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The impact of expertise on themediating role of the audit

committeeZalailah Salleh

Department of Accounting and Finance, Universiti Malaysia Terengganu, Kuala Terengganu, Malaysia, and

Jenny Stewart Department of Accounting, Finance and Economics, Grifth Business School,

Grifth University, Meadowbrook, Australia

AbstractPurpose The purpose of this paper is to examine external auditors perceptions of the impact of audit committee nancial expertise and industry expertise on the mediating role played by thecommittee in resolving auditor-client disagreements.Design/methodology/approach The study is a 2 2 between subjects experimental design,using 61 Malaysian auditors as participants. The authors manipulate audit committee nancialexpertise and industry expertise at high and low levels.Findings It is found that external auditors perceive that audit committees play a greater mediatingrole and use mediating techniques to a greater extent when committee members nancial andindustry expertise is high compared to when expertise is lower.Originality/value This is the rst paper to examine the importance of audit committee expertiseon the mediating role of the audit committee. The major contribution of the paper is the nding thatauditors believe the audit committees role as a mediator is strengthened not only by the committeemembers accounting and auditing expertise but also by their industry expertise. The papers ndingshave implications for practitioners and regulators who are concerned with the role of the auditcommittee in enhancing the integrity of the nancial reporting and audit process.Keywords Malaysia, Audit committees, Dispute resolutions, External audit,Auditor-client dispute resolution, Audit committee expertisePaper type Research paper

1. IntroductionAudit committees are recognized globally as an important governance mechanism forensuring the integrity of the nancial reporting and audit process (DeZoort et al., 2002;Cohenet al., 2007).Notsurprisingly, marketregulators have set in place certain standardsor requirements designed to strengthen audit committee effectiveness. In addition to the

requirement for audit committees to be comprised of independent directors,

The current issue and full text archive of this journal is available atwww.emeraldinsight.com/0268-6902.htm

The authors acknowledge with thanks the helpful comments of two anonymous reviewers, Jean Bedard, Ken Trotman, and participants at seminars at Grifth University and MacquarieUniversity, at the annual conference of the Accounting and Finance Association of Australia andNew Zealand, Adelaide, July 2009 and at the First World Accounting Frontiers Series Conference,Macau, July 2009. The authors also thank Yves Gendron, Mike Gibbins and Hun Tong Tan forproviding copies of research instruments used in prior studies and are particularly grateful to theauditors who gave up their time to participate in the study.

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Received 8 September 2010Reviewed 9 February 2011Accepted 30 March 2011

Managerial Auditing JournalVol. 27 No. 4, 2012pp. 378-402q Emerald Group Publishing Limited0268-6902DOI 10.1108/02686901211217987

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regulators have emphasized the need for at least one committee member to possessnancial expertise (Blue Ribbon Committee, 1999; Sarbanes-Oxley Act (SOX), 2002).Some jurisdictions have also recognized the importance of industry expertise (ASXCorporate Governance Council, 2010).

A small but growing body of research has explored the association between auditcommittee expertise and factors such as nancial reporting quality, earningsmanagement, external audit quality and internal control strength. While results havebeen mixed, it is generally recognized that audit committee expertise is an importantattribute which strengthens the effectiveness of the audit committee (McMullen andRaghunandan, 1996; Chtourou et al., 2001; Bedard et al., 2004; Abbott et al., 2004;Krishnan, 2005; Carcello et al., 2006; Zhang et al., 2007).

Our research extends this literature by examining the inuence of audit committeeexpertise on auditors perceptions of the mediating role that the audit committee playsin resolving auditor-management disagreements on contentious accounting issues.Auditors perceptions in this regard are important because the resolution of disagreements is a necessary step in nalizing the nancial statements so that anunqualied audit opinion can be issued. According to Ng and Tan (2003, pp. 803-4), thesize of an audit adjustment is the result of a negotiation process with the clientsmanagement, and consideration of bargaining power should factor into the auditorsassessments of the ultimate negotiated outcome. An effective audit committee shouldstrengthen the bargaining power of the auditor and therefore improve nancialreporting quality (Brown and Wright, 2008). Ng and Tan (2003) examine auditorsperceptions of the impact of audit committee effectiveness on their judgments relatingto audit adjustments. However, they operationalize audit committee effectiveness interms of the committees ability to exercise independent judgment. No prior researchhas focused on the impact of audit committee expertise in this context.

While we would expect audit committees to be involved in resolving disputes as part

of their oversight responsibilities, the extent of their involvement is unclear. Somestudies have found that audit committees do not play a signicant role in resolvingdisputes, but instead expect disagreements to be resolved before they arebrought beforethe committee (Cohen et al., 2002, 2007; Gibbins et al., 2007). In contrast, other studieshave demonstrated that audit committees are involved in resolving disagreementsbetween auditors and management (Knapp, 1987; Beattie et al., 2000; Goodwin, 2002;Ng and Tan, 2003; Beattie et al., 2008; Salleh and Stewart, 2009). Indeed, it has beenargued that audit committeesplay an important role in mediating auditor-managementdisagreements (DeZoort et al., 2003b, p. 176). This is likely to be particularly the case inthe post-SOX era, with auditors in the USA reporting that audit committees have morepower, expertise and diligence than prior to the SOX legislation (Cohen et al., 2009).Hence, Brown and Wright (2008, p. 104) suggest the need for further research to explorethe inuence of the audit committee on auditor-client negotiations and the reportednancial statement outcomes in the post-SOX environment.

Following DeZoort et al. (2003b), we posit that the audit committee can act as amediator in resolving auditor-client disputes. We then draw on mediation theory andprior corporate governance studies to suggest that the mediating role of auditcommittees is inuenced by the level of expertise of the audit committee. We use anexperimental design to examine the impact of industry and nancial expertise,manipulating both types of expertise at high and low levels.

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Participants in the study were auditors from Big Four and middle tier auditingrms in Malaysia, where publicly listed companies are required to have an auditcommittee comprising a majority of independent directors. At least one member of thecommittee must be either a member of the accounting profession or have a minimum of three years experience as an accountant. However, there is no requirement for auditcommittee members to possess relevant industry or business experience[1]. Although adeveloping country, Malaysias corporate governance regulations and practices havebeen heavily inuenced by those of the UK and the USA. The inuence of SOX can beclearly seen in the Malaysian Code of Corporate Governance best practice guidelineswith respect to boards and audit committees.

