International Journal of Auditing

doi:10.1111/j.1099-1123.2011.00429.x

Int. J. Audit. 15: 191203 (2011)

The Determinants of Audit

Committee Independence and
Activity: Evidence from the UK

ija_429

191..203

Basil Al-Najjar
Middlesex University Business School

We investigate the determinants of audit committee

independence and activity in UK firms. We employ panel data
analysis for non-financial films that provide the required
information for the period from 2003 to 2008. Our findings
show that audit committees are more independent when firms
have large boards and more insider ownership. In addition,
we detect that large firms place less demand on audit
independence. This study also provides new evidence that
firms with more free cash flows require more audit
independence. Finally, firms with large audit committees and
large boards that meet more frequently are active and demand
more audit committee meetings.
Key words: Agency
governance

SUMMARY
This paper investigates the determinants of audit
committee independence and activity. The research
sample is composed of the 100 largest UK firms
based on their market capitalization, from which
around 70 firms provide the required information
for the analysis for the period from 2003 to 2008.
The results provide evidence that audit committees
are more independent when firms have large
boards and more insider ownership. The study
could not find any supporting evidence for the
effect of non-executive directors and CEO duality
on audit committee independence. Regarding the
financial factors, we observe a negative relationship
Correspondence to: Basil Al-Najjar, Senior Lecturer in Finance,
Middlesex University Business School, Middlesex University,
London NW4 4BT, UK. Email: b.al-najjar@mdx.ac.uk

ISSN 1090-6738
2011 Blackwell Publishing Ltd

theory,

audit

committee,

corporate

between firm size and audit composition,

suggesting that large firms are more advanced in
monitoring and place less demand on audit
independence. In addition, levered firms require
less audit independence as debt providers will be
active in monitoring the firm. We also find
evidence that firms with more free cash flows
require more audit independence. This suggests
that free cash flows can be used as an indicator
ability of managers to utilize private benefits.
Finally, we show the consequence of corporate
governance internal monitoring. Firms with large
audit committees and large boards that meet more
frequently are more active and demand more audit
committee meetings. The paucity of the UK
literature on audit committee independence and
activity motivates this study and reinforces the
empirical importance of the results for managers
and UK policy makers.

192

1. INTRODUCTION
This paper investigates the determinants of audit
committee independence and activity in the UK.
Audit committees are tasked with monitoring
financial reports, and they provide a connection
between firms management and auditors (see, for
example, Carcello et al., 2002a; Ruiz-Barbadillo
et al., 2007). The audit committee can be defined as
a subgroup delegated by the board to ensure the
validity of the accounting information issued by
the internal auditors (Mendez & Garcia, 2007). The
dominant role for audit committees is, therefore, to
act as an internal control mechanism to effectively
monitor the audit processes. This suggests that
audit committees can alleviate agency problems by
reducing the information asymmetry between
insiders and outsiders (Klein, 1998). It is argued
that the benefits in employing audit committees
can be deduced from their characteristics, which
include the independence of the audit committee
(Ruiz-Barbadillo et al., 2007; Turley & Zaman,
2007). This argument highlights the importance
of investigating the determinants of audit
independence. Ruiz-Barbadillo et al. (2007) even
suggest that audit committees without nonexecutive directors1 can hinder good corporate
governance.
Research in the area of the independence of
audit committee indicates the importance of
non-executive directors on the audit committee.
For example, Abbott et al. (2000) investigate the
effect of audit committee independence in
mitigating financial fraud. They argue that firms
with non-executive directors in audit committees
are less likely to have fraudulent financial
reporting. On the same note, Klein (1998)
investigates the economic determinants of audit
composition and argues that firms with strong
CEOs employ more inside directors in the audit
committee compared to firms with weak CEOs.
There are contradictory arguments as regards
the role of audit committees in earnings
management. Beasley (1996) argues that the
presence of an audit committee does not
necessarily reduce the probability of financial
fraud. In the same vein, Spira (1999) finds
evidence that audit committees are not
significantly improving financial reporting,
whereas Dechow et al. (1996) provide evidence
that audit committees are important in monitoring
management. This importance is supported
further by DeFond and Jiambalvo (1991) who
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B. Al-Najjar

