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The effect of
The effect of audit committee audit committee
performance on earnings quality performance
Jerry W. Lin
Department of Accounting, University of Minnesota Duluth, 921
Duluth, Minnesota, USA
June F. Li
Department of Business Administration,
University of Wisconsin – River Falls, River Falls, Wisconsin, USA, and
Joon S. Yang
Department of Accounting, University of Minnesota Duluth,
Duluth, Minnesota, USA

Abstract
Purpose – The role of audit committees in ensuring the quality of corporate financial reporting has
come under considerable scrutiny due to recent high-profile “earnings management” cases and the
collapse of Enron. The purpose of this paper is to examine the association between the characteristics
of audit committees (size, independence, financial expertise, activity, and stock ownership) and
earnings restatement – a direct measure of earnings management.
Design/methodology/approach – Univariate correlations and multivariate statistical analyses are
performed. In particular, a multivariate logistic regression model is used.
Findings – Evidence suggests a negative association between the size of audit committees and the
occurrence of earnings restatement. The remaining four audit committee characteristics are not found
to have a significant impact on the quality of reported earnings.
Research limitations/implications – This study focuses on the fiscal year 2000 only. As data
become available for more fiscal years, future studies may re-examine the issue.
Originality/value – Results of this research provide useful information for the accounting
profession, the regulators and corporations on the effective practice of audit committees.
Keywords Audit committees, Corporate governance, Earnings
Paper type Research paper