We nd that both nancial and industry expertise are perceived by externalauditors to inuence the mediation role of the audit committee and the mediationtechniques used by audit committees to help resolve disputes. Hence, we contribute tothe corporate governance literature by demonstrating the importance of both types of expertise for audit committee effectiveness in the context of resolving auditor-clientdisputes. Our results have implications for regulators who are concerned to strengthenthe effectiveness of audit committees as a corporate governance mechanism and forcorporations as they seek to appoint directors with the appropriate expertise to serveon audit committees.

The paper is structured as follows. In the next section we provide the background tothe study and Section 3 develop our hypotheses. Section 4 describes the researchmethod while Section 5 reports and analyses the results. In the nal section, someconclusions are drawn.

2. Background MediationMediation can be dened as a process involving a third party who assists two or moredisputing parties to resolve their dispute (Kressel and Pruitt, 1989). Wall et al. (2001)suggest that the process has three dening elements:

(1) assistance or interaction by;(2) a third party who; and(3) does not have the authority to impose an outcome.

They acknowledge, however, that the third element is contentious, with many scholarsrecognizing that in some situations mediators do have the power to impose an outcome.

Prior literature suggests that a variety of techniques are available for mediators inapproaching conict resolutions between disputants. These techniques includecontrolling the agenda, information gathering, pressing, siding, advising thedisputants and proposing a solution (Conlon and Fasolo, 1990; Laskewitz et al., 1994;Wall et al., 2001). The techniques are not mutually exclusive and are frequently used inconjunction with each other. For example, as information gatherers, mediators maygather information from the disputants, the environment or from written documents.They may then offer advice and information concerning the problem or they may gofurther and propose a solution themselves (Wall et al., 2001). Such a solution can be anintegrative solution (Conlon and Fasolo, 1990) or a new collaborative solution (Kaufmanand Duncan, 1992).

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The mediation literature has further demonstrated an association between mediatorexpertise and mediation effectiveness. For mediation to be effective, the disputingparties must view the mediator as credible and expertise is recognized as a key factorthat generates credibility (Kolb, 1985; Arnold, 2000). Previous studies focus on twotypes of expertise, namely process and content expertise (Arnold, 2007). Processexpertise is dened as the mediators experience and knowledge of the mediationprocess while content expertise refers to the mediators knowledge and insight relatingto the issue under dispute (Silver, 1996; Arnold, 2000, 2007)[2]. Arnold (2000) found thatmediators who were perceived as having greater content expertise were viewed asmore credible. In turn, more credible mediators were judged more favourably and wereseen as more capable of performing a mediation role. However, Arnold (2007) studiedthe interaction between process expertise and content expertise and found that contentexpertise was only important when mediators lacked process expertise. Whenmediators were expert in mediation procedures, it did not seem to matter whether theyhad in-depth knowledge of the issue under dispute.

Notwithstanding Arnolds (2007) ndings, in the present study we focus on contentexpertise for a number of reasons. First, audit committee members are unlikely topossess high process expertise because they are not specically trained in mediation.Second, audit committeecontentexpertise is recognisedas an importantelement of auditcommittee effectiveness (DeZoort et al., 2002). Third, Arnolds (2007) study involvedmanagement students with limited work experience who role-played as employeesnegotiating with their supervisor over a pay dispute. Mediator content expertise in thestudy was manipulated as familiarity with company policies and a high awareness of the specic issue under dispute. This type of expertise is quite different to the specialistknowledge possessed by an audit committee when dealing with highly experiencedauditors and management. Hence the results of Arnolds (2007) study may not begeneralizable to the scenario in the present study.

The mediating role of the audit committeeResearch on audit committee involvement in auditor-client negotiation has providedmixed results. In the pre-SOX era in North America, some studies found low auditcommittee involvement in resolving disagreements between auditors and management(Gibbins et al., 2001; Cohen et al., 2002). In a Canadian study, Gibbins et al. (2001) usedboth interviews and questionnaires to develop a model of auditor-client negotiation.They conclude that, while such negotiation is commonplace, the audit committee isinvolved less frequently. Cohen et al. (2002), in an interview study of 36 practitionersfrom north-eastern ofces of US audit rms, report that interviewees believe that auditcommittees are often ineffective because they lack the power to resolve contentiousissues and members lack the expertise to perform their job effectively. In contrast,however, an earlier US study by Knapp (1987,p. 582) found a substantial percentage of audit committee members in the sample had been involved in resolvingauditor-management conicts, leading him to suggest that audit committees oftenmediate such disputes.

With the strengthening of audit committee responsibility in the last decade, it isreasonable to expect that audit committees now play an even more importantmediating role to help resolve disputed issues (DeZoort et al., 2003b). Cohen et al. (2009)nd that auditors view audit committees as more diligent, more active, more powerful


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and having greater expertise in the US post-SOX environment compared to thepre-SOX era. However, they still report limited post-SOX audit committee involvementin resolving disputes with clients. In contrast, DeZoort et al. (2008) nd that auditcommittee members in a post-SOX environment have an increased sense of responsibility for resolving auditor-management disagreements compared to theirpre-SOX counterparts. Specically, DeZoort et al. (2008) replicated their pre-SOX study(DeZoort et al., 2003a) which examined audit committee members support for anauditor-proposed adjustment relating to an inventory writedown. The authors ndsupport for their hypothesis that the changes to audit committee responsibilities in thepost-SOX environment would lead to audit committee members being more likely tosupport the auditors position (DeZoort et al., 2008).

In a UK survey, Beattie et al. (2008) indicate that audit committees are activelyinvolved in discussions and negotiations on nancial statement issues. Further, Sallehand Stewart (2009), in an interview study of audit committee members, chief nancialofcers and external auditors of seven Malaysian listed companies, nd that auditcommittees play a mediating role in material disputes between auditors and clients.They also report that the mediating role is strengthened by the authority of thecommittee, the committees understanding of possible issues and the membersaccounting, industry and business expertise.

