Audit committee financial expertise and information asymmetry

Abstract

Purpose

The purpose of this study is to examine the association between audit committee expertise and asymmetric information in the US equity market.

Design/methodology/approach

The authors use measures of information asymmetry for 705 US firms (5,260 firm-year observations) over the period from 2007 to 2018, and use the theory of expertise (Ericsson and Smith, 1991) to examine the association between audit committee financial expertise and information asymmetry. The authors use multiple econometric approaches such as firm fixed-effect regression and two-stage ordinary least squares regression to control for possible endogeneity and reverse causality and find that the results remain the same.

Findings

The authors find that the existence of an audit committee with financial expertise is negatively and significantly associated with information asymmetry. The authors further provide empirical evidence through which audit committee financial expertise affects the firm’s informational environment. Additional analysis supports the argument that the audit committee’s financial expertise enhances the firm’s informational environment by increasing (decreasing) analyst following (dispersion).

Research limitations/implications

One limitation to consider, like most studies on audit committees, is that the authors do not examine the actual role performed by the audit committee. The authors focus on the characteristics stipulated by the Sarbanes–Oxley Act 2002 and stock exchange rules regarding the financial expertise of audit committee members only.

Practical implications

This study is useful to policy makers, standard setters, investors, activists, managers, lenders and various stakeholders who rely on the financial statements of firms with an expert audit committee on board. The outcome of this study promotes recruiting audit committees with financial expertise due to the assumed benefits of this trait to the US firm.

Social implications

The results of this study are not event-dependent and therefore have persistent effects, which is important to the evaluation of the usefulness of a regulation. This study promotes recruiting audit committees with financial expertise on boards because of the assumed benefits to the firm and investors.

Originality/value

This study is the first to document that financial expertise of audit committee characteristics is not only negatively related to the magnitude of information asymmetry but also driven by the financial expertise of audit committee members rather than chairs.

Citation

El Mahdy, D., Hao, J. and Cong, Y. (2022), "Audit committee financial expertise and information asymmetry", Journal of Financial Reporting and Accounting, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JFRA-12-2021-0440