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Features of an effective audit committee, and its role in strengthening the financial reporting: Evidence from Amman Stock Exchange

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Features of an effective audit committee, and its role in strengthening the financial reporting: Evidence from Amman Stock Exchange
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  Journal of Public Administration and Governance ISSN 2161-71042011, Vol. 1, No. 1 www.macrothink.org/jpag 39 Features of an effective audit committee, and itsrole in strengthening the financial reporting: Evidencefrom Amman Stock Exchange  Dr. Mo’taz Amin Al –Sa’eed (Corresponding author)Chairman, Accounting and AIS Department, Faculty of Financial and AdministrativeScience, Al Balqa’ Applied University, Amman – JordanE-mail: motazalsaid@yahoo.com   Dr. Soud M. Al-MahamidBusiness Administration Department, Faculty of Business Administration andEconomics, Al Hussein Bin Talal University   E-mail: Soud.almahamid@ahu.edu.jo   Received: June 02, 2011 Accepted: June 6, 2011 DOI: 10.5296/jpag.v1i1.698 AbstractPurpose: This study aims to understand the features of an effective audit committee and itsrole in strengthening financial reporting.  Design/methodology/approach: A questionnaire based survey was circulated to public listedcompanies on the Amman Stock Exchange (Banking, insurance, and financial institutions).The study was aimed at internal audit managers and finance managers. Out of 156questionnaires, we received 110 back which represents a 71% response rate. Findings: The study results show that the   research respondents have a good level of education and experience. In addition, there is a relationship between internal controls,international standards on auditing, institute of internal audit; Jordan securities commissionrequirements, external audit, understanding of audit committee functions, and financialreporting. Further more, the internal control, international standard on auditing and instituteof internal audit, Jordan securities commission requirements, External audit, understanding of audit committee functions can explain a significant amount of the variability in financialreporting. Finally, the research results also show that age and gender make a difference forour respondents when they evaluate financial reporting.  Journal of Public Administration and Governance ISSN 2161-71042011, Vol. 1, No. 1 www.macrothink.org/jpag 40 Research limitations/implications: The study like other cross sectional studies is not free of limitations. Originality/value: Managerial implications and new avenues of future research are supplied.Future research also can borrow the research model and apply a longitudinal study to solvethe cross sectional study problems. Keywords: Audit committee, effectiveness, independence, internal control, financialreporting, disclosure, and corporate governance. 1. Introduction Audit committees play a crucial role in firms' financial reporting processes, and thus haveattracted considerable attention from researchers, especially in the wake of recent high profilefinancial reporting scandals. Research has not, to date, examined how audit committeefeatures in Jordan’s efforts to strengthen the firm’s financial reporting environment. Auditcommittees have been in existence for many decades.The establishment of audit committee aimed to mitigate corporate fraudulent or creativeaccounting practices through internal control initiated by independent and effectivelyfunctioning non-executive members of audit committee. Recently; Jordan has made firmmoves to be an attractive investment environment; so that there is an increasing need of agood corporate governance and accountability in the corporate sector in Jordan. •   There are three benefits of having an audit committee: •   to improve or maintain the quality of the financial reporting process, •   to aid the actual and perceived independence of the internal and externalauditors, and finally; •   to improve the confidence of the financial statement users in the quality of financial reports (Simnet et al., 1993).The existence of an audit committee should improve the monitoring of corporate financialreporting and internal control. Indeed, users of financial statements often lack informationrelating to the company except that disclosed in the annual report and other statutoryannouncements, because most of the documents and records are classified as private andconfidential.Generally, our motives for such research are enforcing and encouraging the establishment of an audit committee. Which may lead to the following? •   to institute good corporate governance, •   to strengthen the role and effectiveness of non-executive directors, to assistdirectors in discharging their statutory responsibilities with regard to financialreporting,  Journal of Public Administration and Governance ISSN 2161-71042011, Vol. 1, No. 1 www.macrothink.org/jpag 41 •   to preserves and enhances the independence of internal auditors, •   to improve communication between the board and internal auditors, •   to assist auditors in the reporting of serious deficiencies in the controlenvironment or management weaknesses, •   to improve communication between the board and external auditor, and •   To preserves and enhances the independence of external auditors (Collier,1993).One of the main responsibilities of the audit committee is to oversee the external auditfunction, including the selection, compensation, work and independence of the externalauditor. Effective oversight is expected to strengthen “audit quality”.Additionally one of the primary functions of the audit committee is the oversight of internalcontrol (BRC, 1999; Carcello et al., 2002). Effective oversight is assumed to strengtheninternal quality control.Therefore, there is need for a study to be carried out to examine features and characteristicsof an effective audit committee, and its role in strengthening the financial reporting process inJordanian listed corporations on the Amman Stock Exchange. The objective of this researchis to explore and evaluate features of an effective audit committee, and its role instrengthening the financial reporting of companies that are listed on the Amman Stock Exchange. The findings are important for policy makers, stakeholders and company’smanagement to help them formulate practical guidelines to improve the corporate governancepractices among listed firms.Given the new corporate governance environment, it is essential for audit committees tofocus on a process to support effective oversight that goes beyond mere compliance with therules. This requires an oversight framework that facilitates the coordination of the activitiesand information needed to support the audit committee's understanding and monitoring of thecompany's financial reporting process.The paper is organised into eight sections. The first section provides an introduction. TheJordanian Business Environment and corporate governance structure are explained in thesecond section. The third Section provides research objectives. The fourth section provides aliterature review on audit committees. The fifth section presents the research model andhypothesis development. While the sixth section offers the data collection and researchmethodology, the seventh section discusses data analysis and research findings. And finally;the last section concludes the research. 