Earnings Conservatism and Audit Committee Financial

Accounting and Finance 55 (2015) 279310
Earnings conservatism and audit committee nancial

expertise
Nigar Sultanaa, J-L. W. Mitchell Van der Zahn
a
School of Accounting, Curtin University, Perth, WA, Australia
Abstract
Using an Australian sample of 494 rm-year observations, this study nds that
accounting nancial expertise is the primary type of expertise that inuences
earnings conservatism, rather than nonaccounting nancial expertise. The
association between accounting nancial expertise and conservatism holds only
when the accounting nancial expert(s) on audit committees is (are) independent. Overall, results suggest that audit committee accounting nancial
expertise is important in recognising the asymmetrical timeliness of losses.
Findings provide a better understanding of the dynamics between audit
committee nancial expertise and earnings conservatism and demonstrate the
importance of accounting nancial expertise in improving nancial reporting
quality.
Key words: Conservatism; Corporate governance; Audit committee nancial
expertise
JEL classification: M41, M42, M48, G38
doi: 10.1111/ac.12042
1. Introduction
The primary objective of this study is to examine the association between
audit committee nancial expertise and earnings conservatism within an
Australian capital market setting. Debate about audit committees and the
The authors gratefully acknowledge the valuable comments from Steven Cahan (Editorin-Chief) and two anonymous reviewers. The authors also acknowledge the many
helpful suggestions of Robert Durand, Ross Taplin, Kamran Ahmed, Sue Wright,
Asheq Rahman, Ann Tarca, Ray Da Silva Rosa, Paul Gerrans, Paul Mather, Manzurul
Alam and both the discussant and participants at the AFAANZ 2012 conference,
seminar participants at the Curtin Business School 2012, the UWA Business School
2012 and the La Trobe Accounting Research Seminar 2012.
Received 16 March 2013; accepted 22 July 2013 by Steven Cahan (Editor in Chief).
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280 N. Sultana, J-L. W. Mitchell Van der Zahn/Accounting and Finance 55 (2015) 279310
subcommittees eectiveness have been central themes in the corporate

governance literature during the past several decades given major nancial
crises (e.g. Asian Financial Crisis, Global Financial Crisis) and corporate
accounting scandals (e.g. HIH, Enron, WorldCom, One.Tel). In response, in
2003 (revised in 2007 and again in 2010), the Australian Securities Exchange
Corporate Governance Council (ASX CGC) introduced a best practice guide
titled the Principles of Good Corporate Governance and Best Practice
Recommendations (ASX CGC 2003), placing greater responsibility on a rms
audit committee in ensuring the integrity of its nancial reporting processes
(ASX Corporate Governance Council, 2003). One of the features of an audit
committee emphasised by ASX CGC 2003 is audit committee nancial
expertise. Specically, ASX CGC 2003 mandates the disclosure, by rms,
whether an audit committee includes a nancial expert. To date, limited research
has been conducted on the importance of audit committee nancial expertise in
Australia (Goodwin-Stewart and Kent, 2006; Baxter and Cotter, 2009). Of the
limited research undertaken, the results remain inconclusive on whether the
presence of a nancial expert on an audit committee enhances the committees
eectiveness. As such, examining the importance of an audit committee nancial
expert within the Australian context remains an open question.
This study therefore seeks to examine the association between audit committee
nancial expertise and earnings conservatism using a sample of 494 rm-year
observations comprising data collected from Australian publicly listed rms
between 1 January 2004 and 31 December 2008. To comprehensively test the
earnings conservatism/audit committee nancial expertise linkage, both marketbased that is, timeliness of earnings to news (Basu, 1997) and accounting-based
that is, accrual-based loss recognition (Ball and Shivakumar, 2005) approaches
of earnings conservatism are used.1 The general proposition of this study is that
audit committee members with dierent types of nancial expertise inuence
conservative accounting practices by rms. Findings are consistent with this
proposition. Specically, this study nds evidence of a positive association
between earnings conservatism and (i) overall nancial expertise and (ii)
accounting nancial expertise. Empirical ndings, however, indicate that the
inuence of accounting nancial expertise on earnings conservatism is more
pronounced. Further analysis also suggests that audit committee members with
accounting nancial expertise perform their monitoring function eectively
only when they are independent. Overall, results suggest that resourcing audit
1
This study adopts conservatism as the measure of nancial reporting quality for a
number of reasons. Conservatism is an essential property of earnings quality and is
recognised as an important attribute of accounting reliability, given it reduces
managements discretion to manipulate earnings and decreases information asymmetry
and the moral hazard problems caused by agency conicts (Watts, 2003; Lim, 2011).
Conservatism also enhances the eciency of debt covenant arrangements and reduces
both litigation risk and political costs (Krishnan and Visvanathan, 2008; Lara et al.,
2009).
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N. Sultana, J-L. W. Mitchell Van der Zahn/Accounting and Finance 55 (2015) 279310 281
committees with members who have accounting nancial expertise is more

