The Relationship Between Audit Committee Characteristics and Financial Performance of Listed Banks in Ghana
The Relationship Between Audit Committee Characteristics and Financial Performance of Listed Banks in Ghana
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Abstract
This study presented a description of the performance of eight banks listed on the Ghana stock exchange using
return on equity and return on asset as performance indicators. It also presented aggregate information on the
performance of these eight banks over a five-year period. It further analyzed the association between performance
and audit committee size, independence, audit committee members’ expertise and experience and gender diversity
of the audit committee. Audit committee size and the expertise and experience of audit committee members was
found to be positively correlated with return on equity. However, the independence of the audit committee
members and gender diversity of the committee had a negative correlation with return on equity. Similarly, audit
committee size and the expertise and experience of audit committee members correlated positively with return on
asset. However, audit committee independence and gender diversity had a negative correlation with return on asset.
This means in response to the hypothesis; ROE is positively related to audit size and the audit members’ expertise
and experience but negatively related to audit committee independence and gender diversity of the audit committee.
Similarly, ROA is positively related to audit size and the audit members’ expertise and experience but negatively
related to audit committee independence and gender diversity of the audit committee.
Keywords: Audit committee, Return on Assets, Return on Equity, Financial Performance
DOI: 10.7176/RJFA/11-10-03
Publication date:May 31st 2020
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stakeholders of financial institutions and institutions under study for decision making towards organizational
performance.
Given this background, it was considered necessary to conduct this study to gather and analyse data to
understand and appreciate the role of auditing in the performance of listed banks in Ghana.
The conduct of top management if not properly monitored can lead to loss of owners’ and stakeholders’
investment. Without effective auditing to monitor managers’ practices, organizations stand a high risk of losing
investments (Campbell & Mínguez-Vera 2008; Afify 2009; Ghazali 2010).
The recent poor performance and collapse of several banks such as UT Bank and Capital Bank in Ghana call
for serious auditing committees to monitor management and provide proper financial reporting. Some
observations about the poor performance of several banks in Ghana of late are that the banks have weak capacity
to perform crucial financial reporting systems due to poor auditing. Glover-Akpey (2016) observed that fraudulent
financial reporting has increased among the banking institutions in Ghana and this has made stakeholders at all
level to become astounded.
It is believed that fraudulent financial reporting could be corrected or minimized by employing an effective
audit committee (Rustam & Zaman, 2013). This is because it is in the best interests of audit committee activities
to exercise influence over the financial resources available to the internal audit function.
Also, it is widely argued that the quality of the audit committee characteristics determines the effectiveness
of the audit committee which in turn positively impact the performance of the organization (Carcello & Neal, 2000;
Abbott et al., 2003; Rustam & Zaman, 2013). Thus, this study seeks to assess the impact of audit committee
characteristics on the performance of listed banks on the Ghana Stock Exchange (GSE).
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& Metrick, 2003), the evidence of a positive association between corporate governance and firm performance may
have little to do with the agency explanation. Whilst some studies (Weisback, 1988; Rosenstein & Wyatt, 1997;
Mehran, 1995; and John & Senbet, 1998) find better performance for firms with boards of directors dominated by
outsiders, other studies (Weir & Liang, 2001; Pinteris, 2002) find no such relationship in terms of accounting profit
or firm value. Besides, Forsberg, (1989) found no relationship between the proportion of outside directors and
various performance measures.
2.1.3 Resource-Based Theory
Penrose (1959) provides theoretical basis of the resource-based theory where the organization was seen as
managerial firm and the gathering of internal resources that have significant effects on the firm’s strategies,
efficiency and performance. The theory is an economic model that are adopted and used by organization to decide
the available strategic resources in the organization. The focus of the theory is the basis for competitive advantage
of the organization which lies mainly in the application of the packaged resources at the disposal of the firm.