2. The Jordanian Business Environment and Corporate Governance Structure Jordan is a free market oriented economy, with outward-oriented economic policies and aprivate sector led approach. Jordan experienced an ongoing privatization of major state-owned enterprises and implemented significant advances in structural and legal reform.  Journal of Public Administration and Governance ISSN 2161-71042011, Vol. 1, No. 1 www.macrothink.org/jpag 42 Below are select highlights for the data included in the profile.1.   Index of Economic Freedom score improved this year reflecting a substantial increasein business freedom, moderate increases in trade freedom and government size, and aslight decline in freedom from corruption.2.   According to the World Economic Forum's Global Competitiveness Report for 2007-08, the three most problematic factors for doing business are tax regulations,inefficient government bureaucracy, and tax rates. •   Income category: Lower middle income •   Population: 5,906,042 •   GNI per capita (US$): 3306.07 (World Bank, IFC, 2009). •   Jordan ranks in the top six of the seventeen countries examined with regard to doingbusiness in the Middle East region (Doing Business Report, World Bank, 2009). •   Jordan enjoys competitive labour laws: ranks 2nd in areas of employing workers, hiringand firing and flexibility in hours (Doing Business Report, World Bank, 2009). •   Jordan does an exemplary job at moving goods quickly across borders. •   Jordan is committed to the protection of investors’ rights irrespective of national srcin. •   Jordan has one of the most impartial and efficient legal systems in the region, comparableto international standards.The Annual Doing Business Report conducted by the World Bank’s International FinanceCorporation (IFC) provides a comparative insight into Jordan’s relative rankings along anumber of measures for typical business operations. The results show that Jordan ranks in thetop six of the seventeen countries examined with regard to doing business in the Middle Eastregion. Jordan ranks in the top tier among countries ranked for employing workers in theareas of hiring and firing and flexibility in hours. The country has very competitive laws inthis regard. The Kingdom is ranked first relative to its peers for enforcing contracts in atimely matter and second for legal rights involved in obtaining credit. The legal protectionsencourage investors to continue investing capital in Jordan. (Jordan Investment Board, 2009).2.1 Strong Banking and Financial ServicesJordan enjoys a very well developed banking sector by regional standards with a wide arrayof business, investment, and retail services. Both local and international banks are operationaland growing in Jordan. The Amman Stock Exchange is modern and enjoys no taxes oncapital gains, no taxes on cash dividends, free repatriation of investment and income, noceiling on foreign equity ownership and privatization. Jordan Securities Commissionregulates Securities. Insurance Commission of Jordan regulates Insurance. Publicshareholding companies were established in the early 1930s. Ever since, the Jordanian publichave been subscribing and dealing in shares. Corporate bonds were issued in the early sixties.Transactions were handled in individual brokerage offices. Thus, the need for a well-organized market arose, and the establishment of the Amman Financial Market became  Journal of Public Administration and Governance ISSN 2161-71042011, Vol. 1, No. 1 www.macrothink.org/jpag 43 crucial. January 1, 1978 was the birth of a leading securities market in the region. Since thatdate, the Amman Stock Exchange played the role of the stock exchange as well as aregulatory body.2.2 The Functions of the Board of Directors  A - General principle (i) The Board of Directors has overall responsibility for the operations and the financialsoundness of the company and ensures that the interests of shareholders, depositors, creditors,employees, and other stakeholders, including the regulatory bodies of Jordan, are met. TheBoard ensures that the Company is managed prudently and within the framework of laws andregulations and the Company’s own policies. (ii) The Company affirms that the obligations of each Director are owed to the Company as a whole, and not to any particular shareholder.(iii) The Board sets the Company's strategic goals, as well as overseeing the executivemanagement of the Company. The day-to-day operation of the Company is the responsibilityof executive management, but the Board as a whole ensures and certifies that internal controlsystems are effective and that the Company's activities comply with strategy, policies andprocedures approved by the Board or as required by law or regulation.  B - Audit Committee Subject to the provisions of the relevant legislation, the board of directors shall establish anaudit committee according to the following: - (Jordan Depository Centre, 2009).(A) The audit committee shall consist of a chairman and two other members, provided thatone of them, at least, shall have the experience in auditing, accounting or finance, or shall bea public accountant according to the relevant legislation in force. The board of directors shallelect the committee members among its members other than the members of the executivemanagement or any of the committees established by the board. The audit committee shallmeet, at least, once every three months, or whenever necessary. (B) The functions andauthorities of the audit committee shall be clearly specified, and shall include the following:-1.   Recommending to the board of directors to nominate the external auditor to be electedby the general meeting.2.   Monitoring the extent of comprehensiveness of the external audit of the business of the company.3.   Ensuring the existence of coordination between external auditors, in the case wherethere is more than one.4.   Reviewing the observations in the reports of the Insurance Commission and thereports of the external auditor and following up measures taken in their reports.5.   Studying the annual plan of the internal audit and reviewing the observations in theinternal audit reports and following up measures taken in their reports.6.   Ascertaining the accuracy and soundness of the accounting, financial and controlprocedures and the extent of compliance therewith.
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