likely to contribute to the eectiveness of the audit committee in improving the
quality of nancial reporting rather than including members with nonaccounting nancial expertise. Results are robust to alternative measures of earnings
conservatism, dierent measures of audit committee nancial expertise,
inclusion of additional control parameters and endogeneity bias.
This study makes various contributions to the extant literature. First, this
study is one of the rst to provide empirical evidence that audit committee
nancial expertise inuences conservative accounting practices.2 Second, this
study contributes to the limited Australian corporate governance literature by
examining the association between audit committee nancial expertise and
earnings conservatism. Third, this study also adds to the audit committee
literature by demonstrating that audit committee nancial expertise is an
eective corporate governance attribute. Fourth, this study considers the
inuence of three types of nancial expertise measures with an aim to identify
the type of nancial expertise most likely to enhance audit committees
eectiveness. Specically, audit committee expertise is measured as follows: (i)
overall nancial expertise based on the US Securities and Exchange Commission (SEC) 2003 denition,3 (ii) accounting nancial expertise applying the
ASX CGC 2003 denition, and (iii) nonaccounting nancial expertise based on
the SEC 2003 denition.4 Fifth, this study uses more recent data compared to
the previous studies. More importantly, this study selects data after the
introduction of the rst denitive set of guidelines (i.e. ASX CGC 2003)
governing the establishment and operations of audit committees for Australian
publicly listed rms. Findings from this study are relevant to policy-makers as
they identify the type of nancial expertise within audit committees most likely
2
Only one prior study of note (i.e. Krishnan and Visvanathan, 2008) examines the audit
committee nancial expertise and earnings conservatism association for a sample of the
US rms.
3
In 1999, the SEC, in its proposed rule, suggested a narrower denition of nancial
expertise (i.e. an audit committee member with professional qualications and/or
experience as a public accountant, auditor, principal or chief nancial ocer, controller,
principal or chief accounting ocer). However, subsequently in 2003, in its nal rule, the
SEC dened nancial experts broadly incorporating nonaccounting nancial experts
(i.e. an audit committee member with experience as a CEO or president of a for-prot
rm) (Securities and Exchange Commission, 2003). In this study, whenever the term
SEC (2003) denition is used, it refers to the broader denition of nancial experts in
SECs nal rule in 2003.
4
ASX CGC 2003 Recommendation 4.2 requires at least one member of the audit
committee to be a nancial expert and denes a nancial expert as a qualied
accountant or other nance professional with experience of nancial and accounting
matters. This denition is more stringent than the one prescribed by regulators in other
international settings (e.g. Blue Ribbon Committee, 1999; Securities and Exchange
Commission, 2003). However, the ASX CGC 2003 denition of nancial expertise is
similar to the one initially proposed by the SEC in 1999.
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positive and statistically signicant at the 10 per cent level in regression

