In this paper we investigate what factors influence voluntary audit committee formation, focusing on both agency costs and corporate governance characteristics of the firm. Considering three kinds of agency costs which can occur between owners and man...
In this paper we investigate what factors influence voluntary audit committee formation, focusing on both agency costs and corporate governance characteristics of the firm. Considering three kinds of agency costs which can occur between owners and managements, between owners and creditors, and between majority and minority stockholders, we examine whether each category of agency costs is associated with voluntary audit committee formation. Based on the agency theory, we hypothesize that firms with higher agency costs between their stakeholders are more likely to voluntarily form their audit committees than those with lower agency costs.
We also investigate whether the existence of outside monitors such as independent directors, foreign investors and external auditors is associated with voluntary audit committee formation. Since the existence of external monitoring incentives is more likely to induce firms to voluntarily adopt audit committees, we hypothesize that the existence of the external monitoring incentives is more likely to be associated with voluntary audit committee formation.
We use data concerning Korean listed companies for the period 2000-2006. In Korea, listed firms having more than or equal to 2,000 billion won of assets are required to form their audit committees. This paper focuses on the firms of less than 2,000 billion won of assets. We selected non-financing firms voluntarily forming audit committees, matched with those not forming audit committees. The matching criteria used in the paper include year, industry classification and firm size. Our final sample consists of 172 non-financing firm-year data with voluntary audit committee formation and 172 control data without audit committees.
In our paper, the dependent variable is a dummy variable which indicates whether the firm voluntarily adopts its audit committee or not. Independent variables include agency costs and external monitoring incentives. The agency costs between stakeholders are measured in terms of whether or not top management is an owner, the debt ratio, and the number of related firms. External monitoing incentives are measured in terms of the ratio of independent directors on the board, foreign investors' stockholding ratio, and whether external auditors are big or not. We also include control variables such as firm size, board size and fixed asset size.
Our main empirical results are as follows:
We find that among the agency cost variables, the agency costs between the majority and minority owners are positively associated with the voluntary audit committee formation. Since minority owners have few other tools than audit committees to monitor majority owners, firms with higher agency costs between minority and majority owners are more likely to voluntarily adopt audit committees. We cannot document that the other agency cost variables are significantly associated with voluntary audit committee formation. Our results seem to reflect the Korean situation in which the agency problem between minority and majority owners is more striking.
We also find that voluntary audit committee formation is positively associated with the proportion of the independent directors on the board of directors and the stockholding ratio of foreign investors. This result implies that both majority independent directors on the board and foreign stockholders are more inclined to demand audit committee formation to effectively monitor management. However, the quality of external auditors is not significantly associated with voluntary audit committee formation.
One of our interesting results is that voluntary audit committee formation is negatively correlated with firma size which is currently used to require firms to form their audit committees by the regulation bodies in Korea. This empirical result can be interpreted that since large firms can engage high-quality external auditors to monitor managements, they might be less likely to form their audit committees. Our study may also implies that the regulation body should consider the size of agency costs of the firms and the existence of external monitoring incentives such as the proportion of the independent directors and foreign stockholders, instead of the firm size criteria, in order to require firms to form their effective audit committees.