Relationship between audit committee characteristics and firm performance Essay


The intent of this survey is to look into the relationship between the audit commission features and steadfast public presentation. In order to detect the relationship, some methodological analysiss have been applied to set about the research. This chapter deals chiefly with research methodological analysis applied in this survey. The methodological analysis chosen are outlined in item to assist the user ‘s understand what statistical tools are used in this research.This chapter is divided into several subdivisions.

The organisation of this chapter is allocated into some subdivisions. For Section 3.2, it enlightens on the conceptual model. Section 3.3 describes on development on hypothesis and followed by Section 3.4 that explains on measuring of the variables. The arrested development theoretical account is developed in Section 3.

5. Following, Section 3.6 enlightens on the measuring of variables that explains in inside informations on the pick of dependant, independent and control variables that are selected based on the aim of survey and eventually Section 3.7 presents the arrested development theoretical account used for this survey. Section 3.

8 describes the methods that are used in this survey to garner the relationship.

3.2 Conceptual Model

The theoretical model for this survey derived from the old research by Anthony Kyereboah_Coleman ( 2007 ) . In his research on the patterns of the 103 listed companies on Ghana, Nigeria, Kenya and Johannesburg stock exchange, in their survey it have combined the corporate administration construction that are board features and audit commission features towards the house public presentation. For this research the research worker is merely utilizing the features of audit commission that are size, independency and activity in audit commission that affect the public presentation of the company. The research worker besides added another one variable that is fiscal cognition among audit commission.

This variable has been used by the old research workers in their research. As explained, this survey investigates the relationship between audit commission features with the public presentation of the company that measured by Return on Asset. The independent variables are size, independency, activity and fiscal cognition of audit commission.

3.3 Development of Hypothesis


3.1 Company public presentation ( Dependent Variable )

Derive on assets in this survey used as public presentation indexs, Return on assets is besides used by Barber and Lyon ( 1996 ) ; the computation for the ROA as operating net income before depreciation divided by entire assets. Derive on assets ( ROA ) is a fiscal ratio that shows the per centum of net incomes that a company produces in relation to overall resources. It is typically defined as net income ( or net income before revenue enhancement ) / entire assets. ROA is known as the ratio of net incomes or productiveness, for supplying information on public presentation direction in the usage of little concern assets to bring forth income. ROA and other fiscal ratios can supply little concern proprietors and directors with a valuable tool to mensurate their advancement against predetermined internal ends, a specific rival, or industry as a whole.

ROA is besides used by bankers, investors, and concern analysts to rate companies use the resources and strengths the fiscalO. Gill.J ( 1996 ) noted in his book Financial Basics of Small Business Success, most enterprisers decide to have concern to do better determinations on their money than is available through a bank or a low hazard investing. If the ROA and other profitableness ratios showed that this did non go on, particularly on little concerns, it has moved beyond the start up stage, the enterpriser should see selling the concern and put his money back or elsewhere. ROA measurings include all the assets of a concern including those originating from the duties to creditors or that which arises from parts by the investors.

For this ground, the ROA is normally less attractive to stockholders of several other fiscal ratios. However, the inclusion of the duty is to do ROA even more valuable as a tool to mensurate the public presentation, peculiarly in measuring the public presentation of assorted sections or subdivisions companies.ROA is a superior internal direction ratio because it measures net income against all of the assets a separation uses to do those net incomes. Hence, it is a manner to measure the division ‘s public presentation and efficiency.

It ‘s besides more suited because division directors seldom get caught up in raising money or do a determination when utilizing the mix between debt and equity. As written by. Kristy.A.J and.

Diamond.Z.S ( 1984 ) in their bookA Finance without Fear, A ” One of the central regulations in pull offing concern professionals is to keep them accountable for merely those activities they control. ROA comes near to making merely that. ”( hypertext transfer protocol: //www. )

3.3.2 Audit Committee Characteristics ( Independent variables )

Formation of audit commission can heighten the company public presentation. As a subcommittee in the cooperation, an audit commission aims to provide an confidence on fiscal and conformity issues through increased analysis, answerability, and the capable usage of resources. An audit commission may besides provide an consultative undertaking concentrating on public presentation betterment within the organisation.