results reported in Table 5 Column II. Similarly, the coecient on
CFOjt*DCFOjt*Expt_Accjt is also positive and statistically signicant at the
1 per cent level indicating a greater association between accounting nancial
expertise and conservatism. The coecient on CFOjt*DCFOjt*Expt_CEOjt is
positive but statistically insignicant (see Table 5 Column IV). In contrast,
the coecient on CFOjt*DCFOjt*Expt_Accjt is positive and statistically
signicant at the 1 per cent level when both accounting expertise and
nonaccounting nancial expertise are included in the model. Table 5
Columns II V results relating to the three measures of audit committee
nancial expertise suggest that the presence of members on the audit
committee with accounting nancial expertise has a greater association with
asymmetrical loss recognition through accruals rather than gain recognition
(i.e. indicating greater conservatism).
With respect to control variables, audit committee size is found to be
signicant and positively associated with conservatism across all regressions
reported in Table 5 Columns II V. However, audit committee independence and duality are not signicant in any of the regression results.
Findings reported in Table 5 Columns II V also highlight a signicant
negative association between the asymmetric timeliness of accruals and rm
size. In contrast, a rms growth options and leverage are shown to be
positively and signicantly associated with the asymmetric timeliness of
accruals. Industry type is also found to be positively and signicantly
associated with swifter recognition of bad news via accruals. Finally, Table 5
Columns IIV results also show that the adjusted R2 ranges from 72.7 per
cent to 95.8 per cent.
In summary, results are mostly consistent with hypotheses. Specically,
ndings (reported in Tables 4 and 5) indicate a signicant association between
audit committee overall nancial expertise and both measures of conservatism
providing support for H1. When the analysis is limited to accounting nancial
expertise, the positive association with earnings conservatism becomes
stronger. Results therefore also provide support for H2a. Both Tables 4 and
5 results suggest an insignicant association between the asymmetrical
timeliness of conservatism (via both earnings and accruals) and audit
committee nonaccounting nancial expertise providing therefore no support
for H2b.
4.3. Additional tests
4.3.1. Independence of financial experts
Prior research (Klein, 2002) indicates that the ability (and potential
willingness) of an audit committee nancial expert to contribute positively to
the subcommittees eectiveness hinges on that individuals relationship with
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constraining earnings management. Agrawal and Chadha (2005) nd that the

probability of restatement is signicantly lower when the audit committee has
an independent nancial expert. Karamanou and Vafeas (2005) also provide
evidence that audit committee nancial expertise is positively associated with
the market reaction to management earnings forecasts. Consistent with past
studies, it is expected that audit committee members with nancial expertise
can enhance conservatism by, amongst other things, assessing the adequacy of
nancial provisions such as warranty obligations, lawsuits and other contingencies and detecting aggressive earnings management as a nancial expert can
critically evaluate the reasonableness of explanations provided by management.
Finally, an audit committee member with nancial expertise will also have
greater awareness of the implications of enforcing conservative accounting
practices (e.g. share price movements, impact on corporate managements
reputation) due to the nancial experts greater knowledge and understanding
of accounting-related issues.
Various incentives provide the basis for an audit committee nancial expert
to adopt conservative accounting practices. Past literature has indicated that, in
the event of nancial reporting failure, nancial experts face greater scrutiny
than other audit committee members (Srinivasan, 2005; Krishnan and
Visvanathan, 2008). Financial experts are recognised as the principal individuals within an audit committee with a higher responsibility for the nancial
reporting process due to their superior knowledge and understanding of
nancial matters and reporting issues. Srinivasan (2005), for example, shows
that nancial experts lose more directorships than other audit committee
members in the event of a rms nancial reporting failure. Thus, audit
committee members with nancial expertise have greater incentives to
encourage conservative accounting practices to preserve their reputational
capital, increase the likelihood of serving at boards and reduce litigation
concerns. Furthermore, an audit committee member with nancial expertise
will be motivated to promote conservative accounting as the adoption of
conservative accounting practices (e.g. swift recognition of losses) is less likely
to attract criticism from investors and regulators compared to aggressive
accounting practices (e.g. early recognition of revenue). Based on the above
arguments, we develop the following hypothesis:
H1: Audit committees overall financial expertise is positively associated with
earnings conservatism.
2.1. Accounting and nonaccounting financial expertise
Past studies provide evidence that the accounting and nonaccounting
background of an audit committee member delivers dierent degrees of
nancial expertise and have a diering impact on nancial reporting quality
(Defond et al., 2005; Dhaliwal et al., 2010). Defond et al. (2005) and
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Davidson et al. (2004), for example, identify a signicant positive stock price
reaction to the appointment of an accounting nancial expert but not to a
nonaccounting nancial expert. Similarly, Dhaliwal et al. (2010) and Krishnan and Visvanathan (2008) examine the importance of both accounting and
nonaccounting nancial expertise and conclude that only accounting nancial
experts are associated with higher accruals quality and accounting conservatism respectively. Using an Australian sample, Baxter and Cotter (2009)
document a positive relationship between the existence of an accounting
nancial expert on the audit committee and the rms accruals quality.
Although the majority of past nancial expertise studies show that accounting
nancial expertise is the primary type of expertise that improves nancial
reporting quality, nonaccounting nancial expertise is also found to be a
valuable governance mechanism in improving audit committee eectiveness
(McDaniel et al., 2002; Goh, 2009). McDaniel et al. (2002) document that, in
comparison with accounting nancial experts, nonaccounting nancial experts
are more likely to raise concerns about high-salience nancial statement items
that are nonrecurring in nature and which receive press attention. In addition,
Goh (2009) nds that audit committee members with nonaccounting nancial
expertise are more eective in rectifying material internal control weaknesses.
As suggested by past research, both accounting expertise and nonaccounting
nancial expertise enhance the governance expertise of audit committee
members.
In relation to accounting nancial expertise, consistent with past literature,
we expect that with a more rened and in-depth knowledge of accounting
principles, practices and processes, an accounting nancial expert will be better
able to identify and recommend the most appropriate conservative accounting
policies. On the other hand, although nonaccounting nancial experts do not
have the necessary educational and professional qualications to be classied
as a nancial expert, they nevertheless have valuable knowledge both in
nancial (i.e. monitoring the preparation of nancial statements and certifying
them annually) and nonnancial matters (i.e. overseeing management and the
internal control structure). With knowledge both in accounting matters and
corporate management, nonaccounting nancial experts will be able to
identify, recommend or assess the reasonableness of managements use of
conservative accounting policies. Consistent with the usefulness of both
accounting and nonaccounting nancial experts in promoting conservative
accounting practices, we test the following hypotheses:
H2a: Audit committees accounting financial expertise is positively associated
with earnings conservatism.
H2b: Audit committees nonaccounting financial expertise is positively associated
with earnings conservatism.
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3. Sample and method