Therefore, in order to transform a short-run competitive advantage into a sustained competitive advantage, there
is the need to have heterogeneous resources which are not completely mobile (Preuss, 2013). In a more efficient
manner, this converts into priceless resources that are neither absolutely imitable nor substitutable without great
effort (Preuss, 2013).
The theory focused on some key important areas namely firm attributes and information, assets abilities of
the firm and the acquisition of knowledge by employees and management. These identified valuable resources are
managed by the organization which help them to implement strategies or measures that enhances efficiency and
effectiveness (Miles, 2010). The resource-based theory explains that the valuable resources acquired by the firm
lead to a competitive advantage. This means that the valuable resources are completely controlled by the
organization to improve its contribution to achieving competitive advantage in its industrial context (Hoffman and
Sandelands, 2005). Islam and Siwar (2013) mentioned that the environmental situation of a firm can influence the
sustainable competitive advantage of the firm. They argued that organizations that manage the environmental
factors can generate more sustainable competitive advantage towards employee efficiency (Li and Geiser, 2009).
According to Hindle (2005) a competitive advantage changes into assets in conditions that an organization is
able to apply resources in the competitive environment. This indicates that organizations are to examine their
internally resources using conditions such as scarcity, imitability and value (Koszewska, 2004). The condition of
value explains the opportunities available for the firm to exploit to improve performance. The scarcity of rarity is
the resources managed by the organization’s competitors. The imitability condition is where the organization
acquires few resources and is likely to lose cost advantages compared to other competitors (Hindle, 2005).
2.1.4 Institutional Theory
Institutional Theory provides a theoretical lens through which researchers can identify and examine influences that
promote survival and legitimacy of organizational practices (Glover, 2014). The factors include culture, social
environment, the legal environment, tradition and history, and economic incentives, whilst acknowledging that
resources are also important (Baumol, 2009).
The theory emphasizes on legitimacy which indicates that the adoption of sustainable practices be seen by
stakeholders as being proper and appropriate (Brunton, 2010). Institutional Theory is traditionally concerned with
how groups and organizations better secure their positions and legitimacy by conforming to the rules (such as
regulatory structures, governmental agencies, laws, courts, professions, and scripts and other societal and cultural
practices that exert conformance pressures) and norms of the institutional environment (Scott, 2007). Therefore,
institutions can define what is appropriate or legitimate and thus render other actions unacceptable or even beyond
consideration (Tate et al., 2010). This will then affect how organizations make decisions.
Institutional Theory can be used to explain how changes in social values, technological advancements, and
regulations affect decisions regarding sustainable activities and environmental management (Ball, 2010). It
explains how different organizational strategies lead to the adoption of environmental management practices (Tate
et al., 2010). It is this that can provide insights into the role of different actors towards audit committee program
and their role in the achieving conformity. Hence, the institutional perspective allows for the focus on the role of
conformity, regulatory and social pressures in driving organizational actions (Glover, 2014). This theory can be
used to explain how changes in social values, technological advancements, and regulations affect decisions
regarding sustainable activities (Ball, 2010).
2.1.5 Systems Theory
Systems theory views organization as complex set of dynamically intertwined and interconnected elements,
including its inputs, process, outputs, feedback loops and the environment which it operates. Brammer and Walker
(2007) mentioned organization act as systems interacting with their environment, any equilibrium is constantly
changing as the organization adapts to its changing environment. Systems theory describes the interrelatedness of
all parts of an organization and how one change in one area can affect multiple other parts (Li and Geiser, 2009).
Organizations are viewed as open systems, continually interacting with their environment. They are in a state
of dynamic equilibrium as they adapt to environmental changes. The foundation of systems theory is that all the
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components of an organization are interrelated, and that changing one variable might impact many others (Maignan,
2012). According to Lozano and Valles (2013) system theory views organizational structure as the established
pattern of relationships among the parts of the organization, of particular importance are the patterns in
relationships and duties. These include themes; of integration (the way activities are coordinated), differentiation
(the way tasks are divided), the structure of the hierarchical relationships (authority systems), and the formalized
policies, procedures, and controls that guide the organization (administrative systems) (Maignan, 2012).