report that the possibility for overstating earnings

is less likely in the presence of audit committees.
Klein (2002) also detects an inverse relationship
between the independence of audit committees
and discretionary reporting.
The paucity of the UK literature concerning audit
committee independence and activity motivates
this study and reinforces the empirical importance
of the determinants of audit independence and
activity to managers and UK policy makers. This
study extends the empirical evidence of audit
independence by examining different attributes
that the previous literature has not explored,
including the importance of free cash flows and
Tobins Q as indexes for growth and managers
private benefits, and hence examines in greater
intensity the agency aspect of corporate
governance. In addition, there is limited evidence
in the audit literature as regards the importance of
insider ownership on the internal control decision.
This study therefore examines the impact of insider
ownership on the composition of audit committees.
Furthermore, we provide evidence of audit
committee activity using updated panel data from
around 70 UK firms selected from 100 large firms,
based on their market capitalization, for the period
from 2003 to 2008.
The current study posits that the independence
of audit committees is a function of firm-specific
factors, including financial performance, size,
leverage, free cash flows and growth opportunities.
In addition to firm factors, audit composition is
also related to audit size, board structure, board
size and insider ownership. The study argues
that firms with lower performance and lower
leverage will employ non-executive directors on
the audit committee. In addition, firms with
more non-executive directors, large boards and
more insider ownership will have more audit
independence. Finally, the study argues that free
cash flows and firm size can affect the composition
of audit committees.
With regard to audit committee activity, we
posit that audit committee activity is affected
by different firms characteristics (financial
performance, size, leverage, free cash flows and
growth opportunities). In addition to these firm
specifications, it is also associated with audit size
and independence, board structure, board
meetings and board size.
The results of this study show the importance
of internal corporate governance control systems
on the independence of the audit committee. We
Int. J. Audit. 15: 191203 (2011)

The Determinants of Audit Committee Independence and Activity

detect a positive association between the

independence of audit committee and board size.
This indicates that large boards provide better
monitoring resources (Raghunandan & Rama,
2007), and as a result more non-executive directors
are employed in the audit committee (Klein, 2002).
In addition, the independence of audit improves
with higher insider ownership. This finding
indicates that insider ownership can be viewed as
a good internal governance tool and, in turn,
improves audit committee independence. These
results suggest that the roles of internal governance
mechanisms can be viewed as complements not
substitutes. Furthermore, the results provide
evidence that large firms have stronger internal
control mechanisms, and, as a result, fewer
alternative monitoring tools are required (OReilly
et al., 1998; Klein, 2002). Additionally, debt position
of the firm is inversely related to the proportion of
non-executive directors on the audit committee,
due to the key fact that debt suppliers will act as an
active monitoring tool, placing less demand on the
alternative mechanisms (Raghunandan & Rama,
2007). Finally, the findings provide evidence that
free cash flows can be seen as an indicator for
managers private benefits, suggesting that high
free cash flows lead to more audit independence
(Boone et al., 2007). Our results are consistent as we
control for endogeneity. Further, this study offers
evidence of the importance of audit committees as
internal control tools.
The results also highlight the importance of
internal corporate governance in audit meeting
decisions. We observe a positive relationship
between the frequency of audit meetings and audit
size, board size and board meetings. Large boards
and audits, in turn, provide better monitoring
resources (Raghunandan & Rama, 2007). In
addition, the results extend the evidence that large
firms are more complex and require more audit
meetings.
The rest of the paper is organized as follows.
Section 2 discusses the background and the
literature, while Section 3 presents the data and
methodology. In Section 4, the results are
discussed. Section 5 discusses audit committee
activity and, finally, Section 6 concludes and
summarizes this study.

2. LITERATURE AND BACKGROUND

In this part of the study, a discussion of the related
literature is provided to explain the rationale
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193

behind developing the econometrics model used

by this study. There is a lack of empirical studies
investigating audit committees in the UK in
general, and more specifically the independence of
audit committees. Following the recommendations
of the Cadbury Committee (1992), there has been
pressure on UK firms to form audit committees,
and Collier (1997) found that around 84 per cent
of UK listed firms formed an audit committee.
Collier (1993) examined 142 UK listed firms and
reported that there is a positive relationship
between non-executive directors and the
voluntary formation of audit committees. Collier
and Gregory (1999) investigated audit committee
activity for UK firms and found that the audit
committee should be composed of non-executive
directors to follow the recommendations of the
Cadbury Committee. Collier and Gregory (1996)
provide evidence that the audit committee is
effective in controlling the external audit but there
is no evidence that audit committees are active in
minimizing audit fees. Turley and Zaman (2007)
investigate the efficacy of the audit committee in
the UK and argue that audit committees only
moderately affect internal control, as they find
limited evidence that audit committees discuss or
challenge the reports from the audit. These results
motivate this study to empirically investigate
the importance of audit committees as a
control mechanism in the UK. Regarding the
independence of audit committees, Carcello and
Neal (2000) and Klein (2002) argue that audit
committees may perform insufficiently if there is
no audit independence, due to the fact that such
committees will not effectively question the
outcome of the audit. As argued by McMullen and
Raghunandan (1996), non-executive directors on
the board are involved in evaluating objectively the
control and the practices of the management. The
independence of audit committees has received
much attention from researchers, such as Klein
(1998, 2002), Deli and Gillan (2000), Beasley and
Salterio (2001), Cotter and Silvester (2003), Piot
(2004) and Ruiz-Barbadillo et al. (2007), who
investigate the determinants of audit committee
independence. They detect that the independence
of the audit committee differs across firms. Given
this result and the fact that none of these studies
investigate such evidence using UK firms, we
argue that it is important to provide further
evidence about the independence of audit
committees using UK non-financial firms. Prior
research concerning audit committees argues that
Int. J. Audit. 15: 191203 (2011)

194

agency theory can explain the effectiveness of

audit committees to mitigate agency problems
(Raghunandan & Rama, 2007; Sharma et al., 2009).
We investigate four categories of variables that
affect audit committee diligence: firm-specific
factors, the audit committee, board structure and
insider ownership.