Introduction
The role of audit committees in ensuring the quality of corporate financial reporting
has come under considerable scrutiny due to recent high-profile accounting scandals or
“earnings management” cases (e.g. waste management and WorldCom) and the
collapse of Enron. Since the value of a firm is linked to reported earnings figures, it
creates economic incentives or pressures for management to engage in earnings
management. Former US Securities and Exchange Commission (SEC) Chairman Levitt
(1998) expressed his serious concerns over earnings management in his famous “the
Numbers Game” speech. He called for a fundamental cultural change for corporate
management and strengthening corporate governance, especially improving the Managerial Auditing Journal
Vol. 21 No. 9, 2006
effectiveness of audit committee. pp. 921-933
To address the concerns, the “Blue Ribbon Commission on Improving the q Emerald Group Publishing Limited
0268-6902
Effectiveness of Corporate Audit Committees” (BRC) was formed and it issued a set of DOI 10.1108/02686900610705019
MAJ ten recommendations aimed at strengthening the independence and effectiveness of
21,9 the audit committee (BRC, 1999). In addition, the SEC requires firms to provide
disclosures regarding the memberships and activities of their audit committees. Firms
are also required to attach a copy of the audit committee’s charter and report to proxy
statements filed on or after 15 December 2000 (SEC, 1999). Such recommendations and
disclosures are expected to provide the investors with information about the
922 effectiveness of a firm’s audit committee in ensuring the integrity of the financial
reporting process.
Several studies have examined the effectiveness of audit committees in limiting
earnings management (Abbott et al., 2004; Bédard et al., 2004; Klein, 2002; Xie et al.,
2003; Yang and Krishnan, 2005). While various definitions exist for “earnings
management” (Healy and Wahlen, 1999; Schipper, 1989), earnings management is
inherently unobservable. Thus, these studies, with the exception of Abbott et al. (2004),
use various measures of discretionary (abnormal) accruals as proxies for earnings
management. Discretionary accruals involve assumptions and estimates of the
non-discretionary portion of the total accruals. Therefore, the reliability of estimated
discretionary accruals as a measure of earnings management decreases as the
magnitude of estimation errors increases (Dechow and Dichev, 2002). Similarly, Guay
et al. (1996) contend that accruals derived from alternative models involve considerable
imprecision. Bernard and Skinner (1996) present similar argument that abnormal
accruals derived using the Jones-type models reflect measurement errors partly
because of the misclassification of normal as abnormal accruals. All these studies use
data for fiscal periods prior to fiscal year 2000 when the SEC regulations incorporating
BRC’s recommendations became effective. Therefore, the empirical question on
whether the BRC recommendations and the related regulatory changes have helped
improve audit committee effectiveness in limiting the likelihood of earnings
management remains to be answered.
Using data collected from proxy statements, this study examines the association
between audit committee characteristics and a more direct (observable) measure of
aggressive earnings management – earnings restatement. The issues related to
earnings restatement are of particular interests because of the consequences and
increasing occurrences of earnings restatement as discussed later in the prior research
section. Also, this study is the first to include several variables related to audit quality
that have been shown to have a strong effect on the quality of reported earnings
(Frankel et al., 2002; Li and Lin, 2006).
Further, while there are increasing concerns that compensating audit committee
members with stock and stock options may impair their independence (Millstein, 2002),
the empirical evidence is very limited. Thus, this study also examines the impact of
stock ownership by audit committee members on the occurrence of earnings
restatement. The rest of the paper is organized as follows. In the next section, we
review prior research on the determinants and consequences of earnings restatement
and on the effectiveness of audit committees, and develop the hypotheses. We then
discuss the research methodology, which is followed by discussions of empirical
results. The last section concludes the paper.
Prior research and hypotheses The effect of
Several studies have investigated the determinants and consequences of earnings audit committee
restatement. Higher market expectations for future earnings growth and higher levels
of outstanding debt appear to be the characteristics of firms that restate earnings performance
(Richardson et al., 2002). Restatements of core accounts (mainly revenue accounts)
appear to be associated with a higher frequency of fraud and subsequent bankruptcy
(Palmrose and Scholz, 2002). In addition, the more material a restatement is, the more 923
negatively security price responds to the restatement (Owers et al., 2002; Palmrose and
Scholz, 2002). However, studies on market reactions to causes for earnings restatement
have reported inconsistent results. On the one hand, the market seems to be more
concerned with restatements that are associated with management integrity than those
related to technical accounting issues (Palmrose et al., 2004). On the other hand, Owers
et al. (2002) find that of the categories of restatements, accounting issues (errors,
irregularities or method-changes) have the most negative market reactions. This is
especially true when there is a contemporaneous change in the firm’s CEO.
The effectiveness of audit committees has been a subject of increasing interests due
to increased concerns about the quality of corporate financial reporting process caused
by recent accounting scandals. While many studies have focused on the characteristics
of audit committees as determinants of their effectiveness (see DeZoort et al., 2002 for a
review), a recent study has examined the impact of audit committee characteristics in
the context of restatement. Abbott et al. (2004) report that an audit committee that is
independent, meets at least four times a year, and includes at least one member with
financial expertise is negatively associated with the occurrence of restatement in the
period of 1991-1998.
Independence of audit committee members has been the focus of most of the prior
work. A common expectation is that independent audit committee directors would
ensure better financial reporting (SEC, 1999), and the expectation is generally
supported by existing empirical evidence (Abbott et al., 2000; Beasley et al., 2000).
Specifically, Abbott et al. (2004) document a negative association between occurrence
of earnings restatement and audit committee consisting of only independent directors.
To examine the relationship between audit committee independence and earnings
quality, this study tests the H1 (stated in the alternative form):
H1. There is a significantly negative association between audit committee
independence and the occurrence of earnings restatement.
Encouraged by the BRC (1999), the SEC (1999) mandates that audit committees consist
of a minimum of four directors. Empirical studies provide mixed evidence of the impact
of audit committee size on financial reporting quality. Xie et al. (2003) find no
significant association between the number of directors on the audit committee and
earnings management. Similarly, Abbott et al. (2004) find no impact of audit committee
size on earnings restatement. On the other hand, Yang and Krishnan (2005) find that
audit committee size is negatively associated with earnings management (using
abnormal accrual as proxy), implying that a certain minimum number of audit
committee members may be relevant to quality of financial reporting. To further
examine the relationship between audit committee size and earnings quality, this study
tests the H2 (stated in the alternative form):
MAJ H2. There is a significantly negative association between audit committee size
21,9 and the occurrence of earnings restatement.
SEC (1999) requires that every audit committee includes at least one member with
financial expertise. DeZoort and Salterio (2001) argue that the audit committee’s
financial expertise increases the likelihood that detected material misstatements will be
924 communicated to the audit committee and corrected in a timely fashion. Abbott et al.
(2004) report a negative association between the audit committee’s financial expertise
and occurrence of earnings restatement. To examine the relationship between the audit
committee’s financial expertise and earnings quality, this study tests the H3 (stated in
the alternative form):
H3. There is a significantly negative association between the audit committee’s
financial expertise and the occurrence of earnings restatement.
While it is not mandated by the SEC, the BRC (1999) recommends that audit
committees meet at least once quarterly and discuss financial reporting quality with
the external auditor. The number of meetings (a proxy for diligence) is used in prior
research because inactive audit committees are unlikely to monitor management
effectively (Menon and Williams, 1994). Beasley et al. (2000) find that audit
committees of firms charged by the SEC for fraudulent financial reporting meet less
frequently than those of non-fraudulent firms. Abbott et al. (2004) find that audit
committees of firms restating their financial statements are not likely to meet at least
four times a year. To further examine the relationship between the frequency of audit
committee meetings and earnings quality, this study tests the H4 (stated in the
alternative form):
H4. There is a significantly negative association between audit committee
meetings and the occurrence of earnings restatement.
Lastly, there are concerns that compensating audit committee members with stock and
stock options may result in impairing their independence (Millstein, 2002). However,
empirical evidence on this issue is very limited until recently. Bédard et al. (2004)
document that the more stock options that can be exercised in the short-run relative to
the total of options and stocks held by audit committee members, the higher the
likelihood of aggressive earnings management. Yang and Krishnan (2005) document
that stock ownership by directors on the audit committee is positively associated with
earnings management (using abnormal accrual as the proxy). These results contradict
the findings by Beasley (1996) that the likelihood of fraudulent financial reporting
decreases as stock ownership by outside directors on the board (not necessarily on the
audit committee) increases. It is unclear that the results pertaining to earnings
management (abnormal accrual) would apply to earnings restatement. To further
examine the relationship between audit committee stock ownership and earnings
quality, this study tests the H5 (stated in the alternative form):
H5. There is a significant association between audit committee stock ownership
and the occurrence of earnings restatement.
Research methodology The effect of
Sample selection audit committee
The initial sample firms consist of 267 publicly-held corporations in the USA that
restated their reported earnings for the fiscal year 2000 and are identified by using performance
keyword searches of Lexis-Nexis on the words “income or earnings restatement” and
their variations. These firms are then screened for availability of requisite financial
data on research insight (personal-computer version of Compustat), data on fees paid to 925
external auditors, and data on audit committees in proxy statements. The restatement
sample includes 106 firms, after deleting 106 firms due to incomplete financial data, 44
firms due to missing auditor fee data, and 11 firms due to missing audit committee
data. We match each restatement sample firm with a non-restatement firm based on
four-digit SIC code and firm size. All control sample firms are screened for earnings
restatement (or a lack of). This results in a final sample of 212 firms. Tables I and II
summarize the sample selection process and industry composition of the final sample.
As indicated earlier, fiscal year 2000 is the focus of this study because it is the first
year that publicly-held companies are required by the SEC to improve disclosures
relating to the functioning of audit committees (SEC, 1999). In addition, the major US
stock exchanges have proposed changes to their listing requirements to enhance the
independence and expertise of audit committees. This presents a first opportunity
allowing the examination of the association between audit committee characteristics
and quality of reported earnings after the major reform in audit committees.
Restatements of earnings for fiscal year 2001 and thereafter are not included because