3.1. Sample selection and documentation
Due to the time-consuming task of hand collecting key longitudinal data,
analysis is limited to a stratied randomly selected sample of 100 rms per year
continuously listed on the Australian Securities Exchange (ASX) from 1 January
2004 to 31 December 2008.5 The studys initial sample comprises 2,128 rms
listed on the ASX as at 1 January 2004. Following exclusions,6 the nal useable
pool to conduct the stratied random sample selection comprises 1,090
observations. The 1,090 rms of the nal useable pool are ranked by market
capitalisation (as at 1 January 2004) prior to being categorised into quartiles.
Following Balvers et al. (1990), 25 rms are randomly selected from each
quartile. Annual data spanning the 5-year period (20042008) are collected for
the 100 selected rms resulting in a nal sample of 500 rm-year observations.
Six rm-year observations are excluded due to data reliability concerns or
incomplete information. Consequently, the nal usable sample upon which
analysis is based comprises 494 rm-year observations. Table 1 Panel A provides
a summary of the sample selection process, whilst Table 1 Panel B presents an
industry breakdown (by rm-year observations) of the nal useable sample.
3.2. Measurement of audit committee financial expertise
Appendix 1 denes the test variables of this study. Following prior work
(Defond et al., 2005; Krishnan and Visvanathan, 2008), and SEC 2003 and
ASX CGC 2003 recommendations, this study uses individual proxy measures
for all the three types of nancial expertise used in this study.
In relation to overall nancial expertise, the variable denoted Exptjt is given a
score of 1 if the audit committee of rm j at the end of year t has at least one
member with (i) professional qualications and/or experience as a public
accountant, auditor, principal or chief nancial ocer, controller, principal or
chief accounting ocer (frequently known as accounting nancial expertise)
or (ii) experience as a CEO or president of a for-prot rm (known as
5
A stratied random approach is used to control for potential size biases, and the 5-year
period is selected as it occurs after the introduction of key corporate governance reforms
in Australia (i.e. ASX CGC 2003).
Consistent with prior research (Ball et al., 2000; Givoly et al., 2007), nancial (133),
insurance (10), utility (30), initial public oering (106) and trust (92) rms are excluded.
Foreign incorporated and domiciled rms (64) are also excluded as nancial statements
of these entities are not necessarily prepared in accordance with the typical disclosure
requirements of ASX listed rms. To avoid undue inuences of unexpected share price
changes, 222 rms not continuously listed on the ASX throughout the entire observation
period (i.e. rms delisted and subsequently relisted) are eliminated from the initial
sample. Finally, 381 rms are excluded due to missing data.
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Table 1
Sample selection and industry breakdown
Panel A: Sample selection
Number of rms listed on ASX as at 1 January 2004
Exclusions
Financial institutions
Insurance rms
Utility rms
IPO rms
Trusts
Foreign incorporated rms
Firms that are not continuously listed
Missing data
Total number excluded
Sample pool for random selection
Number randomly selected by quartiles per year
Excluded due to missing data
Final usable sample
Panel B: Sample firm break down by industry
ASX Industry
Consumer discretionary
Consumer staples
Energy
Health care
Industrials
Information technology
Materials
Telecommunication services
Total
2,128
(133)
(10)
(30)
(106)
(92)
(64)
(222)
(381)
100*5
No. Firm-Year
Observations
80
19
35
70
128
34
115
13
494
(1,038)
1,090
500
(6)
494
% of Sample
16.194
3.846
7.085
14.170
25.911
6.883
23.279
2.632
100
nonaccounting nancial expertise). In the case of accounting nancial