Prior research on audit committee expertiseA number of studies have stressed the importance of expertise for audit committeeeffectiveness (Kalbers andFogarty,1993; DeZoort, 1997; Be dard et al., 2004; Gendron andBedard, 2006; Turley and Zaman, 2007). It has been argued that audit committeespossessing relevant expertise are more likely to make judgments that areconsistent withthose of auditors (DeZoort, 1998; DeZoort and Salterio, 2001). Further, audit committeemembers with accounting experience are perceived to be particularly effective in their

investigations when accounting decisions are aggressive (Pomeroy, 2010). Auditcommittee nancial expertise is also perceived to inuence rm performance (Hsu, 2008)and nancial reporting quality (McMullenand Raghunandan, 1996; Chtourou et al., 2001;Abbott et al., 2004; Bedard et al., 2004; Carcello et al., 2006; Dhaliwal et al., 2006). Inaddition, studies also show a positive stock market reaction to the appointment of auditcommittee members withaccounting expertise(Davidson etal., 2004; DeFondetal., 2005).

Most studies focus on nancial expertise due to the nature of the audit committeenancial reporting oversight role. Very few studies have examined other types of expertise such as industry knowledge and general business experience. Knapp (1987)provides evidence that current business experience affects the members support forthe external auditor in disputes with client management. Cohen et al. (2007) argue thataudit committees must be alert to company specic types of weaknesses that are likelyto occur. Salleh and Stewart (2009) report that interviewees in their sample stressed theimportance of having audit committee members with industry expertise and a soundbusiness knowledge in addition to members with nancial expertise. Further, industryexpertise is considered important by some market regulators; for example the ASXCorporate Governance Council (2010) recommends that audit committees should havemembers who have an understanding of the industry in which the company operates.However, we are not aware of any studies that directly examine the effect of industryexpertise on audit committee effectiveness.

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3. Development of hypothesesThe effect of nancial expertise and industry expertise on the mediating role of the audit committeeThe mediation literature demonstrates that mediators should possess relevantexpertise in order to be perceived as credible. Mediators gain the trust of disputantswhen they possess expertise relevant to the issues under dispute (Doney et al., 1998;Goldberg and Shaw, 2007). Therefore, it is important for audit committee members topossess the necessary expertise if they are to play a mediating role in resolvingcontentious accounting issues between auditors and management.

The previous section has demonstrated a relationship between audit committeenancial expertise and nancial reporting quality. A high level of nancial expertiseshould enable the audit committee to better understand the nancial reporting process(McDaniel et al., 2002). Hence, we argue that, when auditors and management are indispute over accounting issues, auditors will have greater condence in the auditcommittees ability to understand the underlying causes of the problem when the audit

committee has a high level of nancial expertise. Auditors will expect this greaterunderstanding to better equip the audit committee to act in a mediating role to helpresolve the problem.

As noted, audit committee industry expertise is considered to be essential to enablethe audit committee to make informed decisions (Salleh and Stewart, 2009). Given thepaucity of prior research examining audit committee industry expertise, it is necessaryto rely on studies that have examined industry expertise in the context of othergovernance parties. Forexample, in thecontextof external auditing, studies have shownthat industry expertise enables auditors to better identify errors (Be dard and Biggs,1991; Owhoso et al., 2002), to be more effective in auditing (Maletta and Wright, 1996)and to better assess the reasonableness of clients estimates and other nancialrepresentations (Kwon, 1996). In view of the similarities in the nature of decisionsbetween audit committees and auditors with respect to the quality and integrity of thenancial statements, it is not unreasonable to draw on studies relating to externalauditors to generate hypotheses about audit committees. We propose that auditcommittees with higher industry expertise are more likely to have a betterunderstanding of the business and the problems nested within the industry in whichthe company operates. This allows audit committees to be more effective mediatorswhen they are involved in disputes between auditors and management. We thereforehypothesize that auditors will perceive that audit committees with a higher level of industry expertise are more knowledgeable and better able to make appropriate judgments on the disputed issue. Hence auditors will expect such committees to play amore important role in resolving disputes between auditors and management.

We therefore test the following hypothesis:

H1. External auditors perceive that the audit committee plays a more importantrole in resolving disputes between auditors and management when:

(a) audit committee nancial expertise is high compared to when nancialexpertise is low; and

(b) audit committee industry expertise is high compared to when industryexpertise is low.


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The effect of nancial expertise and industry expertise on audit committee concerns for the truth and fairness of the nancial statementsIt has been argued that mediators should be perceived as being impartial, unbiased orneutral to ensure that disputants feel they are being treated fairly (Silver, 1996).Disputants perceptions about the neutrality of mediators inuence the successfulnessof the mediation process (Carnevale and Pruitt, 1992). In the context of nancialreporting, an unbiased approach is reected in a concern for the truth and fairness of the nancial statements. Hence, if auditors believe that the audit committees primaryconcern is for true and fair nancial statements, this should enhance their trust in thecommittee to act in an impartial manner.

We argue that audit committees with greater nancial expertise will have a betterunderstanding of technical accounting procedures and standards, and will be moreconcerned with nancial reporting accuracy (DeZoort and Salterio, 2001; DeZoort et al.,2008). Auditors should therefore expect audit committees possessing higher nancialexpertise to be better able to appreciate and to be more concerned about the importanceof the truth and fairness of nancial statements.

Similar to nancial expertise, industry expertise is also expected to provide auditcommittees with a context for understanding the nature of nancial reporting. Again,drawing on the auditing literature that stresses the importance of industry expertise inassessing estimates and representations (Be dard and Biggs, 1991; Kwon, 1996), wepredict that auditors will expect audit committees with higher industry expertise toalso be more concerned that the nancial statements present a true and fair view.

Therefore, we hypothesize that:

H2. External auditors perceive that the audit committee will be more concernedabout the truth and fairness of nancial statements when:

(a) audit committee nancial expertise is high compared to when nancial

expertise is low; and(b) audit committee industry expertise is high compared to when industry

expertise is low.

The effect of nancial expertise and industry expertise on the use of mediationtechniques by audit committeesAs previously mentioned, there are a variety of techniques available for auditcommittees in the mediation process. We examine three techniques which could bereadily manipulated in an experimental design. These are advising, proposing asolution and siding.

Advising and proposing a solution . In order to help resolve the issue under dispute,audit committees require an understanding of the problem to bring both parties to anagreement point that adheres to accounting standards. As noted, audit committeeswith a high level of nancial expertise should be better able to understand theunderlying causes of the problem. Auditors should therefore perceive that such auditcommittees will be in a stronger position both to offer advice on the most appropriatetreatment and, going a step further, to propose a solution to the problem.