Unfortunately, for audit commissions every bit good, the empirical findings of their influence on public presentation are mixed. Audit Committee, if it is formed by independent persons in peculiar, it can hold benefits necessary to increase the dependability of the system of internal controls. This can do a positive impact on market perceptual experience of the company ability to signal to its operations in a mode that is crystalline, right and effectual. ( Fratini and Tettamanzi, 2006 ) .


3.3 Audit commission size

Abbott et Al. ( 2004 ) expressed the sentiment to demo that the audit commission with at least three managers has a better quality in monitoring and associated with a lower incidence of restatement.

However, after the satisfaction of single members may non exercise adequate attempt in the work of the commission. Conversely, the smaller squads can frequently prosecute their undertakings more efficaciously. Yermack ( 1996 ) , for illustration, found that smaller boards are associated with higher quality monitoring. He shows that companies with smaller boards could determine the CEO for a better more disciplined in the instance of hapless public presentation, to give executives a lower degree of entire compensation, and is besides associated with higher market rating. Similarly, the outlook that the job can non be prevented ; increased the effectual map of the big audit commission to descry possible jobs in fiscal coverage. In add-on, if the size of a squad is big, single members may be more vulnerable to the force per unit areas and more capable to follow the others ‘ sentiment without giving another statement. In this instance, the audit commission members are non likely willing to oppugn the possible mistakes in the accounting studies of the internal reappraisal procedure, which in bend can take to a greater opportunity of showing once more subsequently. Conversely, a little squad will ease the exchange of information and a better treatment between members, to help direction to place possible mistakes in fiscal coverage and cut down the incidence of restatement of the lower limit size demands, a big commission may endure from the job of free riders, In old surveies, the size of the audit commission determined by the sum of the figure of audit commission.

These variables have been tested in old surveies conducted by Xie et al. , ( 2003 ) . The consequences showed that the size of the audit commission to give more resources is more likely to supervise fiscal coverage and internal control systems ( Anderson et al, 2004. ) High and facilitate treatments between the audit commission members ( DeZoort and Salterio, 2001 ) .

Empirical grounds shows that companies with greater audit commission prefer to leery hearer switches ( Archambeault and DeZoort, 2001 ) and more likely to hold lower costs of debt ( Anderson et. Al, 2004. ) . Since the exchange, the consequence now requires their registrants to hold at least three managers on the audit commission.Therefore, The first hypothesis is:H1: There is relationship between audit commission size and house public presentation

3.3.4 Independence

Independence of audit commission is determined by two definitions ; first definition is independency is classified if manager is a non executive manager, but it a lame definition because even though they are non affect straight, non executive manager may be hold another relationship through the old employment or in concern relationship that crack the significance independency. The 2nd definition is non executive manager and does non hold any relationship with the company, these definition are similar to Vafeas ( 2001 ) .

A survey done by the Carcello and Neal ( 1999 ) , found that the likeliness of fiscal hurt company received the traveling concern sentiment from the hearers is lower when the per centum of outside manager is bigger in the formation of audit commission, it means that the independency of the audit commission can assist the external hearer to keep their fiducial responsibility without influence from the manager. Another research by them found that a positive relationship between independency of audit commission and fiscal coverage quality ; suggested that holding the independency of manager in audit commission can heighten the house public presentation.The success of the audit commission is besides influenced by the composing of the commission. Previous literature that stated that if the board or executive commission members tend to organize a alliance with the top direction, it is likely to be little because they are really cautious in all affairs impacting the stockholders as they have a duty to protect the involvements of stockholders ( Conyon and He, 2004 ) . In add-on, if the board or commission members have concern dealingss or other relationship with the company or members of the commission, for illustration, as a brother, a company attorney, accountant, or adviser, they may experience a strong sense of responsibility towards the top direction, who they should, depends on obtaining and regenerating the contract understanding ( Core et Al, 1999 ) . Consequently, the associate members may be more loath to dispute the top direction, and are less likely to look for possible mistakes in fiscal coverage.