expertise, the variable denoted Expt_Accjt is given a score of 1 if the audit
committee has at least one member with accounting nancial expertise (i.e.
professional qualications and/or experience as a public accountant, auditor,
principal or chief nancial ocer, controller, principal or chief accounting
ocer) at the end of year t. The variable denoted Expt_CEOjt is given a score of
1 if the audit committee has at least one member with nonaccounting nancial
expertise (i.e. experience as a CEO or president of a for-prot rm) at the end
of year t.
3.3. Measurement of control variables
This study utilises a number of control variables to proxy for the demand for
conservatism. The specic control variables included are audit committee size,
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audit committee independence, duality, rm size, leverage, growth options and

industry type. Control variables are dened in Appendix 1. Past literature on
audit committees suggests that audit committee size aects audit committee
eectiveness (Beasley and Salterio, 2001). For this study, audit committee size
(denoted ACSizejt) is measured as the total number of individuals on the audit
committee. Corporate governance regulators and scholars also frequently
maintain that audit committees comprised either entirely or by a majority of
independent directors are successful in improving the quality of reported
earnings (Klein, 2002; ASX Corporate Governance Council, 2010). Consistent
with past literature, audit committee independence (denoted ACIndjt) is
measured using a dichotomous measure equal to 1 if a majority of the audit
committee is comprised of independent directors. Past research suggests that
the separation of the board chairperson and CEO roles improves the quality of
the nancial reporting process (Lim, 2011). A dichotomous measure is used to
measure duality (denoted Dualityjt) with a rm receives a one if the same
individual holds the roles of chairperson of the board and CEO at the end of
the year. The majority of prior research reveals a negative association between
earnings conservatism and rm size, suggesting less demand for conservatism
by larger rms (Givoly et al., 2007; Lafond and Watts, 2008). To control for
rm size, the variable denoted LnBVTAjt is measured as the natural logarithm
of total assets. Researchers (Goh and Li, 2011) also argue that higher leverage
levels tend to create greater bondholder shareholder conicts that increase the
demand for conservative accounting practices. Thus, the variable Levjt (i.e. sum
of long-term debt and current liabilities of rm deated by total assets) is used
to control for nancial leverage. Past literature also infers that a rms growth
options can inuence the demand for conservative accounting (Lafond and
Roychowdhury, 2008). To control for growth option eects, the market-tobook ratio (dened as the ratio of the market value of equity to the book value
of equity) is used (denoted MTBjt). Finally, Givoly et al. (2007) assert that the
degree of conservatism exhibited by a rm varies across dierent industries.
Consistent also with past Australian studies (Lim, 2011), a dichotomous
variable denoted Industryjt is included, whereby a score of 1 is given if the
primary operations are within a particular ASX Global Industry Classication
Standard (GICS) industrial or materials industry sector.
3.4. Measurement of earnings conservatism
Prior research (Basu, 1997; Ball and Shivakumar, 2005) suggests that
earnings conservatism can be conceptualised in several dierent ways. Two
dominant views detailed in the past literature depict earnings conservatism as a
function of either (i) timeliness of earnings to news (Basu, 1997), or (ii) accrualbased loss recognition (Ball and Shivakumar, 2005). To ensure a comprehensive analysis, this study employs both these market-based and accrual-based
views of the earnings conservatism concept. As used in the majority of prior
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earnings conservatism research, measures of earnings conservatism focusing on