2.1 Firm-specific factors

Empirical studies provide evidence that firmspecific factors are important determinants of audit
committee independence. Ruiz-Barbadillo et al.
(2007), Klein (2002) and Piot (2004) report the
importance of firm size as a determinant of audit
independence. It is argued that large firms adopt
more strict monitoring mechanisms, suggesting
more demand on audit independence (Klein, 2002).
However, large firms are not in need of alternative
control mechanisms, as these firms provide
more efficient internal controls. This leads to less
demand on audit independence (Klein, 2002;
OReilly et al., 1998). Given that our sample is based
on the 100 largest UK firms, we emphasize the
latter argument and suggest that large UK firms
need fewer alternative control mechanisms.
Therefore, the first hypothesis is:
H1: Audit committee independence is negatively
related to firm size.
In addition, it is argued that creditors require
more audit committee independence as the
demand for monitoring financial reporting
increases. This is because managers tend to
overstate earnings to avoid the violation of debt
contracts (DeFond & Jiambalvo, 1991). In the same
vein, Dechow et al. (1996) detect a direct association
between fraud and debt level, arguing that fraud
is more likely to occur within higher leveraged
firms. Accordingly, such firms tend to improve
their monitoring mechanisms (Menon & Williams,
1994; Deli & Gillan, 2000; Piot, 2004). In contrast to
this argument, there is a view that debt providers
act as an additional important monitoring
mechanism to guarantee that firms do not defy the
loan covenants and, in turn, alleviate agency
conflicts. Hence, firms with high financial leverage
are less demanding on audit control (Shleifer &
Vishny, 1986). Ruiz-Barbadillo et al. (2007) detect a
negative but insignificant relationship between
leverage and audit independence. These mixed
arguments suggest the importance of leverage on
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B. Al-Najjar

the independence of audit committees. Our second

hypothesis therefore is:
H2: Audit committee independence is related to
financial leverage.
Klein (2002) argues that growing firms are
associated
with
great
uncertainties
and
complexities, suggesting that such firms rely more
on inside directors, not non-executive directors.
For this reason, firms with great growth
opportunities
tend
to
have
less
audit
independence. This result is also detected in the
findings of Deli and Gillan (2000). Additionally,
growth opportunities can be seen as an indicator
of fraud (Penman, 1996; Raghunandan & Rama,
2007), thus more internal monitoring is required in
these firms. This study uses market-to-book ratio
to proxy for firms growth opportunities (Deli
& Gillan, 2000; Klein, 2002) as well as Tobins Q
(Guest, 2008). Consequently, we hypothesize that:
H3: Audit committee independence is positively
related to growth opportunities.
The current study investigates the importance of
free cash flows as an index for managers private
benefits (Boone et al., 2007). This aspect has not
been explored in the previous literature. This paper
carries forward the argument of Boone et al. that
net benefits of monitoring improve with the ability
to use private benefits. This suggests that firms
enhance their internal quality control when private
benefits are high and, in turn, show more demand
for the independence of audit committees, which is
consistent with Jensen (1986) who highlights the
importance of reducing free cash flows to mitigate
agency conflicts. As a result, free cash flows can
increase agency problems (Shleifer & Vishny,
1986), thus requiring more internal control. Our
hypothesis regarding free cash flows is:
H4: Audit committee independence is positively
related to free cash flows.
Finally, it is argued that financial statements are
less value relevant if firms experience repeated
losses (e.g. Collins et al., 1999). Klein (2002) argues
that firms with repeated losses have less demand for
challenging the reporting system, and are
less likely to have non-executive directors on the
audit committee. Ruiz-Barbadillo et al. (2007) adopt
this argument in their study and report no
significant relationship between losses and audit
independence. Subsequently, the fifth hypothesis is:
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The Determinants of Audit Committee Independence and Activity

H5: Audit committee independence is negatively

related to losses.

2.2 Audit committee

The study also examines the importance of audit
committee size on the independence of audit
committees. Raghunandan and Rama (2007)
suggest that members of the audit committee take
costly investment decisions to be seen as an active
internal monitoring device for firms performance,
thus are prone to costly consequences if financial
statements are not that accurate. This entails that
large audit committees provide better resources to
improve the quality of financial reporting. Large
audit committees also require more discussion and,
indeed, more demand is placed on the presence of
non-executive directors on the audit committee.
Subsequently, we adopt the following hypothesis:
H6: Audit committee independence is positively
related to audit committee size.

