Audit Committee Characteristics and Firm Performance in Saudi Arabia

What Are Audit Committees?

Many studies have been carried out to demonstrate the manner in which audit committee reports affect the overall performance of companies in Saudi Arabia and elsewhere in the world. Interest in conducting audits of accounts in different firms peaked in the early 1960s. Two main approaches to accounts investigation have emerged in financial literature. The first is mainly based on sending questionnaires to a predetermined number of financial accounts users, asking them to rank specific accounting items according to their importance to the decision-making process (Buzby, 1974; Firth, 1978; Chandra, 1974; Turkey, 1985). The second approach is based on the link between a disclosure index — whether voluntary, mandatory, or total — and specific company characteristics (Alsaeed, 2005).

The first step in conducting a financial audit is the establishment of an audit committee. Audit committees are essential components of corporate governance (Green, 1994). When defining an audit committee, a great deal of weight is usually placed on its functions and composition. For example, the Canadian Institute of Chartered Accountants (CICA, 1992, p. 20) defines an audit committee as a group or team of directors of a firm whose task is to review or examine the annual financial statements of the organization before they are presented to the firm's board of directors. The committee is essentially a link between the auditor or auditing firm and the board of directors. The responsibilities of the committee may also include participation in the selection of the auditor, definition of the scope of the audit, implementation of internal financial controls, and the generation of financial reports for publication (Al-Lehaidan, 2006).

Development of Audit Committees in Saudi Arabia

The initial step toward the creation of audit committees in Saudi Arabia was taken in 1991 following Royal Consent, with the establishment of the Saudi Organization of Certified Public Accountants (SOCPA). This organization was created to regulate the overall field of financial accounting and auditing (Al-Lehaidan, 2006). In Saudi Arabia, banks are regulated by two government institutions: the Saudi Arabia Monetary Agency (SAMA) and the Ministry of Commerce (Al-Moataz, 2003).

In 1994, SAMA issued new rules and regulations to Saudi banks concerning the formation of audit committees (Saudi Arabian Monetary Agency, 1994). The regulations stated that the board of directors in each bank was to elect from among themselves a chairman of the audit committee to serve a minimum term of three years, and that their independence from the banks' management was of paramount importance to ensure effectiveness (1994, p. 3). The selection of the chairman was regarded as a critical activity because chairmen set the agenda, scope, tone, and manner of operations for the audit committee. For this reason, the individual appointed to lead the audit committee had to meet the following requirements:

1. He should not be a relative of, or associated in any way with, the bank's senior management.

2. The chairman of the board of directors could not be elected to this position.

3. He should not be associated in any way — financial or otherwise — with other members of the board of directors.

The regulations further specified that audit committees should comprise three to five board members, and that a quorum of three members was required for a meeting to be properly constituted. Audit committee members may be chosen from the current board, former board members, and qualified outsiders. However, the majority of the committee members should be outsiders who are not directors, senior managers, employees, or major clients of the bank or its affiliates (Al-Lehaidan, 2006).

The Current State of Audit Committees in Saudi Arabia

In 2003, the SOCPA drafted new rules and regulations intended to further improve the effectiveness of audit committees. These rules included the following provisions:

All public firms were required to form audit committees. Audit committees were required to have a minimum of four members, all of whom were to be independent directors. It was recommended that audit committees meet a minimum of four times per year. The chairman of the audit committee should not be a member of the board of directors. The audit committee should include at least one member holding a minimum of an undergraduate degree in financial accounting or finance. Each audit committee was required to maintain a formal charter.

The International Audit Committee (IAC) sent this draft to interested parties — including internal and external auditors and academics with expertise in accounting — so that they could provide input toward drafting best practices and regulations for financial auditing.

However, to this day no changes have been made to the initial rules and regulations, and it remains uncertain whether the input from these non-governmental parties will be adopted by the Saudi Arabia Ministry of Commerce (SMC) or the Saudi Stock Exchange Commission (SSEC). The structures of audit committees in Saudi Arabia are governed by laws and codes of best practice, including recommendations and guidelines; they are not regulated directly by SSEC listing rules regarding the setup and framework of audit committees (Al-Lehaidan, 2006).