Observations

Firms restating earnings for the fiscal year 2000 identified from
Lexis-Nexis 267
Less: financial data not available from research insight (106)
Less: auditor fee data not available from the proxy statements (44)
Less: audit committee data not available from the proxy statements (11)
Final sample Restatement firms: 106
Control firmsa: 106
Table I.
Note: aControl firms are matched based on four-digit SIC code and total assets Screening procedure

SIC code Observations

100-999 2
1000-1999 12
2000-2999 42
3000-3999 68
4000-4999 14
5000-5999 32
6000-6999 4
7000-7999 28
8000-8999 10 Table II.
Total sample (n) 212 Sample composition
MAJ there is a considerable time lag between original reporting and subsequent restatement
21,9 of earnings for the same fiscal year. This sample screening criterion provides
reasonable assurance that any control firm would not restate its earnings for fiscal year
2000.

Model specification
926 We utilize the following logistic regression model, where the dependent variable
(RESTMT) equals “1” if the firm restated its earnings for fiscal year 2000, and “0”
otherwise. ACINDD, ACSIZED, ACEXPD, ACMEETD, and ACOWNPT are the audit
committee variables to test our hypotheses. The other variables in the model are
included to control for factors related to audit quality and financial characteristics of
the firms that may influence management’s decision to manage or manipulate reported
earnings:

RESTMT ¼ b0 þ b1 ACINDD þ b2 ACSIZED þ b3 ACEXPD þ b4 ACMEETD

þ b5 ACOWNPT þ b6 BIG5 þ b7 AUDTEN þ b8 LNAUFEE
þ b9 LNNONAU þ b10 CFO þ b11 ABSCFO þ b12 ACC þ b13 ABSACC
þ b14 MKRTX þ b15 LOSS þ b16 MKBKF þ b17 LEVERG
þ b18 FINACQ þ b19 LNMVE þ 1