2.3 Board structure and size

Klein (2002) argues that the composition of audit
committees is affected by the boards structure, as
audit committees are subsets of the boards. The
board must have a sufficient size to enjoy the
benefits of a diversity of skills and backgrounds,
and should be under the control of the chairman. It
is argued that the larger the board size, the lower
the efficacy in the discussions between board
members, and the greater the free-rider problem is
(Goodstein et al., 1994). Similarly, Ruiz-Barbadillo
et al. (2007) argue that large boards tend to have less
audit independence, since boards are more easily
controlled. In contrast to this, large boards offer
better monitoring resources and are more efficient
in internal monitoring (Sharma et al., 2009). On the
same note, Klein (2002) argues that large boards
tend to employ more non-executive directors in
the audit committee. Consequently, the seventh
hypothesis is:
H7: Audit committee independence is positively
related to board size.
Non-executive directors are considered as a key
monitoring tool and these directors improve the
monitoring resources for financial reporting
(Beasley, 1996; Dechow et al., 1996; Sharma et al.,
2009). Similarly, Klein (2002) argues that the greater
the number of non-executive directors, the higher
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195

the chances of having more audit committee

independence, and hypothesizes a positive
relationship between non-executive directors and
audit composition. Deli and Gillan (2000) and
Menon and Williams (1994) follow the same
argument. Raghunandan and Rama (2007) argue
that non-executive directors are important in
reflecting
efficient
corporate
governance.
Accordingly, this study adopts this argument and
states the following hypothesis:
H8: Audit committee independence is positively
related to non-executive directors.
For robustness of results, the study examines the
impact of CEO duality (a dummy variable taking
the value of 1 if the CEO is a board member
and 0 otherwise). We stress the argument of
Ruiz-Barbadillo et al. (2007) that, if the CEO is a
member of the board, then management will have
less motivation to improve the control mechanisms,
including employing non-executive directors in
the audit committee, since the boards control will
be inefficient. Hence, we expect a negative
relationship between CEO duality and the
independence of the audit committee.

2.4 Insider ownership

It is argued that insider ownership can be viewed as
a dominant monitoring role. Al-Najjar and
Hussainey (2009) argue that the presence of insider
ownership can alleviate agency conflicts. The issue
of insider ownership is under-researched in the
audit committee independence literature. Klein
(1998) detects a negative relationship with
institutional holdings and argues that outside
shareholders in audit committees are more active
and reveal inefficient earnings management. We
argue that insider ownership is an important
monitoring tool and the presence of such holders
improves the monitoring resources and provides
better control. Hence, insider ownership will place
more demand for better internal control and, as a
result, more audit committee independence. Hence,
the study proposes the following hypothesis:
H9: Audit committee independence is positively
related to insider ownership.

3. DATA AND METHODOLOGY

According to The Combined Code on Corporate
Governance (2003), UK listed firms are required to
Int. J. Audit. 15: 191203 (2011)

B. Al-Najjar

196

Table 1: Descriptive statistics

Variable

Mean

Std Dev.

25th
percentile

75th
percentile

Audindp
Audsize
Bodsize
Indep
Ins
Bodmeet
Audmeet
Size
Lev
Loss
MB
FCF
TobQ
CEO

0.502
3.8
9.50
0.554
0.269
7.92
4.09
14.05
0.425
0.087
0.982
0.617
1.49
0.118

0.257
0.99
3.26
0.251
0.928
2.34
1.95
1.8
0.983
0.280
44.76
1.167
2.15
0.323

0.314
3
7
0.355
0
6
3
12.93
0.190
0
0.392
0.115
0.267
0

0.718
4
11
0.770
0
9
5
15.23
0.542
0
1.496
0.642
1.34
0

Note: Audindp is the percentage of non-executive directors on the audit committee; Audsize is the number of
members on the audit committee; Bodsize is the number of members on the board of directors; Indep is the
percentage of non-executive directors on the board; Ins is the percentage of insider ownership; Bodmeet is the
number of times the board meets annually; Audmeet is the number of times the audit committee meets annually;
Lev is the total debt to total assets ratio; Loss is a dummy variable that takes the value 1 if the firm has losses at
year t and 0 otherwise; MB is the market-to-book ratio; FCF is the free cash flows per share; TobQ is Tobins Q;
CEO is a dummy variable that takes the value 1 if the CEO is a member of the board and 0 otherwise.

set up audit committees and to disclose their

activities in financial reports. This contains the
information regarding the composition of the audit
committee. Nonetheless, some UK firms started
to disclose such information following the
recommendations of the Blue Ribbon Committee
(1999) and the Sarbanes-Oxley Act (2002). Our
initial sample is composed of the 100 largest UK
firms, based on their market capitalization.
Information on audit composition, board size,
board composition and CEO duality are taken from
the annual reports. The other investigated financial
variables, including insider ownership, are
collected from Datastream. The study excludes
financial firms and firms without information
about the audit committee. The final sample is
composed of around 70 firms for the period from
2003 to 2008. Due to missing information and using
lags as instruments in our models, the number of
observations is dropped to around 203.
Table 1 reveals that on average 50 per cent of the
audit committees are made up of non-executive
directors, thus audit independence is considered as
an important internal mechanism tool for these
firms. Audit committees have an average of four
members, while the board has an average of ten
members. Furthermore, firms rely on debt
2011 Blackwell Publishing Ltd

financing as the average debt level is 42.59 per cent.