Prior studies have shown that industry expertise helps external auditors to assessthe reasonableness of a companys estimates and nancial representations(Kwon, 1996; Maletta and Wright, 1996). We suggest that it is not unreasonable

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to argue that, when audit committees possess higher industry expertise, they too canapply this experience and knowledge to understand the context of the problem. Hence,auditors should perceive that audit committees with strong industry expertise will bemore capable of advising the parties on how to resolve the problem and proposing asolution to the problem.

These arguments lead to the following hypotheses:

H3. External auditors perceive that the audit committee will be better able toadvise on the most appropriate treatment to resolve a dispute betweenauditors and management when:



H4. External auditors perceive that the audit committee is more likely to propose asolution to resolve a dispute between auditors and management when:



Siding . As part of the mediation process, a mediator can side with one of the parties in adispute. While some argue that mediators should remain impartial (Kruk, 1998; Silver,1996) and therefore should not take sides, prior research shows that this technique issometimes appropriate (Laskewitz etal., 1994; Wallet al., 2001). Hence, audit committees

may take sides with auditors or management in order to resolve disputes overcontentious accounting issues. A number of studies have explored the impact of auditcommittee experience or expertise on siding. For example, Knapp (1987) reports thataudit committee members with corporate management experience are more likely tosupport theauditor. DeZoort andSalterio (2001)nd that audit committeemembers withindependent director experience and audit knowledge tend to support the auditor,whereas those members with current experience as executive directors are less likely todo so. DeZoort et al. (2003b) nd that audit committee members with more experienceand with accounting qualications are more likely to side with the auditor. In contrast,DeZoort et al. (2003a) report that audit committee members who are CPAs are morelikely to support management. However, in a follow-up study to examine the impact of SOX on audit committee judgments, DeZoort et al. (2008) nd that post-SOX auditcommittee members who are CPAs are more likely to side with auditors in the event of adispute compared to their pre-SOX counterparts.

It should be noted that audit committee support for the auditors position does notnecessarily reect a lack of impartiality. Rather, it could reect a shared commitmentwith external auditors that the nancial statements should portray a true and fair view.We therefore predict that auditors will expect that audit committees with a higher levelof nancial expertise will initially adopt the auditors view rather than the view of management.


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While studies have not directly addressed the impact of industry expertise on siding,there is some evidence that audit committee members with managerial experience andgeneral board experience support auditors in auditor-client disputes (Knapp, 1987;DeZoort et al., 2003b). Directors with this type of experience are likely to have greaterindustry expertise and hence we suggest that audit committees possessing industryexpertise are more likely to support auditors in disputes with management. Therefore,we propose that auditors will also expect audit committees with a higher level of industry expertise to initially side with auditors rather than with management.

Thus, we hypothesize the following:

H5. External auditors perceive that the audit committee is more likely to initiallyside with auditors when:


(b) audit committee industry expertise is high compared to when industry

expertise is low.

The effect of nancial expertise and industry expertise on the outcome of the mediation processResearch on audit committee inuence on the outcome of disputes between auditors andmanagement has been relatively sparse. Ng and Tan (2003) argue that auditorsassessment of the ultimate outcome of a disagreement will be inuenced by theirperceptions of the relativebargainingpower between themselves and client management.They suggest that an effective audit committee strengthens the bargaining power of theauditor, particularly in the absence of authoritative guidance relating to the issue underdispute. Both nancial expertise and industry expertise are key elements of auditcommittee effectiveness (DeZoort etal., 2002)and hencewe predict anassociationbetweenaudit committee expertise andsupport forthe auditors position in thenaloutcome of thedispute. This prediction is further supported by the arguments and research evidencepresented above with respect to the use of the siding technique (DeZoort and Salterio,2001; DeZoort et al., 2003b, 2008; Knapp, 1987). Hence, our nal hypothesis is as follows:

H6. External auditors perceive that the nal outcome of the dispute will betowards the auditors initial position when:



4. Research methodCase development The research instrument involved a case study that was developed by the authors. Thescenario was modied from an actual auditor-client dispute identied from discussionsbetween one of the researchers, an audit partner in a Big Four accounting rm and theclient company. Participants were asked to assume that they were the partner-in-chargeof theaudit of a hypothetical publicly listedmanufacturingcompany. They hadheld this

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role for the past three years and had a good working relationship with management.However, this year they were faced with a major accounting issue on which they had notbeen able to reach agreement with management. The issue involved a proposedadjustment relating to the impairment of machinery resulting from an unprotablebusiness segment that the company planned to discontinue. The auditor hadrecommended that the machinery be written down from its carrying value of RM15 million[3] to scrap value of RM1 million. The proposed amount would reduce theearnings for the year to RM0.36 per share, signicantly below the unaudited earnings of RM0.40 per share announced to Bursa Malaysia at the end of the nal quarter (equal to10 percent variance). Management argued that the machinery could be sold to acompetitor for RM8 million and hence the write-down should be RM7 million. Thiswould give anearnings per share gure ofRM0.38(resulting ina 5 percent variance fromtheannounced unauditedearnings)[4]. Participantswere advised that the issue was to beraised at the forthcoming audit committeemeeting, attended by theauditor, theCEOandthe CFO. The audit committee comprised three independent non-executive directors.

Independent variablesWe examine two independent variables, namely the nancial expertise and industryexpertise of the audit committee. Both types of expertise were varied at high and lowlevelsby manipulatinginformation pertaining tosuch expertise. Fortheaudit committeepossessing a high level of nancial expertise, participants were informed that:

. the audit committee members were all members of the Malaysian Institute of Accountants;

. the audit committee chair had extensive experience as a nance director in listedcompanies; and

. another member was a former partner in a large accounting rm, while the third

member also had a strong accounting and nance background.On the other hand, for the audit committee in the low level of nancial expertisecondition, participants were informed that:

. only one of the audit committee members was a member of the MalaysianInstitute of Accountants, having been principal of a small accounting rm untilhis retirement a year ago; and

. the audit committee chair and the other committee member did not have anaccounting or nance background.

In the high level of industry expertise condition, the participants were informed thatthe audit committee also had considerable industry expertise, with the audit committeechair and one other member having held senior positions in companies in the sameindustry. In contrast, for the low level of industry expertise condition, the participantswere informed that none of the members had signicant expertise in the industry inwhich the company operates.

