satisfaction levels with current audit

committee reports (SEC, ). As of today, it seems over-

all stakeholder satisfaction is acceptable as the SEC has

not issued any changes about audit committee disclosure

requirements.

Our sample consists of the top  US bank holding com-

panies from  to , a period covering all major events

that affected the audit committee report development. Our

results suggest that audit committees with higher levels of

voluntary disclosures describing monitoring activities of

the external auditor (or in selecting the lead audit part-

ner) tend to have a higher level of audit quality. Our

results also support the evidence that audit committees’

roles have strengthened with the Sarbanes-Oxley (SOX)

Act, which emphasizes oversight of the external audit pro-

cess (US House of Representatives, ). Audit commit-

tees have a fiduciary duty to protect investors’interests and

can be sued for not providing adequate oversight (Blythe,

). Accordingly,audit committee voluntary disclosures

in oversight of the external audit process are real activities

and not impression management practices. This research

uses the Sahyoun and Magnan’s () manual coding

grid to measure voluntary audit committee disclosure. We

rely on two sets of measures to ascertain audit quality: a

fee dependency ratio that considers the economic bond-

ing between the auditee and the audit firm, and an out-

put measure that incorporates restatement incidents and

propensity to meet or beat financial analysts’ forecasts.

Both measures are widely used in prior studies as prox-

ies for audit quality (Aobdia, ;DeFond&Zhang,;

Srinivasan, ).

This study provides several contributions. First, we

respond to the call of DeZoort et al. ()byusingvol-

untary disclosure in oversight of the external auditor as a

measure of audit committee due diligence. While criticiz-

ing the number of audit committee meetings as a proxy

for audit committee diligence, they recognize the diffi-

culty in measuring committee diligence, and acknowledge

using the number of audit committee meetings as easier to

obtain. However, they recommend using voluntary disclo-

sure in the audit committee report as a measure for com-

mittee diligence as it can reflect better the work under-

taken to protect shareholders. Cohen et al. () view

that number of audit committee meetings may not reflect

proper due diligence by the committee as the meetings can

be symbolic and only taking place to comply with regula-

tory requirements. We focus on the external auditor over-

sight process that is rarely studied, even though it is one

of the main emphasis of the SOX Act. Second, our findings

confirm that audit committee voluntary disclosure related

to external auditor oversight can be used as a proxy for

due diligence. Our findings are beneficial to sharehold-

ers who need to evaluate audit committees when voting

for directors on an annual basis. Voting rates are usually

higher for members who are more effective in protecting

investors’ interests (Gal-Or et al., ). Our results sug-

gest that higher voluntary disclosure describing external

auditor oversight increases audit quality and shareholders

should consider voting for these audit committee mem-

bers. Third, our study provides public policy implications.

The SEC released a concept statement requesting feedback

from stakeholders about the usefulness of the audit com-

mittee report (SEC, ). Our empirical evidence can ben-

efit the SEC in addition to the Public Company Accounting

Oversight Board (PCAOB) as they can rely on these find-

ings in making future regulations. Finally,the focus of this

paper is on the banking industry which has been rarely

researched due to significant differences with other indus-

tries. The banking industry plays an important role in the

economy as a major component of stock market indices

while being essential to financial system stability (Jizi &

Nehme, ). Accordingly, banks’ audit committees play

an important role in corporate governance along with the

multiple stakeholders’ interest to understand the commit-

tees’ role in such governance.

The remainder of the paper is as follows. Section pro-

vides a literature review.Section develops the hypotheses.

Section presents the sample and the econometric mod-

els. Section discusses the results. Section concludes the

paper, and Section discusses the study’s practical impli-

cations.

2LITERATURE REVIEW

2.1 Audit committee oversight of the

external auditor

Agency theory stipulates that shareholders need protec-

tion as management may not consider the owners’ inter-

ests when making all decisions (DeZoort et al., ;