There is another good indicator that UK firms are
adopting good corporate governance practices, in
that 55.4 per cent of boards are made up of
non-executive directors (Raghunandan & Rama,
2007). Finally, on average audit committees meet
four times a year, which is in line with the
recommendations of the Smith report (2003) (at
least three meetings for the audit committee). Thus,
we argue that our sample of firms enjoys good
corporate governance.

Model
In this section of the study, we discuss the empirical
analysis of this paper and demonstrate the
econometrics model. In modelling audit committee
independence, the analysis employs pooled
regression models and includes industry and year
dummies to consider the effect of heterogeneity in
the sample, as well as to control for omitted variable
bias in the model. We estimate the following model
using the instrumental variable (IV) method to
capture the endogeneity effect between the audit
committee independence on the one hand, and
audit size, board size, non-executive directors and
Tobins Q, on the other:
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The Determinants of Audit Committee Independence and Activity

197

Table 2: Regression model (audit independence)

Variables

Model 1

Model 2

Model 3

Model 4

Audsize

-0.019
(0.439)
0.012*
(0.088)
-0.120
(0.544)
0.003**
(0.036)
-0.033**
(0.039)
-0.017*
(0.083)
0.017
(0.793)
0.0016
(0.128)
0.0361**
(0.021)
0.002
(0.744)

-0.024
(0.333)
0.013*
(0.072)
-0.114
(0.556)
0.003**
(0.029)
-0.031*
(0.059)
-0.017*
(0.079)
0.023
(0.736)
0.001
(0.128)
0.034**
(0.047)
0.002
(0.761)
0.004
(0.949)
0.905***
(0.001)
0.114
202
yes
yes

-0.26
(0.262)
0.011
(0.129)
-0.97
(0.606)
0.002*
(0.073)
-0.033**
(0.032)
-0.023***
(0.006)
0.030
(0.618)
0.0007
(0.283)
0.031**
(0.034)
0.005
(0.946)

-0.0317
(0.197)
0.011
(0.112)
-0.89
(0.632)
0.002*
(0.061)
-0.318**
(0.046)
-0.023***
(0.005)
0.034
(0.573)
0.0007
(0.289)
0.029*
(0.074)
0.0007
(0.926)
0.003
(0.957)
0.974***
(0.000)
0.086
202
no
no

Bodsize
Indep
Ins
Size
Lev
Loss
MB
FCF
TobQ
CEO
Constant
R2
No. observations
Industry dummy
Year dummy

0.917***
(0.001)
0.110
203
yes
yes

0.990***
(0.000)
0.084
203
no
no

Note: Variables have the same definitions as in Table 1. The instruments for models 14 include one-year lag for
internal control variables and TobQ. ***, **, *significant at 1%, 5% and 10%, respectively. The standard errors are
corrected for heteroscedasticity.

Audindpit = 0 + 1 Audsizeit + 2Bodsizeit +

3 Indepit + 4 Insit + 5Sizeit + 6 Levit +
7 Lossit + 8 MBit + 9 FCFit + 10TobQit +
Ind + year + it
where: Audindp is the percentage of non-executive
directors on the audit committee (Deli & Gillan,
2000); Audsize is the number of members on the
audit committee; Bodsize is the number of members
on the board of directors; Indep is the percentage of
non-executive directors on the board; Ins is the
insider ownership measured by the number of
shares held by insiders over the number of shares
outstanding; Size is firm size measured by total
assets; Lev is the ratio of total debts to total assets;
Loss is a dummy variable that takes the value 1 if the
firm has losses at year t and 0 otherwise; MB is
market-to-book ratio; FCF is free cash flows per
2011 Blackwell Publishing Ltd

share; TobQ is Tobins Q; Ind and year are dummy

variables to capture the industry and year effects;
and eit is an error term.
Finally, the study retests the model to check for
the robustness of the analysis by including CEO
duality effect, CEO, which is a dummy variable that
takes the value 1 if the CEO is a member of the
board and 0 otherwise.