Dependent variablesThe rst dependent variable relates to the mediating role of the audit committee.Participants were asked whether they expect the audit committee to play an important


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role in resolving the dispute. The second dependent variable is a perception concerningthe likelihood that the audit committee is able to appreciate and is concerned about theimportance of the truth and fairness of the nancial statements. Specically,participants were asked whether the audit committees primary concern will be toensure true and fair nancial statements.

The next four dependent variables measure the use of mediation techniques byaudit committees to resolve disputes between auditors and management. Participantswere asked to indicate the extent to which they agree that:

(1) The audit committee will be able to advise auditors and management on themost appropriate treatment to the problem.

(2) The audit committee will put forward their own solution to the problem.(3) The audit committee will initially side with the auditor in the dispute.(4) The audit committee will initially side with management in the dispute.

Participants were asked to make all of these judgments by marking a point on a scaleranging from one to seven, with end points marked as entirely disagree and entirelyagree.

The nal dependent variable measured in the study is an estimate of the write-downamount of the machine that is expected by the participants as the nal outcome fromthe mediation process[5].

ParticipantsA total of 61 auditors participated in the experiment, 50 of whom were from Big Fourrms and11 were from non-Big Four rms. Theparticipantscomprised 17 audit seniors,13 managers, 23 senior managers or directors and eight partners. About 30 participantshad between three and ten years of auditing experience, 24 had ten to 20 years of

experience and the remaining seven had in excess of 20 years of experience. The meannumber ofyears of audit experience was 10.56,with a minimum of three and a maximumof 30 years. From Table I, it can be seen that the background of participants variedacross the four treatment groups, giving rise to the possibility of confounding effects.We conducted analyses of covariance (ANCOVAs) to test for the confounding effect of current position and years of experience. However, meaningful tests could not beundertaken for the rm type variable due to the small number of participants fromnon-Big Four rms across the four treatment groups. Both current position and years of experience were found to have a signicant effect on some of the dependent variables.As both of these factors are measures of experience and as such are highly correlated(r 0.820), we report only the results of our hypothesis testing after controlling forparticipants position. Qualitatively similar results were obtained when we controlledfor years of experience. A correlation test found that current position and years of experiencearepositively correlated with the dependent variables. This nding indicatesthat participants in more senior roles and with more auditing experience perceive thatthe audit committee will play a greater mediating role and use mediating techniques to agreater extent compared to those participants with less seniority and experience.These differences in perception most likely arise because auditors in more seniorpositions have a greater level of interaction with audit committees and this, in turn,inuences their perception about the mediating role of the audit committee.

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ProceduresExtensive pilot testing was conducted before producing the nal versions of theresearch instruments. Participants in the pilot study included ve academics withauditing experience, two managers with experience in dealing with auditors and twoaudit partners. Following discussions with the pilot study respondents, minor changeswere made to the content and presentation of the instruments.

Big Four and non-Big Four audit rms in Malaysia were approached to participate inthe study. A letter was sent to the human resources department and/or to senior partnersof the rms to solicit participation. Approval to distribute research instruments wasreceived from all of theBig Fourand from fourmiddle tier audit rms.We delivered copiesof the research instrument package[6] to the contact person who then distributed them toaudit seniors, audit managers and audit partners. Knowing that auditors at this level arevery busy, we did not attempt to conduct the experiment in a controlled environment.However, it was considered that having participants of appropriate seniority outweighsthe loss of validity resulting from the lack of a controlled environment.

5. Results Manipulation checksIn order to ensure that the nancial and industry expertise manipulations were effective,participants were asked to indicate the level of both types of expertise on a scale rangingfrom one (very low expertise) to seven (very high expertise). We conducted independentgroup t -tests to test the responses. The means in the high level of expertise scenarioswere signicantly higher (6.06 for nancial expertise and 5.39 for industry expertise)than the means in the low level scenarios (3.77 for nancial expertise and

High nancial/highindustry expertise

group

High nancial/lowindustry expertise

group

Low nancial/highindustry expertise

group

Low nancial/lowindustry expertise

group Total

Panel A: participants positionPartner 2 2 3 1 8Director/seniormanager

4 6 4 9 23

Manager 5 2 3 3 13Senior 5 5 5 2 17Total 16 15 15 15 61 Panel B: years of audit experienceBelow 10years

9 10 6 5 30

10-20years

5 3 6 10 24

More than20 years 2 2 3 0 7Total 16 15 15 15 61 Panel C: rm typeBig four 11 14 11 14 50Mid tier 5 1 4 1 11Total 16 15 15 15 61

Table I.Participants background

and experience bytreatment group


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2.97 for industry expertise). The differences in means are signicant at p 0.000,suggesting that both manipulations were successful.

Multivariate analysis of covariance (MANCOVA)A MANCOVAtest indicated that industry expertise andparticipants current position intheir rm have a signicant effect on the combined dependent variables at the 0.05 level(Wilks Lambda of 2.354 ( p 0.032) for industry expertise and 2.257 ( p 0.039) forcurrent position). Financial expertise has a marginally signicant effect, with a WilksLambda of 2.070 ( p 0.057)[7]. We therefore perform separate ANOVAs on each of thedependent variables to test our hypotheses.

The mediating role of the audit committee H1 predicts that external auditors perceive that the audit committee will play a moreimportant role in resolving disputes between auditors and management when:

. audit committee nancial expertise; and

.

audit committee industry expertise are high compared to when they are low.Table II reports the descriptive statistics on the auditors perceptions of the importanceof the audit committees mediating role. The cell means fall between 4.93 and 6.13,indicating that participants generally perceive that audit committees do play animportant role in resolving disputes between auditors and management. The overallmeans for both nancial expertise and industry expertise are in the hypothesizeddirection, being higher for the high levels of expertise than for the low levels.

The results of the ANCOVA are presented in Table III. The table shows that thecovariate is highly signicant ( p 0.000). Table III also shows that both main effectsare signicant at the 0.05 level ( p 0.008 for nancial expertise and p 0.021 forindustry expertise). There is no signicant interaction effect between the two factors,

indicating that they have an additive effect on the dependent variable and that theyare independent of each other. The results suggest that audit committees with a higherlevel of nancial expertise are perceived to play a more important role in resolvingdisputes between auditors and management than those with a lower level of nancialexpertise. Consistent with this result, audit committees are also perceived to play amore important role in resolving disputes when they possess higher industry expertise.Therefore, H1 is supported.

