Audit Committee Gender Diversity Accounting Essay

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This chapter outlines the general idea of the research design. It also gives an overview of how this research is conducted. Firstly, this study will discuss about the research design. Next, it will describe regarding the population and the sample selection. After that, the study will provide the theoretical framework of the study. Further, the formulation of hypothesis, measurement procedure which explains the variables and the statistical analysis that used to analyze the data of the current study are shown in the final part of this chapter.

3.2 Research Design

Data was collected through Securities Commission regarding the company that involved in fraud and also content analysis of the annual reports of fraud companies that have been identify in Bursa Malaysia for six years starting from 2005 to 2010. Besides that, the data of non fraud firm that has been match to the fraud firm also collected. This study is conducted to examine and evaluate the effectiveness audit committee attributes as represented by audit committee independent, audit committee expertise, audit committee meetings, audit committee gender and audit committee ethnicity in relation to financial statement fraud, and firm size, leverage, performance and growth of the companies as control variables. The annual reports of fraud and non fraud companies were gathered from the website of Bursa Malaysia. The study is conducted to evaluate the effectiveness of the audit committee in Malaysia in curbing the financial statement fraud.

3.3 Population and Sample

The companies selected were listed in the main board and ace market in the Bursa Malaysia. The companies that identify by Securities Commission that commit fraud on that particulars year will be selected as sample. In a meanwhile, the non fraud firm will also been chosen by matching the total assets of the companies. …………

3.4 Theoretical Framework

The study intends to examine the effectiveness of audit committee attributes in the fraud and non fraud companies from the year 2005 to 2012. The increasing fraud cases reported in Malaysia has given a negative impact to the investors. In addition, the value of company that commits fraud has badly affected. This study emphasize on the relationship between independent variables of the audit committee on corporate fraud. As highlighted by MCCG on the function of audit committee in a company to oversee the financial reporting of the company. In addition to that, agency theory also affirms that the role of the agent is to act on the best interest of the principal or owner of a company. Therefore, audit committee of listed company has the role to monitor the management and to ensure that the management activities and action is benefiting the shareholder wealth. The effectiveness of audit committee can help the company to curb fraudulent financial fraud. There are several elements in the effectiveness of audit committee which will be tested as independent variables in this study. The variables of audit committee elements that would influence the financial statement fraud are audit committee independence, audit committee expertise, audit committee meetings, audit committee gender and audit committee ethnicity. As stated by MCCG, every company must have at least three members from board and should consist of non-executives directors with majority of the members are independent. Independent directors appointed to ensure they provide unbiased review on financial reporting. The audit committee must have at least one of its members from accounting background. The member is known as audit committee expertise. This is to ensure that the member may effectively review the financial reporting and can communicate with external auditor as well. The committee may face difficulties and ineffective in reviewing financial statement if they are not financially literate. Audit committee meetings as highlighted by MCCG must be held at least four times a year. The meeting held is to discuss any matter of the company that relate to their duties especially on the financial matters, internal controls, internal auditors as well as external auditors. The frequently of the meeting will enhance the committee to prevent fraud or vice versa. The gender diversity in audit committee has seen to be important factors in determine the effectiveness of audit committee. Different gender may impose different behavior and understanding regarding the manipulation of accounting. The perspective on gender regarding their roles and ethical behavior in conducting their duties may give different impact on their oversight roles in the audit committee. Nowadays, female also play an important role in boards as well as audit committee because of their personalities and ethical conduct. Ethnic diversity of audit committee is another important variable in this study. In Malaysia, there are multiracial society that consists of different groups of ethnic represent the unique culture in Malaysia. The different culture of ethnic may presume different behavior in oversee the unethical conduct in financial reporting. This is because culture may pose different attitude in accounting practice. Normally there are two different ethnic groups in Malaysia which is Bumiputera and Non Bumiputera. Other than the dependent and independent variables that have been discussed, the study also includes some control variables such as firm size, leverage, performance and growth of the company. These variables have been chosen because previous study has stated that the variables may have influence on the fraudulent financial reporting.

The framework is based on the literature gathered and the relationship between corporate fraud and audit committee as shown in Figure 3.1

Independent variable Dependent variable

Audit committee expertise

Audit committee independent

Audit committee gender

Audit committee meeting

Audit committee ethnicity

Corporate Fraud

Control variables:

Firm size, leverage, performance and growth


Figure 3.1: Research framework

3.5 Hypotheses Development

This study has developed several hypotheses based on previous literature. The review on literature is specifically emphasized on the corporate fraud and in association with audit committee effectiveness. The effectiveness of audit committee is comprises of the audit committee independent, audit committee meeting, audit committee expertise, audit committee gender and audit committee ethnicity. Moreover, this study also examines the relationship between firm size, leverage, performance and growth.