The relationship between an organization and its environment is characterized by a two-way flow of
information and energy (Marron, 2013). Most organizations attempt to influence their environment. Menon (2013)
expressed that the relationship between the environment and organizational structure is especially important.
Organizations are open systems and depend on their environment for support. Kumar (2012) stated that senior
management support plays a pivotal role in the institutionalization of responsible behavior. This theory provides
the basis for the role of changes in organizational structure in the implementation of audit committee programs
which is associated with audit fees.
2.1.6 Transaction Cost Economics Theory
The Transaction Cost Theory had its origin in the institutional economics, formulated by Coase (1937) to explain
three areas of transaction costs. These costs include the cost of using the price mechanism, the costs involved in
bargaining and finishing a detach for each swap over contract that happens in the market and the costs of unveiling
the applicable prices. Williamson (1985) expanded the original transaction cost economies theory by Coase (1937)
and identified two types of costs namely direct and secondary costs. On one hand, the secondary costs are linked
to the cost of spending from the decisions and regulations of the government of a nation. On the other hand, the
direct costs are the expenditures from management relations. Williamson (1985) further identified five transaction
costs which include monitoring cost, cost of enforcement, and cost of negotiation, cost of searching or research
and contracting costs.
Further, the transaction Cost Economics Theory portrays the situation for an organization to control an
economic exchange both internally and externally with the motive of improving efficiency and performance
(Williamson, 2008). In transaction cost economics, the aim of the organization is to reduce the total costs of
production and transaction. It answers queries about why the organization operates or exists in the first place? It
also answers the questions on how do organizations define their boundaries and how they decided to govern their
operations (Kumar, 2012; Williamson, 2008).
Brammer and Walker (2007) explained that transaction costs are useful for analyzing issues that involve
selecting the best out of the many that could improve the efficiency and performance of the business. This is
because the cost component of the decisions or strategies to be carried out by the firm has to be discussed before
conclusion can be made (Brammer and Walker, 2007). According to Tate et al. (2011) the transaction cost can be
understood when related to the competitive bidding process which determines effective means of determining the
lowest cost of taking decisions on who should be chosen to perform audit of firms. In the decision process and
from the basic economic model, the higher the costs involved in the transaction or business the less it is likely for
the organization to make a final conclusion (Tate et al. 2011).
2.1.7 Relevance of the Theories to the Study
From the above theories, it can be understood that firms listed on the Ghana Stock Exchange (GSE) is to provide
financial and non-financial services to the public and also earn enough to make them financially sustainable. The
performance of the firms however depends on how successful management is in adapting to the changing
circumstances. The ability to quickly and properly react to changes in the business environment characterize the
quality of the company’s management. The maximization of firm’s wealth is influenced by two main factors
namely, internal and external factors. The external factors are the external influences that are beyond the control
of management in the institution. The internal factors emanate from inside the institution and encapsulate the
ability of management to develop and implement planning strategies that fit the business to the environment
(Channar et al., 2015). The agency theory is relevant to this study because audit committee is one of the many
mechanisms used internally by firms to improve its performance. It helps to examine the interactions between the
administrators and workers to ensure effective implementation of audit committee programs that would benefit
the institution.
The agency theory, system theory, institutional theory, resource-based theory and transaction theory
presented above refer to how researchers develop thoughts to answer a question. The thought are clustered into
themes that frame the subject of discussion (Telewa, 2014) such as audit committee programs in relation to firm’s
performance. This study investigates the effects of audit committee and audit fees on the performance of banks
and non-banking institutions in Ghana which can be understood by the institutional, resource-based, systems and
transaction cost economics theories which are also linked to the research objectives indicated in chapter one of
this study.