timeliness draw on the methodology developed by Basu (1997). With respect to
the accrual-based loss recognition perspective of earnings conservatism, the
approach of Ball and Shivakumar (2005) based on the dierence in current
period accruals and cash ows is adopted.7
3.4.1. Timeliness of earnings to news
The Basu (1997)8 seminal methodology to measure the timeliness of earnings
conservatism is grounded in the assumption that the timeliness of earnings is
asymmetric. Basu (1997) argues that earnings are more likely to fully reect
negative news (as shown in contemporaneous stock returns) than positive news.
As shown in Equation (1), the timeliness of earnings is inferred from the
responsiveness of accounting income to changes in market value (Basu, 1997).
Negative market-adjusted stock returns proxy for bad news, whereas positive
returns proxy for good news. The asymmetric recognition of bad news relative
to good news is captured by a positive coecient on RRAjt*DRjt in the
following equation:
Xjt b0 b1 DRjt b2 RRAjt b3 RRAjt DRjt ejt
where Xjt is the operating prot after tax deated by market value of equity at
beginning of the scal year, DRjt is an indicator variable equal to 1 if RRAjt is
negative, and RRAjt is the annual share returns for the rm from 3 months
after the previous scal year to 3 months after the current scal year, adjusted
for the All Ordinaries Index over the same period.
To test H1, Equation (2) is developed. If audit committee members
with overall nancial expertise inuence conservatism, the coecient on
7
To calculate the earnings conservatism variables, share price data are obtained from
DataStream whilst accounting-related information is obtained from the FinAnalysis/
DatAnalysis Aspect Huntley Financial Database. Data for the three types of audit
committee nancial expertise are hand collected from the 2004-2008 annual reports of
each selected rm. Annual reports were obtained from the Annual Reports Collection
(Connect 4 Pty Ltd) and the FinAnalysis/DatAnalysis Aspect Huntley Financial
Database.
Although the Basu (1997) model is the most commonly used method to measure the
timeliness of earnings conservatism, it is not without limitations (Ball and Shivakumar,
2005; Dietrich et al., 2007). Dietrich et al. (2007), for example, argue that the dierence
in slopes predicted and reported by the Basu (1997) timeliness model reects sample
variance ratio and sample truncation biases. In addition, Ball and Shivakumar (2005)
note that the reverse regression approach assumes asymmetrical and ecient reaction to
economic news. Therefore, taking the limitations of the Basu (1997) model into account
and in an eort to capture an additional dimension to earnings conservatism, an
alternative measure of earnings conservatism proposed by Ball and Shivakumar (2005)
is also used.
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RRAjt*DRjt*Exptjt is expected to be positive and signicant. Equation (2) is

formally dened as follows:
Xjt b0 b1 DRjt b2 RRAjt b3 RRAjt DRjt k1 Exptjt
k2 DRjt Exptjt k3 RRAjt Exptjt k4 RRAjt DRjt Exptjt
X
9
Control Variables
d Yeark ejt:
k1 k
To test H2a and H2b, Exptjt in Equation (2) is replaced with Expt_Accjt,
Expt_CEOjt, and nally, to determine the incremental eects of accounting and
nonaccounting nancial expertise on conservatism, Exptjt is replaced with both
Expt_Accjt and Expt_CEOjt concurrently. See Appendix 1 for the denitions of
all variables.
3.4.2. Accrual-based loss recognition
Whilst the Basu (1997) timeliness of earnings to news model focuses on the
timely recognition of negative news in share prices, Ball and Shivakumar (2005)
introduced a model based on the extent to which accruals are timely in
reecting cash ows. In the Ball and Shivakumar (2005) model, operating cash
ows are used to determine bad news and good news. Specically, Ball and
Shivakumar (2005) argue that conservatism exists when negative cash ows are
recognised earlier than positive cash ows. Equation (3) details the Ball and
Shivakumar (2005) model where the coecient on CFOjt*DCFOjt is predicted
to be positive and signicant if conservatism exists:
ACCjt b0 b1 DCFOjt b2 CFOjt b3 CFOjt DCFOjt ejt
where ACCjt is accruals (i.e. dierence between operating prot and cash ow
from operations) scaled by the book value of total assets at the beginning of the
scal year, DCFOjt is an indicator variable equal to 1 if CFOjt is negative, CFOjt
is cash ow from operating activities scaled by the book value of total assets at
the beginning of the scal year.
9
Consistent with past published literature on conservatism, a number of interaction

