THE USE OF AUDIT COMMITTEES FOR MONITORING

The Treadway Commission (National Commission on Fraudulent Financial Reporting 1987, p. 40) has recommended that companies be required to maintain audit committees (ACs). Some recent papers (Eichenseher and Shields 1985; Pincus et al. 1989; Bradbury 1990) in this journal have identified characteristics of firms which voluntarily formed ACs. The mere formation of an AC does not mean that the board of directors actually relies on the AC to enhance its monitoring ability. Companies may form ACs for their image value. In this study, we look for evidence that firms actually rely on ACs. We consider two indicators of a board's reliance on ACs as a mechanism to control management, the frequency of AC meetings and AC composition. Our sample consisted of firms which faced no requirement to form ACs. Although the majority of firms formed ACs, many of these firms did not appear to rely on them. Some ACs did not meet at all or met only once during the year studied. In many instances ACs included at least one manager which is inconsistent with the role of Acs as a monitor of management. The results of the analysis suggest that reliance on audit committees is related to board of directors composition. As the proportion of outside directors on the board increases, firms seem more likely to exclude officers from ACs, and ACs are more active. Our study also found that frequency of meetings is associated with firm size.