The resource-based theory basically explains the available resources used by an organization to improve their
effectiveness and efficiency (Miles, 2010). The ability of management of the banking and non-banking institutions
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to implement effective audit committee depends on the available resources. This is as a result of the fact that audit
committee attracts audit fees for auditors. The institutional theory explains the theoretical lens through which
academicians or researchers can identify and assess influences that inhibit or promote the efficiency and survival
of organizations (Gatari, 2014). The institutional structure has influence of the ability of the firm to conduct
frequent audit committees. In relation to this Hay et al., (2008) and Vafeas and Waeglein (2007) mentioned that
the effect of audit fees and audit committee on performance depends on total assets (firm size) of the business, age
of the firm, profitability and other features of audited entity which can be classified as institutional structure. The
system theory gives an overview of the interrelatedness of all the components of an organization and how changes
in one component influence others towards achieving efficiency (Li and Geiser, 2009). To achieve efficient audit
committee in a firm it requires coordination among members of the committee.
The transaction cost economies theory provides the basis for understanding the relationship between audit
committee and firm performance. The theory provides a diagnostic structure for organizations to understand
conditions where audit committee can generate benefits for a firm. The transaction cost economics theory explains
measures to be taken by organizations to reduce audit fees or costs associated to the activities of the audit
committees. From the theories indicated above, it can be deduced that an institution is influenced by many diverse
factors that determine its capacity to conduct effective and frequent audit committee activities.
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problems which affect board decisions. This is due to the fact that more members in the committee indicate
different expertise and knowledge and thus improving their audit performance and performance of the company
as well. On the contrary, Karamanou and Vafeas (2005) argued that the larger the size of audit committee the more
could face challenges regarding process losses and diffusion of responsibility. The literature provides mixed and
inconclusive results on the relationship between audit committee variables and firm’s performance.
The audit experience is also an important component of audit committee characteristics. Most available firms
have interests in appointing at least an accounting and financial professional to form part of the audit committee
membership. It is evidenced in literature that professionals or experts’ representation in audit committee
memberships improves effectiveness of their work (Soliman and Ragab (2014; Abbott et al., 2004; Xie et al.,
2003).
Further studies such as DeFond et al. (2005) have provided evidence that markets react positively to the
appointment of people who have financial and accounting skills to form part of audit committees. Madawaki and
Amran (2013) added that experts on audit committees improve financial reporting quality and thus improving
financial performance of a company. Nevertheless, Yang and Krishnan (2005) and Lin et al. (2006) had different
views on audit committee experts and financial performance. According to the authors there are no relationship
between audit committee experts and financial performance. Notwithstanding this, it is obvious to believe that
audit committees with professionals or experts are capable of discussing and resolving important business issues
in a more efficient and effective manner. They are also more likely to appoint independent and high-quality
external auditor, which can generally improve audit quality.
Kikhia (2014) mentioned that audit committee with majority of outside directors provides an effective
supervision. This is in turn, minimizes the internal control risk. According to Klein (2002) audit committee
members should consist of independent officers so as to become effective. This is because independent audit
committee helps to improve transparency of the company. It also reduces the possibility of earning management.
Stanley (2011) added that composition of audit committee should make up of non-executive officers of which
majority of them would be independent. Literature indicates that firms with fewer independent members on the
audit committee experience fraud (Hat et al. 2006; Sottani, 2007; Baxter and Cotter, 2009).
In the view of Carcello and Neal (2000), a negative relationship exists between non-independent directors
that form the audit committee and the number of times of audit meetings. In spite of this contradictory argument,
it is noted that the independency of audit committee affect the extent of monitoring or supervision. This is due to
the fact that the directors make objective decisions and demand less discussion therefore, the need for fewer
meetings. Ismail et al. (2008) shared their views that audit committee independency do not affect the quality of
reporting of firms because the company only fulfill its requirements.