ACINDD (audit committee independence) is equal to “1” if all the audit committee
members are independent, and “0” otherwise. ACSIZED (audit committee size) is equal
to “1” if the audit committee consists of at least four members, and “0” otherwise.
ACEXPD (audit committee financial expertise) is equal to “1” if the audit committee
includes at least one financial expert, and “0” otherwise. ACMEETD (audit committee
meetings) is equal to “1” if the audit committee meets at least four times for the year,
and “0” otherwise. ACOWNPT (audit committee stock ownership) is measured as the
percentage of outstanding common shares held by the audit committee members.
In addition to the five audit committee variables, this study includes two variables
as proxies for audit quality. Prior studies suggest that Big-5 auditors (BIG5) are less
likely to allow earnings management than non-Big-5 auditors (Becker et al., 1998;
Francis et al., 1999). Another variable is auditor tenure (AUDTEN) measured in the
number of years the same auditor has audited the client’s financial statements. Prior
research suggests that auditor independence decreases as the length of auditor tenure
increases (Beck et al., 1988; Lys and Watts, 1994). On the other hand, others claim that
as auditor tenure increases, the auditor is better at assessing risk of material
misstatements by gaining insights into the client’s operations and business strategies
(Arens et al., 2003). This study also includes two fee variables, log transformations of
fees for audit (LNAUFEE) and non-audit services (LNNONAU), as proxies for auditor
independence. These two measures are consistent with the argument that higher fees
from either kind of services would presumably increase the economic bond and thus
impair auditor independence and audit quality (Kinney and Libby, 2002).
This study also includes several variables that are frequently used in prior research
to control for other factors influencing management’s incentives to manage or
manipulate reported earnings. Several measures of firm performance are reported to be
correlated with earning management (or earnings quality) in prior studies (Dechow
et al., 1995; Frankel et al., 2002; McNichols, 2000): cash flows from operations deflated The effect of
by average total assets (CFO), the absolute value of cash flows from operations deflated audit committee
by average total assets (ABSCFO), total accruals deflated by average total assets
(ACC), the absolute value of total accruals deflated by average total assets (ABSACC), performance
annual market returns (MKRTX) and an indicator variable (LOSS) equal to “1” if the
firm reports a loss for fiscal year 2000, and “0” otherwise. In addition, Matsumoto
(2002) suggests that firms with higher growth prospects are more likely to manage 927
earnings. Growth prospects are measured by the market-to-book ratio (MKBKF). This
study also includes financial leverage (LEVERG), measured as the ratio of total
liabilities to total assets, and a financing indicator variable (FINACQ) equal to “1” if the
firm issued equity or debt securities during 2000, and “0” otherwise. These two
variables are included because prior studies find leverage and external financing needs
are related to earning management (Becker et al., 1998; DeAngelo et al., 1994). Finally,
this study controls for firm size measured as the natural log transformation of market
value of equity (LNMVE). Table III summarizes the definitions of all variables.