4. RESULTS
Table 2 reports the results for the pooled models, in
which the dependent variable is the percentage of
non-executive directors on the audit committee.
The results indicate a significant negative
relationship between firm size and audit
independence. This finding is in line with the view
that large firms are not in need of alternative
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B. Al-Najjar

198

control mechanisms, since such firms provide more

efficient internal controls (Klein, 2002; OReilly
et al., 1998) and hence we support H1. The negative
significant coefficient of leverage suggests that
debt suppliers act as an important monitoring
mechanism to ensure that firms do not violate their
loan covenants and minimize agency conflicts.
Consequently, firms with high financial leverage
require less audit control (Shleifer & Vishny, 1986).
The result is consistent with Ruiz-Barbadillo et al.
(2007) and supports H2. We also detect a significant
positive relationship between free cash flows and
audit independence. This result is consistent with
the argument of Boone et al. (2007) that free cash
flows can be used as an indicator of the ability of
managers to utilize private benefits. This result
supports H4. Additionally, the results show a
significant positive relationship between board size
and audit committee independence, suggesting
that large boards provide more monitoring
resources and, in turn, higher demand for audit
committee independence. This result is consistent
with Beasley and Salterio (2001) and Klein (2002),
hence supporting H7. Concerning the effect
of insider ownership, we observe a positive
significant relationship between insider ownership
and the independence of the audit committee. This
result suggests that insider ownership can be seen
as a good monitoring tool, and requires stronger
internal control mechanisms to monitor financial
reporting by placing demand on more audit
committee independence; thus we support H9.
With regard to board composition, the results
show a negative but insignificant relationship,
and therefore the study cannot find significant
evidence that non-executive directors affect the
independence of the audit; thus H8 is not accepted.
The study could not find supporting evidence for
the relationship between audit independence and
audit size, financial losses or growth opportunities.
As a result, we cannot accept H3, H5 and H6,
respectively. Finally, we check the robustness by
including CEO duality. The results are almost the
same and indicate that there are good governance
practices in UK, and suggest that better internal
controls place more demand on audit committee
independence. The CEO coefficient is not
statistically significant.
Our results show the importance of corporate
governance internal monitoring mechanisms in
UK firms. Specifically firms with large boards
and insider ownership employ effectively
non-executive directors in audit committees, and
2011 Blackwell Publishing Ltd

hence are more active in monitoring the financial

reporting.

5. ACTIVITY OF THE AUDIT

COMMITTEE
It is worth noting that the literature on audit
committees has a major limitation in how to define
the concept of effectiveness of the audit committee
(for more discussion, see Cameron, 1981; Lewis &
Minton, 1986; Collier & Gregory, 1996). In this
section, we aim to reinvestigate the activity of the
audit committee within the UK context. We follow
the study by Collier and Gregory (1999) and define
audit committee activity using the number of
annual meetings (Menon & Williams, 1994). The
study adds audit independence (Audindp) and
board meetings (Bodmeet) to the model; this is due
to the important fact that most sub-committee
meetings are held before or after the board meetings
(Sharma et al., 2009). The estimated model is:

Audmeetit = 0 + 1 Audindp + 2 Audsizeit +

3Bodsizeit + 4 Indepit + 5Bodmeetit +
6Sizeit + 7 Levit + 8 Lossit + 9 MBit +
10 FCFit + 11TobQit + it
We posit that the activity of the audit committee is
a function of different firms characteristics,
including financial performance, size, leverage,
free cash flows and growth opportunities. In
addition to firm characteristics, it is also associated
with audit size, board structure, board meetings
and board size. We follow the general hypothesis
that firms with lower performance, more leverage,
large size and more growth will have more
frequent meetings. Furthermore, firms with more
non-executive directors, large boards and more
members on the audit committee will demand
more audit committee meetings. Finally, free cash
flows (as an agency conflict indicator) can affect the
frequency of audit meetings. In so doing, we adopt
the agency costs hypotheses developed by Menon
and Williams (1994) and adopted by Collier and
Gregory (1999), in which they hypothesized that
audit activity increases with leverage, firm size,
non-executive directors, board size and the
dominance of the CEO (for further discussion, see
Menon & Williams, 1994, pp. 1258; Collier &
Gregory, 1999, pp. 31516).
Table 3 presents the results for the audit activity,
in which the dependent variable is the number of
Int. J. Audit. 15: 191203 (2011)

The Determinants of Audit Committee Independence and Activity

199

Table 3: Regression model (audit activity)

Variables

Model 1

Model 2

Model 3

Model 4

Audindp

-0.099
(0.799)
0.277***
(0.007)
0.093**
(0.025)
-0.208
(0.889)
0.0994**
(0.026)
0.256***
(0.003)
-0.010
(0.700)
0.312
(0.315)
-0.002
(0.447)
-0.0.09
(0.347)
0.091*
(0.010)