The Blue Ribbon Committee (1999) report emphasized that independent audit committee monitors the
financial reporting system in a more effective and efficient manner which therefore reduces the emergence of
financial reporting challenges. In other words, to independent audit committee strengthens internal control systems
of a firm. This is because audit committee enhances objectivity and protects the consistency of accounting process.
In fact, audit committee independence has resulted to the minimization of intrinsic and control risks which lead to
less practical challenging (Ismail et al. 2008). Consistent with the agency theory, it can be argued that audit
committee independent encourages owners to supervise activities of managements and reduces the gains of
preserved information. Supervision or monitoring activity becomes very effective in the presence of an
independent audit committee. The reason is that an effective audit committee with independent officers’ preserves
the right and privileges of all stakeholders of the firm (Stanley, 2011).
2.4.3 Audit committee size and performance
Several studies indicate that there the size of an audit committee has impact on its effectiveness and thus the
performance of the organization (Dellaportas et al., 2012; Herdjiono & Sari, 2017). In the view of several
management experts, for effectiveness in controlling and monitoring managers’ behaviour, the audit committee
must have enough members to carry out its responsibilities (Vicknair et al., 1993), with sufficient resources
(Kalbers & Fogarty 1993). However, the results from earlier studies on the relationship between audit committee
size and company performance are not conclusive.
Pucheta‐Martínez & De Fuentes (2007) found that audit committee size affected the probability of companies
receiving audit reports containing errors or non-compliant qualifications. Dalton et al. (1999) reported that audit
committees become ineffective if they are either too small or too large. According to theme, an audit committee
with many members tends to lose focus and become less participative than those of smaller size. On the other hand,
an audit committee with a small number of members lacks diversity of skills and knowledge, and hence becomes
ineffective. This means that, an audit committee of the right size would allow members to use their experience and
expertise in the best interests of stakeholders.
Research by Menon & Williams (1994) found a weak association between the size of the audit committee
and organizational performance. However, Aldamen et al. (2012) concluded that smaller committees with more
experience and financial expertise were positively and significantly associated with performance in the market.
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Similarly, Al-Matari (2013) found that audit committee size had a significant and positive relationship on the
performance of the company he studied. This positive relationship is supported by resource dependence theory
(Pearce & Zahra 1992; Aldamen et al. 2012). According to this theory, the effectiveness of an audit committee
increases when the size of the committee increases, because it has more resources with which to address the issues
faced by the company. Thus, based on the dependence theory perspective, the following hypothesis is developed:
H1: There is a positive relationship between size of an audit committee and organizational performance.
2.4.4 Independence of the audit committee and performance
To ensure effectiveness of the audit committee, it is required that the committee be independent of top management
or the executive board of the organization (Jun-Lin et al., 2008). Although the findings of previous studies on this
association are inconclusive, an independent audit committee does act better than a less independent committee,
since the former is more likely to provide better monitoring through its ability to resist pressure from managers
(Al-Matari 2013; Kallamu & Saat 2015). It is argued that the independence of the audit committee from managers
allows the committee to take an independent view of the financial reporting process of the company and ensure
that the committee is not dominated by managers, leading to a higher audit quality (Peasnell et al., 2005; Kallamu
& Saat 2015). Audit committees chaired by independent directors are positively linked with high-quality financial
reporting and a lower occurrence of fraudulent reporting (Akhigbe & Martin, 2006; Nekhili et al., 2016). However,
the independence of the audit committee chair may be of no use in enhancing the monitoring of management where
the CEO is involved in the selection of directors (Carcello et al. 2011).
The independence of audit committee increases its strength, and reduces the agency problem and the
opportunity for expropriation by insiders (Yeh et al., 2011). Independence makes the committee more objective in
monitoring the transparency of financial reporting; a committee unbiased toward the executive thereby reduces
the agency problem between executives and other shareholders. Chan & Li (2008) found a positive relationship
between the independence of the audit committee and organizational performance. Similarly, Kallamu & Saat
(2015) and Naimah (2017) found a positive association between independent audit committee members and
profitability a proxy for organizational performance. Therefore, it is hypothesized that:
H2: There is a positive relationship between an independent audit committee and organizational performance.