3.5.1. Audit committee independent

Companies listed under Bursa Malaysia are required to have audit committee that consists of independent non executive director. The independent committee is consists of outside board that will perform unbiased duties. The increase in number of independent boards from outside directors, the greater the monitoring on the management (Helland and Sykuta, 2005). The audit committees that comprise of all independent committee will reduce the earnings manipulation by the firm (Saleh et. al., 2007). Furthermore, Felo and Solieri (2009) indicate that lack of independent audit committee will enhance the company management to aggressively manipulate the financial reporting. The monitoring process will be improve by having independent audit committee and also the function of the committee to oversee the financial matter in order to ensure the quality of the financial reporting (Siagian and Tresnaningsih, 2011). The independent audit committee has negative association with the fraudulent financial reporting hence the high proportion of audit committee will lead to the low financial reporting fraud (Beasley, 1996). Therefore, the hypothesis is as follow:

H1 : There is negative relationship between audit committee independent and corporate fraud.

3.5.2 Audit committee expertise

A person that has background of accounting and financial literate and has working experience in corporate finance is considering as having financial expertise (Agrawal and Chadha, 2005). The financial expertise in the committee can oversight their role in preventing financial fraud (Huang and Thiruvardi, 2010). Audit committee that has financial and accounting knowledge will enhance company to have better performance and in a meanwhile can help company to prevent fraud and financial distress situation (Rahmat et. al, 2009). The audit committee that has financial knowledge and competent are able to reduce manipulation of earnings by emphasize on the monitoring system (Choi et al., 2004). Additionally, if the company has high proportion of financial literate in audit committee, the likelihood of fraudulent misstatement is low (Mustafa and Youssef, 2010). Thus, the hypothesis for audit committee expertise as stated below:

H2: There is negative relationship between audit committee expertise and corporate fraud.

3.5.3 Audit committee meeting

The effectiveness of audit committees can be assess through the frequency of meeting held and the committee must held four meeting a year as required by MCCG. The most frequent of the meeting held by the audit committee, the committee become more effective (Song and Windram, 2000). Abbott et al, (2004) posit that the meeting by audit committee at least four times meet in a year will enhance low restatement of financial reporting. Farbers (2005) indicate that, the firm that involve in fraud is having weak governance and low audit committee meeting. There is an inverse relationship between fraudulent financial statement and the number of meeting (Owens-Jackson, 2009). In order to provide effective supervision on financial information disclose, the committee need to have more frequent meeting (Rahmat et al., 2009). The hypothesis of audit committee meeting is as follow:

H3: There is negative relationship between audit committee meeting and corporate fraud.

3.5.4 Audit committee gender diversity

The gender diversity is an audit committee also an important characteristics. Different gender will persuade different attitude and ethical conduct in performing their duties. Female is more ethical in performing their duties especially those who do not have experience than those in employment (Bilic and Sustic, 2011). The presence of women in the boards will enhance the business run healthily and also consider as a complement to the male directors. Additionally, the firms that have both genders in the committee can perform more effective role than the firm that has single gender (Halpern, 2000). The gender diversity show that man in the management process is considered more overconfident than women thus the tendency to commit fraud is higher than women but the evidence is very limited in relation between fraud and gender (Schrand and Zechman, 2011). Moreover, the existence of female board on the audit committee will positively influence the number of meeting held and also enhance the reporting quality of financial statement. Thus, this lead to our next hypothesis:

H4: The presence of female in audit committee is negatively associated with corporate fraud.

3.5.5 Audit committee ethnic diversity

The cultural effects also consider important especially in Malaysian there are many races that act as important players in the industries. Cultural values are important factors especially in order to understand the belief and behaviour of an individual. In Malaysian, there are many different cultures and the development of accounting is influence by this culture (Iskandar and Pourjalali, 2000). Additionally, the races of the directors give no impact to the manipulation of earnings (Rahman and Ali, 2006). The increase in ownership structure and the involvement of Bumiputera in the firm will lead to the individualistic behavior in Malays. The practice of corporate governance is better in the Bumiputera owned firm as compared to Chinese owned firm (Yatim et al., 2006). Furthermore, Haniffa and Cooke (2002) in their study show that individualistic behavoiur is more on the Chinese counterpart as compared to Malays. Malays are considered as having low individualism that they are comfortable to works with others that has same beliefs, behavior and races. There is difference in monitoring system where the ethnic dominance of board composition and listed company (Yatim et al., 2006). The hypothesis for audit committee ethnic diversity is as follow:

H5: There is a relationship between audit committee ethnicity and corporate fraud.

3.6 Measurement Procedure

The measurement procedure being used in this study will discussed in this chapter. The dependent variable is corporate fraud and the independent variables are audit committee independent, audit committee expertise, audit committee meetings, audit committee gender diversity and also audit committee ethnic diversity. Further, the study also includes control variables (firm size, leverage, performance and growth). The measurement of variables will be discusses below.

3.6.1 Measurement of dependent variables

The dependent of this study is corporate fraud. Carcello and Nagy (2004) measure fraud by indicate that the fraud firms equal to the company or its officers were charged violate the rule by the SEC. The study by Huang and Thiruvadi (2010) uses litigation firms that involved corporate frauds by obtaining data from Security Exchange Comission Accounting and Auditing Enforcement Releases. This study uses corporate fraud with association to the firm that disclosed fraud and lawsuit cases in earlier year as stated by Kamarudin et al., (2010).