As a consequence, we expect that the companies have audit commissions composed wholly of independent managers that must keep better quality and to place possible fraud in fiscal coverage and farther cut down the possibility of net income restatement.Therefore, The 2nd hypothesis is:H2: There is relationship between audit commission independency and house public presentation

3.3.5 Activity

A more active audit commission is expected to supply a mechanism for effectual inadvertence of the company. Since, the degree of activity reflects the audit commission of good authorities, should better the dependability of fiscal coverage. Manual of Corporate Governance states that the proviso of an institutionalised forum audit commission encourages external hearers to take a troublesome issue in the early phases. As a best pattern, audit commission meetings should be conducted at least one time a twelvemonth without the presence of members of the executive board to avoid intervention in the issues originating.

However, the figure of meetings depends on the demands of mention and operating complexness. At least three or four meetings should be planned to co-occur with the audit rhythm and the one-year study issued in add-on to the other meeting held in response to the incurred during the financial twelvemonth ( Code on Corporate Governance, 2000 ) . Consistent with this statement, a survey of Anderson et Al. ( 2004 ) showed that the cost of debt is reduced while increasing the frequence of audit commission meetings ; shown to better the public presentation of the company to cut down debt. Xie et.

Al. ( 2003 ) found that the figure of negative audit meetings related to discretional accumulations ( DAC )Effective proctors in companies by the audit commission it is non plenty if they are independent, they besides must be active ( Menon and Williams, 1994 ) . This proposes that when analyzing the independency, the research worker should besides analyze the degree of audit commission activity.Therefore, The 3rd hypothesis is:H3: There is relationship between audit commission activity and house public presentation


3.6 Financial Literacy

The definition of fiscal accomplishments recommended by the Blue Ribbon Committee ( 1999 ) , is which manager holds the enfranchisement from the professional organic structures or members of professional organic structures in accounting and has served as Chief Executive Officer ( CEO ) or senior executive places in finance or accounting. The 2nd definition describes the fiscal expertness of managers who are members of professional accounting organic structure that proposed by Rainsbury Elizabeth ( 2004 ) . This proposal shows that audit commission members should be two chief types of understanding on how concern is presented in fiscal studies and the ability to analyse coverage ( fiscal coverage cognition ) , and the apprehension of the nature and intent of scrutinizing the fiscal study ( audit study cognition ) . Audit commission members with financial-reporting will be even more likely to back up the hearer in differences with the will of the direction of low degrees of cognition ( F. Todd and Salterio, 2001 ) . Members with the cognition that should be better talented to understand the proficient accounting processs and criterions, and therefore appreciate the importance of rating in accounting substance over signifier, the beginning of frequent differences between hearers and direction ( Shah 1996 )Therefore, The 4th hypothesis is:H4: There is relationship between audit commission fiscal literacy and house public presentation


7 Leverage

With the usage of debt funding, possible struggles of involvement arise between stockholders and debtholders which give rise to bureau costs ( Jensen and Meckling, 1976 ) . Accounting-based compacts are typically written into debt contracts by debtholders to extenuate these struggles and hence supervise the actions of direction and stockholders. These compacts frequently require houses to obtain audits of their fiscal statements and a certification of conformity with the compacts ( Smith and Warner, 1979 ) .

However, directors of houses with higher purchase have greater inducements to do accounting policy picks that manipulate their fiscal statements, accordingly avoiding the costs of go againsting debt compacts. Therefore, in such state of affairss, houses have inducements for improved monitoring of the procedure of fiscal coverage ( Klein, 2002 ) . As purchase additions, boards are predicted to voluntarily set up independent audit commissions with fiscal expertness as a agency of reassuring debtholders that the audit commission is efficaciously supervising the fiscal coverage procedure ( Rainsbury et al.

, 2008 ) .This suggests the undermentioned hypothesis:H5: There is relationship between purchase and house public presentation

3.4 Measurement of variables

In this survey, variables are chosen based on the elaborate analysis that has been done from anterior researches.