RESTMT An indicator variable equal to “1” if the sample firm restated its earnings for the
fiscal year, “0” otherwise (the dependent variable)
ACINDD An indicator variable equal to “1” if all the audit committee members are
independent, “0” otherwise
ACSIZED An indicator variables equal to “1” if the audit committee consists of at least
four members, and “0” otherwise
ACEXPD An indicator variable equal to “1” if at least one of the audit committee members
is a financial expert, and“0” otherwise
ACMEETD An indicator variable equal to “1” if the audit committee meet at least four times
for the fiscal year, and “0” otherwise
ACOWNPT Percentage of outstanding common stock shares held by the audit committee
members
BIG-5 An indicator variable equal to “1” if the auditor is a Big-5 firm, and “0”
otherwise
AUDTEN Number of years the auditor has audited the firm ¼ s financial statements
LNAUFEE Natural logarithm of fees paid to the auditor for audit services
LNNONAU Natural logarithm of paid to the auditor for non-audit services
CFO Cash flows from operating activities, deflated by average total assets
ABSCFO Absolute value of cash flows from operating activities, deflated by average total
assets
ACC Total accruals (i.e. net income minus cash flows from operating activities),
deflated by average total assets
ABSACC Absolute value of total accruals (i.e. net income minus cash flows from
operating activities), deflated by average total assets
MKRTX Annual market return of the firm ¼ s common stock
LOSS An indicator variable equal to “1” if the firm reported loss for the fiscal year,
and “0” otherwise
MKBKF Market value to book value for common equity to measure growth prospects
LEVERG Leverage ratio defined as ratio of total liabilities relative to total assets
FINACQ An indicator variable equal to “1” if the firm issued equity or debt securities
during the fiscal year, and “0” otherwise Table III.
LNMVE Natural logarithm of market value of equity at year end Definitions of variables
MAJ Empirical results
21,9 Descriptive statistics and univariate analysis
Table IV shows the means and t-statistics for the pooled sample firms, the restatement
sample firms and their matched control firms. The restatement and control firms differ
significantly, at the 0.10 level, in audit committee activities, ACMEETD (whether the
audit committee met at least four times for the year) and the extent of stock ownership
928 by audit committee members, ACOWNPT (the percentage of outstanding common
shares held by audit committee members). For the control variables, the two groups
differ significantly only in the percentage of firms audited by Big-5 audit firms, fees
paid to their independent auditors for non-audit services, and whether they reported a
net loss for the year. All the other audit committee and control variables are not
significantly different between the restatement and control groups.
Table V presents the univariate Pearson’s correlations and Spearman’s rank
correlations between earnings restatement (RESTMT), the dependent variable, and
audit committee variables, and between audit committee variables. The results
indicate that audit committee stock ownership (ACOWNPT) is significantly (at the 0.10
level) negatively correlated with occurrence of earnings restatement as expected. Also,
the number of audit committee meetings (ACMEETD) is significantly (at the 0.10 level)
positively correlated with occurrence of earnings restatement. The other audit
committee variables are not significantly correlated with occurrence of earnings
restatement. However, these results on the relationships between audit committee
variables and occurrence of earnings restatement are obtained without controlling for

Mean
Variable Pooled sample Restatement firms Control firms t-statistica

ACINDD 0.858 0.868 0.849 0.39

ACSIZED 0.887 0.859 0.915 2 1.30
ACEXPD 0.481 0.453 0.509 2 0.82
ACMEETD 0.557 0.623 0.491 1.94 *
ACOWNPT 2.810 1.865 3.755 2 1.65 *
BIG5 0.939 0.972 0.906 2.01 * *
AUDTEN 8.382 8.066 8.698 2 0.78
LNAUFEE 12.644 12.873 12.415 2.80 * * *
LNNONAU 12.199 12.156 12.242 2 0.14
CFO 0.019 0.008 0.029 2 0.83
ABSCFO 0.121 0.113 0.130 2 0.82
ACC 20.064 2 0.062 20.067 0.21
ABSACC 0.109 0.125 0.092 1.50
MKRTX 5.319 2.275 8.363 2 0.44
LOSS 0.396 0.472 0.321 2.26 * *
MKBKF 0.132 2 2.561 2.824 2 1.26
LEVERG 0.522 0.527 0.517 0.16
FINACQ 0.943 0.934 0.953 2 0.59
LNMVE 5.531 5.617 5.445 0.52
n 212 106 106
Notes: * * *, * *, and * indicate significance at the 1, 5, and 10 per cent levels, respectively, two-tailed;
a
Table IV. for testing that the means for the groups are significantly different from each other; see Table III for
Descriptive statistics variable definitions
 RESTMT ACINDD ACSIZED ACEXPD ACMEETD ACOWNPT
The effect of
audit committee
Panel A: Pearson’s correlations (n ¼ 212)
RESTMT 1.000 0.027 2 0.089 20.057 0.133 * 20.113 *
performance
ACINDD 1.000 0.111 20.097 0.074 20.040
ACSIZED 1.000 0.135 * * 0.011 0.026
ACEXPD 1.000 0.042 0.015 929
ACMEETD 1.000 20.219 * * *
ACOWNPT 1.000
Panel B: Spearman’s Rank Correlations (n ¼ 212)
RESTMT 1.000 0.027 2 0.089 20.057 0.133 * 20.123 *
ACINDD 1.000 0.111 20.097 0.074 20.038
ACSIZED 1.000 0.135 * * 0.011 0.055
ACEXPD 1.000 0.042 0.012
ACMEETD 1.000 20.351 * * *
ACOWNPT 1.000 Table V.
Correlations between
Notes: * * *, * *, and * indicate significance at the 1, 5, and 10 per cent levels, respectively, one-tailed; restatement and audit
see Table III for variable definitions committee variables

other factors related to audit quality and characteristics of the firm. To control for the
potential effects of these factors, a multivariate logistic regression model is used with
results discussed next. Also, while some of the pair-wise correlations between audit
committee variables are significant, they are all relatively low and well below the 0.8
threshold that may cause significant multi-collinearity problems (Gujarati, 1995).