Means (standard deviations) and cell sizesHigh industry expertise Low industry expertise Overall

High nancial expertise 6.13 5.20 5.68(0.885) (1.612) (1.351)n 16 n 15 n 31

Low nancial expertise 5.07 4.93 5.00(1.486) (1.280) (1.365)n 15 n 15 n 30

Overall 5.61 5.07(1.308) (1.437)n 31 n 30

Table II.Descriptive statistics foraudit committee role inresolving the dispute

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Audit committee concerns for the truth and fairness of the nancial statements H2 predicts that external auditors perceive that the audit committee will be moreconcerned about the truth and fairness of nancial statements when:

. nancial expertise; and

. industry expertise are high compared to when they are low.

The descriptive statistics are presented in Table IV. The cell means range from 5.20 to6.31, suggesting that auditors perceive audit committees to be concerned with the truthand fairness of the nancial statements. Further, the results show that the overallmeans are greater in the high conditions for both types of expertise.

Table V summarizes the results of the ANCOVA and shows that the currentposition factor is signicantly correlated with auditors perceptions about auditcommittee concern for the truth and fairness of the nancial statements ( p 0.015).

Table V also shows that both main effects are signicant at the 0.01 level. Again,there is no signicant interaction between the two factors, showing they areindependent of each other. The results suggest that audit committees with a higherlevel of nancial expertise are perceived to be more concerned about the truth andfairness of nancial statements than those with a lower level of nancial expertise.Similarly, audit committees are also perceived to be more concerned with the truth and

Source df Type III sum of squares Mean square F Sig.a

Corrected model 4 34.298 8.575 5.894 0.000Intercept 1 367.679 367.679 252.724 0.000Current position 1 20.544 20.544 14.121 0.000Financial expertise 1 9.189 9.189 6.316 0.008Industry expertise 1 6.318 6.318 4.343 0.021Financial expertise industry expertise 1 1.987 1.987 1.366 0.248Error 56 81.472 1.455Total 61 1,858.000Corrected total 60 115.770 R 2 0.296Adjusted R 2 0.246

Note: a A one-tailed test is used for the two main effects, where a direction is predicted

Table III.Analysis of covariance

for audit committee rolein resolving the dispute




Overall 5.97 5.40(1.048) (1.133)n 31 n 30

Table IV.Descriptive statistics for

concern with the truthand fairness of nancial

statements


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fairness of nancial statements when they possess higher industry expertise.Therefore, H2 is supported.

The use of mediation techniques by audit committees H3- H5 predict the effect of audit committee expertise on the mediation techniques usedby audit committees in resolving disputes between auditors and management. Asnoted, we focus on the three mediation techniques of advising, proposing a solutionand siding.

Advising . H3 predicts that external auditors perceive that audit committees with:. a high level of nancial expertise; and. a high level of industry expertise will be better able to advise management and

auditors on the appropriate treatment for the problem under dispute compared towhen the relevant expertise is low.

The descriptive statistics on auditors perceptions of the use of the advising technique

by the audit committee are presented in Panel A of Table VI. It can be seen that themeans exceed the midpoint of four, suggesting that auditors generally perceive auditcommittees to be able to advise auditors and management on the appropriate treatmentto resolve disputed accounting issues. Consistent with the hypotheses, the means arehigher when the levels of nancial expertise and industry expertise are high comparedto when the respective types of expertise are low.

Panel A of Table VII summarizes the results of the ANCOVA and shows that thecovariate is marginally correlated with auditors perceptions about the ability of auditcommittees to advise auditors and management on disagreements ( p 0.078).

The results also show a signicant main effect for both nancial expertise( p 0.003) and industry expertise ( p 0.042). Again, there is no signicant interactionbetween the two variables. Hence, when there is a high level of nancial expertise, auditcommittees are perceivedtobebetter able tooffer advice toauditors and management ona disputed accounting issue, providing support for H3a . H3b is also supported,providing evidence that audit committees with a high level of industry expertise areperceived by external auditors to be better able to advise management and auditors onthe appropriate treatment for the problem under dispute.


Corrected model 4 16.592 4.148 3.971 0.007Intercept 1 335.081 335.081 320.817 0.000Current position 1 6.548 6.548 6.269 0.015Financial expertise 1 5.852 5.852 5.603 0.010

Industry expertise 1 5.852 5.852 5.603 0.010Financial expertise industry expertise 1 0.285 0.285 0.272 0.604Error 56 58.490 1.044Total 61 2,049.000Corrected total 60 75.082 R 2 0.221Adjusted R 2 0.165


Table V.Analysis of covariancefor concern with the truthand fairness of nancialstatements

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Proposing a solution . H4 predicts that external auditors perceive that auditcommittees with:

. a higher level of nancial expertise; and

. a higher level of industry expertise are more likely to put forward their ownsolution to resolve a dispute between auditors and management than when therelevant expertise is low.

The results for this hypothesis are shown in Panel B of Tables VI and VII.The means in Panel B of Table VI range from 3.33 for the low industry/high nancialexpertise treatment group to 5.00 for the high industry/high nancial expertise group.This suggests that auditors are not strongly convinced that audit committees imposetheir own solution to resolve disputes between auditors and management. Further,Panel B shows that there is little difference in the means between the low and high levelsof nancial expertise. However, for the industry expertise, the difference in means isgreater and is in the direction predicted by H4b .