In world, there are no peculiar accepted regulations or guidelines that can be applied for the chosen of variables in carry out the research. Most likely, those three factors are hardly that are suited and can be considered as principle for the chosen of such variables. First, the research worker can take the variables that have been used by the anterior research workers that provide important explanatory in the past arrested development theoretical account. Second, the choice of variables can be made based on the handiness of the information. Third, variables should be carefully chosen based on the relevance with the factors that are traveling to be tested in line with the of audit commission in listed companies in Malaysia.

3.4.1 Firm public presentation

As this research to mensurate the public presentation of the company, the research worker has used the return on assets ( Kyreboah-Coleman, 2007 ) .

3.4.2 Audit commission size

In this survey, audit commission size is determined by the figure of audit commission in the company.

This variable has been tested in the old survey done by the Xie et al. , ( 2003 ) .

3.4.3 Independence

Independence audit commission can be explained by the two definitions ; the independency of managers is classified if the non executive managers, but the definition is weak for the ground that although they are non straight involved, the executive manager could non hold had other contacts through old employment or concern relationship that cracks in the significance of freedom. The 2nd definition is a non executive manager and is non related to the company. This definition is consistent with that used by Vafeas ( 2001 ) and consistent with the construct of freedom of the BRC ( 1999 ) . For this survey, research worker used the 2nd definition of independency.

While the audit commission independency is considered if all members of the audit commission is in full independency of non holding any relationship with the company interaction and will be encoded with 1, but if the audit commission is non full independent will be encoded with the figure 2

3.4.4 Activity

In this survey the research worker will be utilizing the figure of meeting that is attended by audit commission as a placeholder to mensurate the degree of audit commission activity. This method is similar with the old research done by Menon and Williams ( 1994 ) . They use the figure of audit commission meetings as a placeholder for the degree of audit commission activity. The ground why they use figure of meeting is for the ground that audit commissions that do non run into or run into merely a small times, are improbable to be effectual proctors. With this fact, audit commission activity as an indispensable portion of audit commission effectivity.

3.4.5 Fiscal literate

For this survey the research worker will utilize the definition that is used by the Rainsbury ( 2004 ) ; as the experience of manager if they merely hold the place as a Chief Fiscal Officer.

The ground why the research worker chose the CFO is if the manager has an experience as a CFO, he or she is holding the cognition in fiscal background such as read and analyse the fiscal study. In add-on in best pattern in MCCG it stated that “ all its members should be able to read, analyze and construe fiscal statements so that they will be able to efficaciously dispatch their maps ” ( MCCG, 2007. the audit commission fiscal cognition will be encoded with 1 if an audit commission has the professional makings of the professional accounting organic structures and 2 if it is non.

3.4.6 Leverage

Leverage have been used in anterior survey such as Krishnan and Young ( 2005 ) .

. The chance of this variable to act upon steadfast public presentation is high, since greater adoptions require the loaner to play a greater monitoring function of the company and directors may besides command the net incomes to avoid debt compact misdemeanors. Therefore, purchase is measured by entire liabilities divided by entire assets

3.5 Regression theoretical account

The aim of this survey is to find the relationship between audit commission features and steadfast public presentation in Malaysia companies.

Therefore, arrested development analysis is applied in order to accomplish this aim. It is to place the being of the relation between audit commission features and steadfast public presentation such as audit commission size, frequence meeting, independency and fiscal cognition. The arrested development theoretical account of this survey is as follows:

ROAi = I?0 + I?1 ACSIZE + I?2 ACMEET + I?3 ACIND + I?4 ACFINLIT + control variable E›i

Where,ROAi = EBIT/TOTAL ASSETACSIZE = Total figure of managers on the audit commissionACMEET = Total figure of audit commission run intoing held within the fiscal twelvemonthACIND = Full independent of audit commissionACMEET = Total figure of audit commission meetingFINLIT = Having the profesional certificationControl variable ( Leverage ) = Entire Liability/Total AssetsI? = ParametersE›i = Error

3.6 Data aggregation

This survey involves both quantitative and qualitative attack.