-0.121
(0.775)
0.308*
(0.003)
0.083**
(0.046)
-0.308
(0.833)
0.1033**
(0.018)
0.208*
(0.007)
-0.004**
(0.867)
0.308
(0.329)
-0002
(0.605)
-0.010
(0.905)
0.080
(0.130)
-0.669
(0.134)
-2.090**
(0.191)
0.460
208
yes
yes

-0.181
(0.668)
0.170*
(0.067)
0.126**
(0.036)
-0.181*
(0.668)
0.114**
(0.012)
0.329***
(0.003)
-0.023
(0.417)
0.096
(0.736)
-0.001
(0.668)
-0.089
(0.410)
0.087*
(0.070)

-0.155
(0.715)
0.188**
(0.049)
0.121**
(0.044)
0.243
(0.887)
0.112**
(0.016)
0.328*
(0.003)
-0.022
(0.432)
0.085
(0.767)
-0.002
(0.651)
-0.086
(0.455)
0.086*
(0.074)
0.004
(0.651)
-3.44
(0.107)
0.292
208
no
no

Audsize
Bodsize
Indep
Bodmeet
Size
Lev
Loss
MB
FCF
TobQ
CEO
Constant
R2
No. observations
Industry dummy
Year dummy

-2.836
(0.122)
0.452
209
yes
yes

-3.386
(0.116)
0.296
209
no
no

Note: Variables have the same definitions as in Table 1. The instruments for models 14 include one-year lag for
internal control variables and TobQ. ***, **, *significant at 1%, 5% and 10%, respectively. The standard errors are
corrected for heteroscedasticity.

audit committee meetings. Our results show a

significant positive relationship between the audit
committee size and audit activity, indicating that
large audit committees provide more monitoring
resources, suggesting higher demand on audit
meetings to discuss and monitor the quality of the
financial reports. This result is consistent with
Defond and Francis (2005), Raghunandan and
Rama (2007) and Sharma et al. (2009). Concerning
the effect of board size on the frequency of
audit meetings, the relationship is positive and
significant. This result suggests that large boards
provide better internal monitoring activities and
require more audit committee meetings. (For
more discussion, see Collier & Gregory, 1999;
Raghunandan & Rama, 2007; and Sharma et al.,
2009.) With regard to board meetings, the results
show a positive relationship, suggesting that board
2011 Blackwell Publishing Ltd

meetings lead to more demand for audit meetings.

The results also report a positive significant
relationship between firm size and audit meetings.
This finding is consistent with the view that large
firms are more complex and have better internal
monitoring control for their financial reports
(Collier & Gregory, 1999; Carcello et al., 2002b;
Raghunandan & Rama, 2007; Sharma et al., 2009).
There is limited evidence of a negative relationship
between audit meetings and leverage. High growth
firms face more agency conflicts, requiring more
internal monitoring, which in turn places
additional demand on audit meetings. Consistent
with this fact, we observe a positive significant
impact of Tobins Q on audit committee meetings
(see, for example, among others, Stice, 1991;
Penman, 1996). The results do not support
the relationship between audit independence,
Int. J. Audit. 15: 191203 (2011)

B. Al-Najjar

200

Table 4: Logit regression model (audit activity more frequent meetings)

Variables
Audindp
Audsize
Bodsize
Indep
Bodmeet
Size
Lev
Loss
MB
FCF
TobQ
CEO
Constant
Pseudo R2
No. observations
Industry dummy
Year dummy

Model 1

Model 2

Model 3

Model 4

-1.025**
(0.049)
0.259
(0.159)
0.109**
(0.051)
-0.042
(0.947)
0.201**
(0.011)
0.2017**
(0.011)
-0.020
(0.821)
0.805
(0.153)
0.0012
(0.739)
0.273
(0.210)
0.131
(0.282)

-1.037**
(0.046)
0.377**
(0.031)
0.103*
(0.073)
0.138
(0.830)
0.211***
(0.008)
0.197
(0.130)
-0.006
(0.942)
0.744
(0.186)
0.001
(0.675)
0.425*
(0.100)
0.115
(0.273)
-1.306*
(0.091)
-7.647***
(0.000)
0.23
264
yes
yes

-1.177**
(0.023)
0.257*
(0.100)
0.101*
(0.071)
-0.254
(0.666)
0.227***
(0.001)
0.287**
(0.014)
0.004
(0.963)
0.677
(0.176)
0.003
(0.346)
0.404*
(0.081)
0.160*
(0.090)

-1.200**
(0.020)
0.332**
(0.037)
0.095*
(0.097)
-0.144
(0.807)
0.234***
(0.001)
0.221*
(0.064)
0.0029
(0.976)
0.653
(0.204)
0.003
(0.312)
0.610**
(0.045)
0.154*
(0.076)
-1.06*
(0.069)
-6.594***
(0.000)
0.197
263
no
no