Multivariate results
Table VI reports the multivariate logistic regression results. The H1 states that there is
a significantly negative association between audit committee independence and
occurrence of earnings restatement. As shown in Table VI, this hypothesis is not
supported, regardless of whether the audit committee independence is measured as the
percentage of independent directors on the audit committee or as a dichotomy (all audit
committee directors being independent or not). The H2 predicts that audit committee
size is significantly negatively associated with occurrence of earnings restatement. As
presented in Table VI, this hypothesis is supported. The association between audit
committee size and occurrence of earnings restatement is significantly negative at the
0.10 level. Also, this relation remains significantly negative when the audit committee
size is measured as the number of directors on the committee and as a dichotomy (i.e.
whether audit committee consists of at least four directors).
The H3 states that the financial expertise of audit committee is significantly
negatively associated with occurrence of earnings restatement. The result presented in
Table VI does not support this hypothesis. There is no significantly negative
association between the occurrence of earnings restatement and audit committee
financial expertise, regardless of whether audit committee financial expertise is
measured as the actual number of committee members who have financial expertise or
as a dichotomy (i.e. whether at least one committee member has financial expertise).
Hypothesis four predicts a significantly negative relationship between occurrence of
earnings restatement and audit committee activities (meetings). As reported in
Table VI, the hypothesis is not supported. No significantly negative association exists
MAJ
Variable Coefficient Estimate x2
21,9
Intercept 2 6.779 * * * 6.965
ACINDD 0.081 0.030
ACSIZED 2 0.981 * 3.110
ACEXPD 2 0.194 0.361
930 ACMEETD 0.257 0.579
ACOWNPT 2 0.033 1.700
BIG5 2.040 * * 5.029
AUDTEN 2 0.040 2.013
LNAUFEE 0.702 * * * 8.460
LNNONAU 2 0.185 * * 4.880
CFO 1.122 0.525
ABSCFO 2 1.529 0.671
ACC 2.819 2.359
ABSACC 3.772 * 3.536
MKRTX 0.002 1.593
LOSS 0.865 * * 3.873
MKBKF 2 0.031 1.102
LEVERG 2 0.312 0.284
FINACQ 2 0.510 0.523
LNMVE 2 0.045 0.164
N 212
Table VI.
Summary statistics from Notes: * * *, * *, and * indicate significance at the 1, 5, and 10 per cents levels, respectively, one-tailed;
logistic regression see Table III for variable definitions

between occurrence of earnings restatement and audit committee activity in terms of

actual number of meetings or as a dummy variable taking the value of one if the audit
committee had four or more meetings for the fiscal year affected by the restatement.
Finally, the H5 states that stock ownerships by audit committee members may
significantly associated with occurrence of earnings restatement. Table VI reports no
such significant relationship and H5 is not supported. Overall, the results presented in
Table VI support only H2 that there exists a significantly negative association between
the occurrence of earnings restatement and audit committee size.

Summary and conclusions

This study examines the association between the occurrence of earnings restatement
and characteristics of the audit committee. The results presented in Table VI support
the hypothesis that a larger audit committee may provide more oversight over the
financial reporting process. Such oversight seems to improve earnings quality by
reducing the probability of restating financial statements after their original filings
with the SEC. The findings support one of the recommendations made by the BRC in
1999 and the subsequent SEC (1999) regulations for implementing the BRC
recommendations. However, the other four hypotheses are not supported. In other
words, this study provides no evidence that the other audit committee characteristics –
independence, financial expertise, activity, and stock ownership – have any impact on
quality of reported earnings. These findings are obtained after controlling for several
variables that are frequently used in prior research to control for other factors
influencing management’s incentives to manage or manipulate reported earnings. The effect of
Moreover, the results remain the same when variables used to control for audit quality audit committee
are included in the model. These control variables related to audit quality are not used
in prior similar studies. Finally, the results are robust to alternative measures of the performance
audit committee characteristics variables. However, this study focuses on the fiscal
year 2000 only. As data become available for more fiscal years, future studies may
re-examine the issue of how audit committee characteristics affect quality of financial 931
reporting.

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Corresponding author 933

Jerry W. Lin can be contacted at: jlin@d.umn.edu

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