This is a transverse sectional survey analyzing the relationship between the audit commission features and public presentation in company. The information is collected from published one-year studies downloaded from the cyberspace. All the one-year study is available in Bursa Malaysia web site.

3.7 Sample Selection

This survey focuses on the four largest industry sectors of listed companies in the Main Market. These four sectors are consumer merchandises, industrial merchandises, belongingss and trading/service sectors. This four sectors are holding the high market capitalization..

Subsequently, for each sector, the company is chosen harmonizing the graded sampling method. The entire companies that are listed in the four major industries is 684. From this entire population proportionate stratified trying are utilizing to find the sample size 169 companies.Graded random sample choice is chosen in order to hold general representative sample from a important proportion of the listed companies, with respect to the extent of audit commission features on company public presentation. Therefore, the consequences obtained are able to be generalised to Malaysian listed companies in the several industrial sectors.

The research worker acknowledged the possibility of incompatibilities in the analysis and consequence, but harmonizing to Kyereoah-Coleman ( 2007 ) the differences that occur are really little impact on the consequences giving genuineness. A sample size of 169 is acceptable for statistical analysis, as harmonizing to Fisher ( 2007 ) , under the criterion of minimal sample size of 30 is satisfactory and the sum of sample is proposed by Sekaran ‘s ( 2003 ) ; the sample reflects the entire population. Furthermore, the sample must be big plenty to supply sufficient dependability, but non excessively farther as this will be a waste of resources. A regulation of pollex showed that the samples should be someplace between 100-1000 units and non more than ten per centum of the population ( Alreck & A ; Settle,1995 ) . This regulation of pollex hence suggests that the maximal sample size is someplace in the scope 100-500 units.

Data is sourced from single company one-year studies. These one-year studies are available and downloadable from the web site of Bursa Malaysia ( hypertext transfer protocol: // ) .

3.8 Analysis of informations and Research design

The findings of the survey will be analyzed utilizing the Statistical Package for the Social Sciences ( SPSS ) computing machine plan for Windowss Version 17.

The analysis of the information was performed in two phases: ( 1 ) look into the normalcy ; and ( 2 ) statistical processs: descriptive statistic, correlativity analysis and arrested development analysis.

3.8.1 Test of Normality

Trial of normalcy employed several descriptive secret plans on the information set. In this survey, normal chance secret plans are plotted to visually analyze the distribution of informations. The exploratory informations analysis employed two types of chance secret plans to show that the informations came from a normal distribution. In the Normal Q-Q secret plan for house public presentation, the ascertained values seemed to constellate along a consecutive line, supplying an indicant that the informations were usually distributed ( Figure 3.

2 ) . Normality trial will assist to warrant which type of trial to farther be carried out either parametric or non-parametric for illative statistics. Therefore, Kolmogorov- Smirnov statistics is used to find the normalcy of informations in this survey. If the consequence from the trial marked a significance degree which is greater than 0.05 ( P & gt ; 0.05 ) , it is assumed that the information is usually distributed. Two types of correlativity trials that can be applied are the Pearson and Spearman coefficient.

If the information is usually distributed ( p & gt ; 0.05 ) , parametric trial ( Pearson ) is applicable. On the other manus, the non-parametric trial ( Spearman ) is applicable if the information is non usually distributed ( p & lt ; 0.

05 ) .Similarly, the ascertained values of the Detrended Q-Q secret plan in Figure 3.2, every bit good clustered indiscriminately around the horizontal nothing line to connote that the information of house public presentation are sampled from an about normal distribution.


8.2 Descriptive Statisticss

Harmonizing to Leary ( 2001 ) , descriptive statistics is a powerful tool to depict and understand the informations so that they can be easy comprehended by others. The descriptive statistics employed in this survey are as followed: ( 1 ) steps of cardinal inclination ; ( 2 ) steps of variableness ; and ( 3 ) frequence distribution. These statistics are used to pull out and sum up quantitative information from the sample.Measures of cardinal inclination helped to happen a individual index that could stand for the whole set of step. This survey utilized the mean or norm to depict the informations in footings of norm values. Mean is chosen due to the variables investigated in this survey such as the dependant variable and the independent variables. Ary et al.