3.6.2 Measurement of independent variables Audit committee independent

Audit committee independent (ACIND) is one of the independent variables in this study. The proportion of independent directors in audit committee is measure by the number of independent non-executive directors over total number of audit committee members (Abdul Rahman and Mohamed Ali, 2006). In addition, Owen-Jackson (2009) measure independent audit committee by the proportion of independent directors on the audit committee. Thus, this study measure audit committee independent using the percentage of independent non-executive directors to the total number of audit committee members (Hashim and Abdul Rahman, 2011). Audit committee expertise

The measurement of expertise in audit committee (ACEXP) is the proportion of directors who are accounting experts on the audit committee (Yin et al., 2012). Chan et al. (2011) measured audit committee expert using the number of AC members with financial expertise by the total number of AC members. Hence, this study measured audit committee expert as the percentage of audit committee that is financial expertise such as member of MIA or Chartered Accountant to the number of directors in audit committee (Mohamed Yunos et al., 2012). Audit committee meeting

Audit committee meeting (ACMEET) is measured by the number of meeting held in a year (Mohamed Yunos et al., 2012). In addition, Hashim and Abdul Rahman (2011) measure the meeting of audit committee by identifying the number of meeting held during the year. Therefore, this study measured audit committee meeting by the number of meeting held during the financial year (Yin et al., 2012). Audit committee gender diversity

Gender diversity in audit committee (ACGEN) also another independent variables in this study. Thiruvadi (2012) acquire data about the female composition of audit committee by review all the related annual report and identify the name of the director or via the photo of the directors if available in the report. In addition, obtain data by searched for gender identifiers such as "Miss", "she" or "her". It is also consistent with the study by Huang and Thiruvadi (2011). Both of the study using dummy variables indicate that the presence of female in audit committee is equal to 1 otherwise is 0. Thus, the variable of this study denote that 1 if the female presence in audit committee and 0 is otherwise. Audit committee ethnic diversity

Ethnicity in the audit committee (ACEC) can refer to Bumiputera directors or non Bumiputera directors. Some of the study denoted ethnic status of the directors as Chinese or Malay directors. Mohamed Yunos et al. (2012) measure the ethnicity of the audit committee member using the proportions of Bumitputera directors to total directors on audit committee. Abdul Rahman and Mohamed Ali (2006) using the ratio of Malay directors over total directors on audit committee as their measurement of ethnicity. Therefore, this study measured audit committee ethnicity using the proportion of Malays directors to total directors in audit committee.

3.6.3 Controls variables

The control variables included in this study are firm size, leverage, performance and growth. Firm size is measure by logarithm of total assets in the selected firm (Ika and Mohd Ghazali, 2012). Yin et al. (2012) measure firm size by natural logarithm by total assets. Firm size in this study is measure using logarithm of total assets. Other variable which is leverage is measure using total debts over total assets (Abdul Rahman and Mohamed Ali, 2006). Persons (2009) also measure the leverage by total debts to total assets. Leverage in this study is using total debts over total assets. Further, performance of a firm is measure by the differences between profit-making and non-profit making firms (Ahmed et al, 2002). This study measures the performance suing dummy variable where 1 if the company has positive profit after tax and 0 is otherwise. Growth is another control variable in this study. Lin et al (2006) measure growth prospect using market to book ratio. In addition Carcello et al. (2012) also measure growth by market to book ratio. Thus, this study will measure growth by using market to book ratio.

All the measurement of the dependent and independent as well as control variables as stated in table below:

3.7 Statistical Analysis

The data for dependent and independent variables is obtaining form the year 2005 to 2010 from annual report. The data collected is recorded in Microsoft Excel 2007 then the data are analysis using Statistical Package for Social Science (SPSS) version 20.

Multiple Regression Model

Multiple regressions model is used to find the result on the relationship of dependent variable and independent variables. Furthermore, it will test all the hypotheses stated in this study whether the result is support the hypothesis or in contrast. The regression model of this study is as follows:

CF = β0 + β1ACIND + β2ACEXP + β3ACMEET + β4ACGEN + β5ACEC + β6SIZE

+ β7LEV + β8PER + β9GROWTH + Ɛ


CF Corporate fraud, the firm that disclosed fraud and lawsuit cases in earlier year

β0 Intercept coefficient, when all other independent variables are zero

ACIND Percentage of independent non-executive directors to the total number of audit committee members

ACEXP Percentage of audit committee that is financial expertise to the number of directors in audit committee

ACMEET Number of meeting held during the financial year

ACGEN Dummy variable, 1 if female presence in audit committee and 0 is otherwise

ACEC Proportion of Malays directors to total directors in audit committee

SIZE Log10 of total assets

LEV Total debts over total assets

PER Dummy variable, 1 if the company has positive profit after tax and 0 is otherwise

GROWTH Market to book ratio

Ɛ Error Term

3.8 Chapter Summary

This chapter discusses the research design adopted in this study. Further, this chapter also explains the measurement procedures employed by each of the variables in this study and also the sample of the data collected.