2.4.5 Expertise and experience of audit committee members and performance
The expertise (knowledge) and experience of audit committee members is an important feature that ensures the
effectiveness of and audit committee. Several studies argue that audit committee members’ knowledge or
experience is directly associated with the committee’s effectiveness (McDaniel et al., 2002; Bedard et al., 2004).
Jun-Lin et al. (2008) argued that the audit committee’s main task is to supervise corporate financial reporting
and auditing processes, therefore, its members should have the capability to understand the issues being examined
or discussed. DeFond et al. (2005) and Aldamen et al. (2012) indicated that an audit committee composed of
directors with prior executive experience or financial knowledge is positively associated with company
performance. The industry experience of directors may be more beneficial to a small company in its early stage of
development, since the directors could serve as a management resource by providing a link to outside resources,
such as contracts and connections. On the other hand, an established company in the declining stage of its
development and with dispersed shareholders may benefit more from directors with technical or financial expertise
who will concentrate on monitoring the company (Carcello and Neal 2003). Hamid & Aziz (2012) suggested that
there is a positive and significant impact on organizational performance when the audit committee has directors
with accounting and financial backgrounds. Therefore, it is hypothesized that:
H3: There is a positive relationship between audit committee members’ knowledge and experience and
organizational performance.
2.4.6 Gender Diversity of Audit Committee and Performance
It is argued that females have different perspectives and demand different information from men. Thus, it is
claimed that gender is likely to have effect on organizational decisions (e.g. Peni & Vähämaa, 2010; Hameed &
Counsell, 2012; Alqatamin et al., 2017).
Feminist economists argue that women are more inclined to be neutral in moral judgements and behaviour
than are men (Nelson 2012). Carter et al. (2003) reported that a significant relationship exists between the
proportion of women on a board and the firm’s performance. Erhardt et al. (2003) examined the relationship
between gender diversity on the board and a company’s financial performance among US companies. Their results
indicate that the percentage of women on the boards of directors is positively associated with the firm’s financial
performance. Likewise, Campbell & Mínguez-Vera (2008) investigating the effect of gender diversity on the
boards of directors on firm financial performance, found a positive relationship. Miller & del Carmen Triana (2009)
examined the relationship between board diversity and company’s performance. Their findings revealed that board
diversity leads to enhanced organizational performance.
Similarly, Lückerath-Rovers (2013) found that the percentage of women on the board is positively and
significantly related to company performance of Dutch companies. Lückerath-Rovers (2013) confirmed that firms
with women directors performed better than those without women on their boards. However, Rose (2007) and
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Carter et al. (2010) found no relationship between the proportion of females on the board and company
performance among Danish and US companies. Therefore, it is hypothesized that:
H4: There is a positive relationship between gender diversity on the audit committee and organizational
performance.
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5.1 Conclusion
The function and activities of the audit committee are crucial to the success of any organization anywhere. These
effects can be seen the financial performance of these banks over the period and trickles down to the overall
performance of the banking sector. A weak independence of the audit committee has serious implications for the
financial performance of the banks. These results are not limited to the banking sector alone but they can be
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extended to other companies and the economy as a whole. From the findings of the study, one can conclude that
audit size and the expertise and experience of members of a banks audit committee can positively influence the
performance of banks listed on the Ghana Stock Exchange
5.2 Recommendations
Based on the findings of the study, recommended that management of banks should ensure that the best corporate
governance practices, with respect to audit, must be adhered to.
Policy makers and regulators of financial institutions should also ensure that management of the banks are
supervised and regulated to implement quality metrics as this would enhance the performance of the banks.
Unlisted banks and other corporate originations should be included in further studies so that that the findings
can be generalized for all companies that have audit.
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