Panel A: advising High nancial expertise 5.69 4.87 5.29

(1.014) (1.457) (1.296)n 16 n 15 n 31


Overall 5.13 4.60(1.310) (1.380)n 31 n 30

Panel B: proposing a solutionHigh nancial expertise 5.00 3.33 4.19

(1.095) (1.234) (1.424)n 16 n 15 n 31


Overall 4.61 3.70(1.054) (1.179)n 31 n 30

Panel C: siding High nancial expertise 4.31 3.87 4.10

(1.138) (1.598) (1.375)n 16 n 15 n 31


Overall 4.06 3.60

(1.063) (1.429)n 31 n 30

Table VI.Descriptive statistics

for use of mediatingtechniques


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Table VII shows that only the main effect for industry expertise is signicant( p 0.001) at the 0.05 level, while the main effect for nancial expertise is notsignicant. However, there is a strong interaction effect ( p 0.007) between nancialexpertise and industry expertise on auditors perceptions that the audit committee willput forward its own solution to the problem. The interaction effect is shown in Figure 1.A Post Hoc Multiple ComparisonTest (Tukey HSD) indicated that the mean ofgroup one(high nancial expertise and high industry expertise) is signicantly ( p 0.000)

Source df Type III sum of squaresMeansquare F Sig.a

Panel A: advising Corrected model 4 21.845 5.461 3.432 0.014Intercept 1 247.256 247.256 155.391 0.000Current position 1 5.131 5.131 3.225 0.078Financial expertise 1 12.291 12.291 7.725 0.003Industry expertise 1 4.890 4.890 3.073 0.042Financial expertise industryexpertise 1 1.308 1.308 0.822 0.368Error 56 89.106 1.591Total 61 1,557.000Corrected total 60 110.951 R 2 0.197Adjusted R 2 0.140 Panel B: proposing a solution

Corrected model 4 24.280 6.070 5.475 0.001Intercept 1 172.506 172.506 155.608 0.000Current position 1 2.586 2.586 2.332 0.132Financial expertise 1 0.085 0.085 0.077 0.391Industry expertise 1 13.380 13.380 12.069 0.001Financial expertise industryexpertise 1 8.665 8.665 7.816 0.007Error 56 62.081 1.109Total 61 1,144.000Corrected total 60 86.361 R 2 0.281Adjusted R 2 0.230 Panel C: siding Corrected model 4 8.409 2.102 1.339 0.267

Intercept 1 135.537 135.537 86.299 0.000Current position 1 0.953 0.953 0.607 0.439Financial expertise 1 4.535 4.535 2.887 0.047Industry expertise 1 3.499 3.499 2.228 0.070Financial expertise industryexpertise 1 0.005 0.005 0.003 0.956Error 56 87.951 1.571Total 61 994.000Corrected total 60 96.361 R 2 0.087Adjusted R 2 0.022


Table VII.Analysis of covariancefor use of mediationtechniques

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different from group two (high nancial expertise and low industry expertise). Thedifference in means between group one and group four (low nancial expertise and lowindustry expertise) is also marginally signicant ( p 0.081). The results suggest thatindustry expertise has a signicant effect on the audit committee problem solving roleonly when the audit committee possesses high nancial expertise. When nancialexpertise is low, the main effect of industry expertise is not signicant. Thus, H4a is notsupported, while H4b is supported only when nancial expertise is high.

This result can be tentatively interpreted as follows. When audit committees have ahigh level of nancial expertise,external auditors believe that they will also be cognizantof their need for industry expertise. Hence, when they have high industry expertisetogether with high nancial expertise, they will be willing to put forward a solution tothe problem. However, when they have low industry expertise and high nancialexpertise, they will notbe willing to suggesta solution.This resultcontrastswith the lownancial expertise treatment where external auditors perceive that audit committeeswill be relatively indifferent to their level of industry expertise when positing a solutionto the problem. This interpretation suggests the need for further research to explore thiscomplex interaction in more depth.

Siding . H5 predicts that external auditors perceive that audit committees with:. higher nancial expertise; and. higher industry expertise will initially side with auditors.

Panel C of Table VI presents the descriptive statistics on auditors perceptions of whether the audit committee will initially side with auditors. While the means are in thedirection predicted by the hypothesis, they are close to or below the mid-point of four,indicating that auditors generally believe that audit committees will not initially sidewith auditors.

Panel C of Table VII summarizes the results of the ANCOVA. The table shows a

signicant main effect for nancial expertise at the 0.05 level ( p 0.047), supporting H5a . Industry expertise is signicant at the 0.1 level ( p 0.070), and hence H5b ismarginally supported. The interaction effect is not signicant. Thus, while the lowmeans demonstrate that external auditors recognize that the audit committee generallydoes not take sides in the event of a dispute between auditors and management,a higher level of audit committee expertise is expected to drive the committee to leantowards the external auditors position[8].

Figure 1.Interaction effect of

nancial expertise andindustry expertise onproposing a solution

4.2

5.0

4.07

3.33

3

3.5

4

4.5

5

5.5

Low High

M e a n s

Financial expertise

HighLow

Industry expertise


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The outcome of the mediation processWhile prior evidence on the outcome of mediation has been limited, studies on auditcommittee support of the auditor suggest that audit committees with a high level of expertise are more likely to take the auditors position. In order to explore the effect of thetwo types of expertise on the nal outcome, participants were asked to indicate theestimated written down value of the machine. As noted from the case, the auditorsproposed a RM14million write-down (carryingvalueRM1million),while themanagementwished to recognize only a RM7 million write-down (carrying value RM8 million).

Table VIII shows the relevant descriptive statistics. The results indicate that there islittle variability across the treatment groups, with all means exceeding 10.5. Thissuggests that participants expect that the nal outcome of the mediation process will bea compromise between the auditors initial position and that of the client, but erringtowards the auditors initial position. This outcome is regardless of the level of bothtypes of expertise. In all treatmentgroups, however, thestandard deviation is quite high,suggesting considerable variability in responses.

The results of the ANOVA presented in Table IX show that neither the main effectsnor the interaction arestatistically signicant. Thus, H6 is notsupported as participantsdo not perceive that the level of nancial or industry expertise possessed by the auditcommittee would inuence the nal outcome of the mediation process. This is in spite



Low nancial expertise 11.00 11.00 11.00

(3.464) 3.207 (3.280)n 15 n 15 n 30Overall 11.19 11.53

(3.311) (3.256)n 31 n 30

Table VIII.Descriptive statistics formediation outcome


Corrected model 3 12.269 3.067 0.274 0.893Intercept 1 958.931 958.931 85.811 0.000Current position 1 0.887 0.887 0.079 0.779Financial expertise 1 7.312 7.312 0.654 0.211

Industry expertise 1 2.069 2.069 0.185 0.669Financial expertise industry expertise 1 1.746 1.746 0.156 0.694Error 56 625.796 11.175Total 61 8,511.000Corrected total 60 638.066 R 2 0.019Adjusted R 2 2 0.051


Table IX.Analysis of covariancefor mediation outcome

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ofdifferencesin perceptionsof the impact ofboth typesof expertise on the mediating roleof the audit committees and on the techniques used by the committee to resolve thedispute. A possible reason for the insignicant results is that auditors may believe theirposition should be taken to be the correct outcome. However, a willingness tocompromise to some extent towards managements position may reect their concernabout avoiding the need to issue a qualied audit opinion. Overall, this nding issomewhat anomalous with the results for our other hypotheses and hence is animportant avenue for future research.

