Effectiveness of audit committee on firm performance

1. EFFECTIVENESS OF AUDIT COMMITTEE ON FIRM PERFORMANCE
By
SUJATHA N
Research Scholar,
Dept. of Commerce,
Bangalore University
Ph-9538889221
Email Id sujatha.n1982@gmail.com
&
Dr.M.MUNINARAYANAPPA
Professor,
Department of Commerce,
Bangalore University, Bangalore
Abstract
This Conceptual paper seeks to examine and analyse the Effectiveness of Audit Committee on
Firm Performance. The research proclaims that the Audit Committee acts as a Catalyst for good
Corporate Governance which fortifies the Organisation’s Credibility, Integrity and
Accountability. As a bed-rock of good governance, audit committees are positioned to provide
an objective assessment of whether or not firm’s resources are responsibly and effectively
managed.
Keywords: Audit Committee, Corporate Governance, Firm Performance, Accountability
Introduction
Audit committees are pivotal part of good corporate governance and their formation strengthens
the credibility on firms’ performance. If there is any better word that can best describe the
credibility of Financial Reports of the firm, it is Audit Committee. The existence of an Audit
Committee as an oversight structure is a paramount ingredient of good corporate governance.
Good corporate governance enhances the Goodwill of the organisation and makes a valuable
contribution towards the enrichment of performance and accountability.
Investment decisions, Financial decisions, Dividend decisions and alike., are per se based on the
accuracy and credibility of the financial information of the organization. However, some firms
resort to Window Dressing or manipulation of Financial Data which doesn’t reveal authentic

2. picture of the financial position of the firm. Ill-famed frauds such as Enron, WorldCom, Satyam,
etc., emphasize the importance of strong corporate governance. Wherefore, a body like
independent Audit Committee is required to keep a track of such scandalous activities (Nidhi
Bansal & Anil Sharma, 2013). The presence of Independent Auditors goes a long-way in
ensuring investor trust. The Audit Committee’s role is cardinal in ensuring the potency of
internal control structure. It assesses the Financial Reports of a firm and performs the role of an
Arbitrator among Board of Directors, Managers, External And Internal Auditors, and ensures
transparency and proper flow of information (Bhardwaj & Rao, 2015).
Background of Audit Committee Phenomenon
Audit committees first originated in the private sector and were initially introduced in large
companies. These committees were first introduced in 1872, with the first Audit Committee
being established by the Great Western Railway in the United Kingdom (Marx, 2009c: 13, as
cited in Brewer, 2011.11). The concept was adopted by other companies in later years due to
their concern about the credibility of financial reporting. Audit committees were established as
subcommittees of the Board of Directors, and as a result of this structural arrangement, they are
accountable to the Board.
However, during the 1990s, the audit committee’s role became more imperative as a result of
the collapse and bankruptcy of multinational companies in the United States of America (Marx,
2008:1). The prevalence of the credit crunch in the global market brought about an increase in
the risk of unethical behaviour and potential fraud in companies. As a result, the boards of
companies hinged on Audit Committees to provide assurance that mitigating strategies would be
developed and implemented to address these emerging risks. It was on this ground that Audit
Committees became the main pillars of the governance structure in Public and Private sectors.
Practices of Audit Committees to promote Effectiveness
The brainchild of Audit Committees has, inter alia, to do with a thoroughly constituted a body
including independent members who, as a collective, have sufficient domain knowledge and
relevant experience in Auditing, Finance, Risk And Internal Controls, which assists the firm to
function effectively. In recent years, there has been a review of regulations governing the affairs

3. of Audit Committees for reinforcing their effectiveness and implementing best practices
regarding audit activities (Braiotta, 2004: xv). This initiative was supported by auditing and
accounting professional agencies, which developed a code of best practices to promote the
effectiveness of audit committees (Marx, 2008:11).
Audit Committee Effectiveness
The contradictory objectives of Stakeholders and Management in the Private sector created a
need for the establishment of a monitoring instrument to control investors’ interests and to bridge
the gap between Shareholders and Management. Audit committees are also an integral part of
quality Corporate Governance and their establishment strengthens government’s credibility. In
the same vein, audit committees form an accountability structure in both government
departments and local government, and are required by legislation to provide an assurance of
accountability by public sector management. They also ensure transparent and credible financial
reporting processes.
Maintaining effectiveness needs processes that are capable of rapid adaptation and flexible as
well. However, the extent of effectiveness of any applied process needs to be measured if any
improvements or adaptations are to be made (encyclopedia, 2012). To remain competitive,
organisations have to continually establish effective and innovative strategies to meet the
changing circumstances and to deliver quality services. The appropriateness of the adopted
strategies in the organisation can be measured by the extent to which service delivery priorities
meet the real needs of the local community and their ability to adapt to meet those needs.
Therefore, there are distinctive traits and attributes, in terms of financial management and
financial reporting, that the businesses ought to adopt in order to maintain their effectiveness,
efficiency and credibility.

4. Audit Committee’s (AC) Effectiveness Model
Source: Adapted from Mohiuddin and Karbhari (2010:112)
The evaluation of effectiveness of Audit Committee is associated with the key roles that include
overseeing financial reporting; assessment of internal controls and risk environment; and
governance and evaluation of the audit process. Audit committees are applauded to be involved
in continuous learning, in order to stay on top of their craft (PwC, 2012). Continuous learning
sharpens audit committees’ approaches and also guides the committee with information on
leading practices.
Conclusion
The objective of the assessment of effectiveness of Audit Committee on financial reporting is to
ensure that the financial statements presented by Management are Credible, Reliable, Accurate,
Timely and in compliance with the Internal Controls, Accounting Policies and Principles, which
entails monitoring and strategizing the implementation of significant changes to internal controls
and related mitigating risk controls. An Audit Committee is required to determine whether or not
the policies and practices of the organisation are aligned with good governance principles, and to
double-check if the compliance programme is periodically reviewed to maintain its effectiveness.
Directions for the future study
AC
Attributes :
Composition
Characteristics
Structure
Process
Independence
AC Roles :
Financial
Reporting
Internal
Auditing
External
Auditing
Risk
Management
Compliance
Issues
Audit
Committee
Effectiveness
Minimizing
Agency
Conflicts
Protecting
Stakeholders’
Interests
Improving
Qualityof
Financial
Information
Reducing
Earning
Management
Enhancing
Firm’s
Performance
Maximizing Firm
Value

5. It is further directed that Indian Companies Act, 2013 has amended the laws regarding
Independent Directors and their functioning. It is therefore suggested to budding researchers to
enrich the learning on effectiveness of Audit Committees as per the revised changes in laws.
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