-8.3220***
(0.000)
0.217
264
yes
yes

-7.230***
(0.000)
0.184
264
no
no

Note: The dependent variable takes the value 1 if the audit meets more frequently (more than three times) as
suggested by the recommendations of the Smith report (2003) and 0 otherwise; independent variables have the
same definitions as in Table 1. ***, **, *significant at 1%, 5% and 10%, respectively. The standard errors are
corrected for heteroscedasticity.

market-to-book ratio, free cash flows and poor

financial performance on audit activity, and report
no significant association between CEO duality and
the frequency of audit meetings.2
Our results show the importance of corporate
governance internal monitoring mechanisms in
UK firms. In particular, firms with large audit
committees and large boards that meet more
frequently are more active in monitoring firms
financial reporting. This suggests more demand for
audit committee meetings.
In order to investigate whether our firms follow
the Combined Code recommendations regarding
audit meetings, the study re-estimated the model of
audit meetings using a logit model with a
dependent variable that takes the value of 1 if the
audit committee meets more than three times a
2011 Blackwell Publishing Ltd

year, which captures the recommendations of the

Smith report (2003), and 0 otherwise. The results of
the logit model, presented in Table 4, are not
substantially different from those reported in
Table 3. In sum, we provide further evidence of a
positive relationship between audit size, board
size, board meetings and firm size with the
likelihood of more frequent meetings. Also, there is
evidence that audit independence increases the
probability of more frequent audit meetings as
well as limited evidence that CEO duality will
negatively impact the probability of audit
committees meeting more than three times a year.
Finally, some evidence is provided for a positive
impact of free cash flows and Tobins Q on the
probability of more frequent audit meetings.
Hence, we argue that our sample of firms enjoy
Int. J. Audit. 15: 191203 (2011)

The Determinants of Audit Committee Independence and Activity

good corporate governance practices for audit

activity and independence.

6. SUMMARY AND CONCLUSIONS

This paper offers the first major evidence
concerning audit committee independence in the
UK. We investigate two groups of factors that
have a significant impact on audit committee
composition: firstly, financial factors, which
include, firm size, leverage, growth opportunities,
firm performance and free cash flows and,
secondly, the internal monitoring mechanisms,
which include, board size, non-executive directors
and insider ownership. In addition, the study
investigates the determinants of audit activity
(meetings). Our sample includes around 70 firms
from the 100 largest UK firms, based on their
market capitalization. The study covers the time
span from 2003 to 2008. This study thus provides
evidence about audit committee independence and
activity from a pooled data perspective. The results
provide evidence that audit committees are more
independent when firms have large boards and
more insider ownership. These findings indicate
that such corporate governance can be seen as an
effective internal monitoring tool, and require
more audit independence. These results are
consistent with prior empirical studies such as
Beasley and Salterio (2001) and Klein (2002). There
is no significant result for the effect of nonexecutive directors and CEO duality on audit
committee independence. Regarding the financial
factors, the present study provides evidence for a
negative relationship between firm size and audit
composition, suggesting that large firms are more
advanced in monitoring and place less demand on
audit independence. Also, more leveraged firms
require less audit independence as debt providers
will be active in monitoring the firm. Additionally,
firms with more free cash flows require more audit
independence. This suggests that free cash flows
can be used as an indicator for managers ability to
utilize private benefits.
Given the paucity of the UK literature regarding
the independence of audit committees, our results
are important for managers and UK policy makers.
The results indicate that board size and insider
ownership are dominant factors in reflecting good
internal control practices and, in turn, improve the
quality of financial reporting. Finally, as regards the
activity of audit committees, the results show that
board size, board meetings and audit size can be
2011 Blackwell Publishing Ltd

201

seen as dominant factors in reflecting good internal

governance practices, and improving the resources
for internal monitoring.
It is worth noting that the models in this study
could not include indexes relating to internal audit
as such information is not publicly available.
Goodwin-Stewart and Kent (2006) investigate this
issue with audit fees. Defining internal audit as
number of employees in the internal audit, they
use survey analysis and conclude that only one
third of their sample use internal audit. Further
research is recommended regarding audit
committees to include other audit characteristics
not included in this study, such as audit experience
and education levels.

NOTES
1. This study uses the term non-executive directors
as recommended by the Higgs Report (2003) to
reflect independent directors. Higgs argues that
the term outside director is used in the US but
is not widely recognized in the UK and the
report recommends not to change the term (for
more details, see Higgs report, 2003, p. 126;
section 6.19).
2. As another robustness check, we re-estimate
the model in Table 2 and include the insider
ownership variable. The results are not
substantially different from what is reported in
this study.

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AUTHOR PROFILE
Dr Basil Al-Najjar is a Senior Lecturer at
Middlesex University in London. His research
interests include corporate finance, corporate
governance and financial reporting. Basil has
published his research in various academic journals
including Managerial and Decision Economics,
Business Strategy and the Environment, Emerging
Market Finance, Applied Accounting Research and
International Review of Applied Economics.

Int. J. Audit. 15: 191203 (2011)