, ( 1996 ) reported that mean could give a more precise step than all the different steps of centrality such as the median or manner as it takes into history the value of every mark. It is besides more stable compared to other steps of cardinal inclination particularly when the samples are indiscriminately drawn from the mark population.This survey besides employed the most normally used step of variableness and standard divergence to happen out the scattering or variableness of the information set. Since it is besides an interval statistic as the mean, it could be used to depict the grade of scattering of all the interval variables ( dependent and the independent variables ) . Frequency distribution is used to pull out of import characteristics of the quantitative information of the survey.

The original informations collected are grouped and presented in a summarized signifier by building appropriate tabular arraies and charts.Statisticss such as agencies, standard divergences, scope per centums are besides used to sum up and depict the information. A combination of these statistics helped to supply a more comprehensive description of the informations presented. It is the purpose of this survey to place the degree of steadfast public presentation before correlating with the independent variables of the survey. Descriptive statistics are besides employed to sum up and depict the informations pertaining to the demographic profiles of respondents in the survey.

3.8.3 Correlation Statisticss

Harmonizing to Ary, et al. , ( 1996 ) , correlativity statistic is a statistical technique used to mensurate the strength of the association or co-variation that exists between two quantitative variables.

The strength of the relationship between two variables are measured by the coefficient of correlativity, R, whose values may run from -1 to +1. If the way of the relationship between two variables is positive, it means that high tonss of one variable are associated with high tonss of another variable and frailty versa. When the relationship existed, correlativity coefficient can besides find the strength of the relationship whether the variables have a strong relationship or a weak relationship. The intimacy of the correlativity coefficient to one implies a strong relationship between the two variables. When the correlativity coefficient is zero, there is no correlativity between the two variables.Since the information in this survey is non normal distributed, the appropriate method to prove the correlativity is utilizing the Spearman ‘s Correlation Coefficient Matrix under non parametric trial.

3.8.4 Level of Significance

Empirical research worker would necessitate to set up the extent of mistake before the research was conducted in order to find the statistical significance of the findings. It is of import in order to cipher the chance of doing mistakes in pulling decisions from the survey. Harmonizing to Lowenberg and Conrad ( 1998 ) , set uping the statistical significance would assist the research worker to make up one’s mind the extent to which the consequences might be due to opportunity or systematic consequence and it could help in finding the extent to which findings from the sample could be generalized to the targeted population.In this survey, a 95 per centum assurance degree ( p & lt ; 0.

05 ) is set as the standard degree for finding statistical significance. This degree has been fixed based on the statements provided by established statisticians. For case, harmonizing to Cramer ( 1997 ) , the degree of P & lt ; 0.05 is the conventional chance for determination that the consequence is non due to opportunity


8.5 Multiple Arrested development

Multiple arrested development is a statistical technique that allows researcher to foretell person ‘s mark on one variable on the footing of their tonss on several other variables. In order to prove the relationship between the dependant variable and independent variable, hierarchal multiple arrested development is most appropriate technique, it because this survey have employed the control variable.

3.9 Drumhead

This survey employed a quantitative research methodological analysis to measure dependent variables that existed.

A descriptive correlativity attack was used to find the relationship between the selected independent variables and house public presentation, the dependant variable. Datas were collected utilizing a validated and dependable research instrument as it appropriateness, practicality and dependability for usage in the local scene were assessed before it was administered. This research instrument was eventually administered to a representative sample drawn from the population of the survey to enable the research worker to do illations or generalisation from the sample statistics to the population understudied. The size of the sample of the informations aggregation is based on the entire figure of population. After the informations were collected, they were analyzed utilizing a combination of statistical analysis such as descriptive statistics, correlativity statistics and multiple arrested development analysis to reply the research inquiries.