6. ConclusionAn experimental study was undertaken to examine external auditors perceptions of the inuence of nancial expertise and industry expertise on the mediating roleof the audit committee. Hypotheses were developed to investigate auditors perceptionsof the impact of the two types of expertise on:

. the importance of the role played by the audit committee in resolving disputes;

. audit committee concern for the truth and fairness of the nancial statements;

. the use of mediation techniques; and

. the nal outcome of the mediation process.

We found that both nancial expertise and industry expertise are perceived byexternal auditors to inuence the mediating role of the audit committee.However, external auditors did not perceive any effect of either nancial expertiseor industry expertise on the nal outcome of the mediation process.

Our ndings have implications for regulators and corporations by demonstratingthe importance of both nancial and industry expertise on the audit committee. Theresults highlight that having only nancial experts on the audit committee may notprovide the committee with sufcient expertise to help resolve contentious accountingissues or to play a mediating role in resolving disagreements between auditors andmanagement. The major contribution of our study is the nding that the auditcommittees role as a mediator is strengthened not only by the committee membersaccounting and auditing expertise but also by their industry knowledge.

We acknowledge a number of limitations of the study. First, it was not undertakenin a controlled environment and hence is subject to certain inherent threats to internalvalidity. Second, we used external auditors to examine the mediating role of auditcommittees. As such, our results must be interpreted with caution as we cannot assumethat other governance parties would necessarily share the perceptions of auditors.Future research is therefore needed to examine the audit committees mediation rolefrom the perspective of client management, audit committee members and the board of directors. Third, some of our participants were audit seniors who may have had limitedexperience. We did not ask participants to indicate their level of experience with auditcommittees or with other relevant factors such as asset writedowns and auditor-clientdisagreements. However, the signicant positive effect of the covariate in ourhypothesis testing suggests that any lack of experience is likely to have understatedthe signicance of our ndings. Fourth, it could be perceived that the writedown in ourscenario did not require a high level of industry expertise to form a judgment andhence this type of audit committee expertise may not have been an important factor


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in helping to resolve this particular dispute. Again, if this were the case, our ndingswith respect to industry expertise would be understated. Fifth, our high nancialexpertise treatment could be construed as combining nancial expertise with a greaterlevel of executive director experience. Similarly, our high industry expertise treatmentcould have been interpreted as combining industry experience with generalmanagement experience. These other types of experience were not mentioned in thelow treatment groups. This may have confounded our results as research evidence hasshown that audit committees with high levels of management experience are morelikely to support the auditor while those with current experience as executive directorsare less likely to do so. Finally, we examined only nancial and industry expertise, anddid not make any mention of audit committee members mediation skills and processexpertise (Arnold, 2007). Hence there are opportunities to explore the effect of mediation skills on the resolution of auditor-client disagreements and whether theseskills interact with other types of expertise.

In addition to the research opportunities arising from the limitations of the study,our ndings provide a number of avenues for further research. We found a stronginteraction effect between nancial expertise and industry expertise with respect toproposing a solution. Research is needed to explore the implication of this interactioneffect in more depth. Further, our study unexpectedly found insignicant results forthe inuence of the two types of expertise on mediation outcome which was somewhatinconsistent with the results for the mediation techniques. Therefore, future research isneeded to investigate this nding. In addition, prior studies have found that informalinteractions between the audit committee and auditors and management can impact onaudit committee effectiveness (Turley and Zaman, 2007; Beasley et al., 2009). It is likelythat these informal communications impact on the audit committees mediating role inresolving disputes between auditors and management and hence future research isneeded to explore whether this is the case. Finally, prior research has shown that the

acceptance of mediation as a dispute resolution mechanism is more accepted in somesocieties than others (Wall et al., 2001). Malaysia is a society that appears to sanctionthis approach to resolving disputes (Mansor, 1998; Wall and Callister, 1999). Wall et al.(2001) point out that, in contrast, disputants in the USA are less likely to turn to thirdparties for assistance. Further research is therefore needed to corroborate the ndingsof the study and to test their overall generalizability to other jurisdictions and othercultures.

Notes1. These rules are specied in the Listing Requirements of Bursa Malaysia, the Malaysian

Stock Exchange.

2. Mareschal (2005) refers to these two types of expertise as process knowledge and substantiveknowledge. Substantive knowledge is dened as mediators understanding of the issue andunderlying problems in thedispute,while process knowledgeis dened asskills in theprocessof facilitating and resolving the disputes.

3. RM denotes Malaysian Ringgit, which is valued at approximately US$0.3.4. If there is a deviation of 10 percent or more between the prot or loss after tax and minority

interest stated in the announced unaudited accounts and the audited accounts, the companyhas to provide an explanation of the deviation to Bursa Malaysia.

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5. To answer this question, participants were asked to complete a sum in the form of Carryingvalue (RM15m) -Write-down (RM. . .m) New carrying value (RM. . .m).

6. The research instrument package comprised: (i) a covering letter; (ii) a coversheet explainingthe purpose of the study, providing instructions and guaranteeing the condentiality of theparticipants; (iii) the research instrument; and (iv) a reply envelope.

7. A correlation test indicated that multicollinearity does not appear to be a concern as thecorrelations between the dependent variables are less than 0.5 in all cases with the exceptionof the correlation between mediating role and the use of the advising technique (r 0.704).

8. Participants were also asked to indicate whether they believed that the audit committeewould initially side with management. The means across the four treatment groups rangedbetween 4.07 and 3.60, with neither of the main effects nor the interaction being signicant.These untabulated results further support the view that audit committees generally are notperceived to take sides.

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About the authors

Zalailah Salleh is a Lecturer in Accounting in the Faculty of Management and Economics atUniversiti Malaysia Terengganu, Malaysia. Zalailah Salleh is the corresponding author and canbe contacted at: [email protected]

Jenny Stewart is Professor of Accounting and Discipline Head of Accounting and Law in theGrifth Business School, Grifth University, Australia.

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