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While there is relatively little empirical evidence supporting the recommendation of an independent corporate board, there is a substantial body of evidence linking superior corporate outcomes with the existence of an audit committee (AC). The superior outcomes are strongest for firms with:
- an AC with an independent AC chair;
- an AC with majority independent members; and,
- an AC with a higher proportion of members with accounting expertise (CPA, CA etc.).
Using only the provided academic working paper: 'Corporate governance in mid-tier companies: Window-dressing or value-adding?' as a source of definitions and references (in particular pages 9-11 & 19-23), briefly explain why these AC characteristics may be beneficial for a company and its shareholders
For a corporation, existence of an audit committee (AC) plays a very important role in corporate governance. AC is able to perform a thorough audit of company's internal and external operations along with the financial aspects of the company. The integrity and efficiency in facilitating audit committee is a deterministic attribute for the level of protection that a corporation offers to the shareholders regarding quality of transparency, necessary disclosures and compliance with financial and ethical regulations.
For effective implementation of audit committee, evidence suggests that independence of the committee and its members is important. A research study revealed that in companies that deployed an independent director for the audit committee having expertise in financial management, the incident rate of financial issues or failure to disclose was lower in comparison with companies with non-independent director of AC (Agarwal and Chadha, 2005). In addition to the director of AC, empirical evidence also argues that having a majority of members in AC is highly beneficial to quality of corporate governance (Klein, 2002).
While independence of the members forming audit committee is an important aspect to consider, it is also vital to look at the area and level of expertise of the members. Auditing operations benefit significantly from the knowledge and experience of the auditor in financial management and accounting. There are a number of studies that point out of the sheer importance of members of audit committees to have skill and experience in accounting as accounting knowledge helps the auditors in more reliably perform auditing tasks (DeFond et al., 2005; Zhang, Zhou and Zhou, 2007).
In the corporate world, it is a common understanding that auditors should operate independently in order to avoid any kind of conflict of interests. The recommendations made by Australian Securities Exchange (ASX) for audit committees also reflects positively on the need for independence of AC members from other components of business and accounting background of the members.