variables are used in this study (Goh and Li, 2011). As interaction variables increase the
likelihood of multicollinearity problems, every caution is taken to meticulously identify
any signicant multicollinearity problems. In some isolated cases, the variance ination
factors are found to be higher than the preferred threshold of 10 (Hair et al., 1995). This
occurs only in the case of interactions used with control variables and does not have any
impact on the main predictor variables. However, to manage any multicollinearity
problems, regressions are reperformed excluding the interactions but including all
control variables. Moreover, consistent with past literature (Hartmann and Moers,
1999; Goh and Li, 2011), the mean centring approach is also used. Results of the
additional analysis remain largely unchanged from main ndings.
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To examine H1, Equation (4) is developed. If audit committee members with

overall nancial expertise favour conservative accounting practices, the
coecient on CFOjt*DCFOjt*Exptjt is predicted to be positive and signicant.
ACCjt b0 b1 DCFOjt b2 CFOjt b3 CFOjt DCFOjt d1 Exptjt
d2 DCFOjt Exptjt d3 CFOjt Exptjt d4 CFOjt DCFOjt
X
Exptjt Control Variables
d Yeark ejt:
k1 k
To test H2a and H2b, Exptjt in Equation (4) is replaced with Expt_Accjt,
Expt_CEOjt, and nally, to determine the incremental eects of accounting and
nonaccounting nancial expertise on conservatism, Exptjt is replaced with both
Expt_Accjt and Expt_CEOjt concurrently. See Appendix 1 for the denition of
all variables.
4. Empirical results
4.1. Descriptive statistics and correlations
Table 2 reports descriptive statistics for the nal useable sample. Average
deated operating prot after tax (Xjt) for the nal useable sample is negative,
whilst the median value is positive. In comparison, average market-adjusted stock
returns (RRAjt) for the nal useable sample are positive with the median being
negative. Importantly, the negative (positive) skewness of earnings (returns) is
consistent with the asymmetric timeliness of earnings and returns (Basu, 1997).
The mean and median for total accruals as a proportion of total assets (ACCjt) are
negative (i.e. 0.49 and 0.18 respectively). The results for ACCjt suggest the
existence of conservatism in the nancial reporting by rms in the sample.
The average (median) number and proportion of directors (#Expt_Accjt and
%Expt_Accjt) on the audit committee deemed as having accounting nancial
expertise are 0.97 (1.00) and 31.39 per cent (33.33 per cent), respectively. For
the nal useable sample, the average (median) number of audit committee
members (#Expt_CEOjt) with prior experience as a CEO or managing director
is 0.45 (0.00). This represents an average proportion of audit committee
members having prior experience as a CEO or managing director (%
Expt_CEOjt) of 14.10 per cent. A total of 379 (or 76.72 per cent) rm-year
observations have at least one director on the audit committee either with
accounting or nonaccounting nancial expertise (see Exptjt). In total, 274 (or
55.47 per cent) rm-year observations in the nal useable sample have at least
one director on the audit committee with accounting nancial expertise (see
Expt_CEOjt). There are 179 (or 36.24 per cent) rm-year observations in the
nal useable sample that have at least one director on the audit committee with
2013 AFAANZ
2013 AFAANZ
Yes
280
214
379
263
274
Pooled
sample
494
494
494
494
494
Variable
DRjt
DCFOjt
Exptjt
Ind_Exptjt
Expt_Accjt
56.680
43.320
76.721
53.239
55.466
0.021
0.095
0.178
0.134
1.000
33.333
0.000
0.000
3.000
2.000
66.667
38,682
2.140
1.850
0.081
0.074
0.492
0.328
0.970
31.390
0.450
14.095
3.163
1.730
54.626
562,016
3.510
2.239
494
494
494
494
494
494
494
494
494
494
494
494
494
494
Xjt
RRAjt
ACCjt
CFOjt
#Expt_Accjt
%Expt_Accjt
#Expt_CEOjt
%Expt_CEOjt
ACSIZEjt
#ACINDjt
%ACINDjt
BVTAjt ($000)
MTBjt
LEVjt
Panel B: Dichotomous variables
Median
Mean
Pooled
sample
Variables
Panel A: Continuous variables
Table 2
Descriptive statistics
0.356
1.134
0.974
0.702
0.890
28.847
0.695
21.344
0.946
1.297
37.778
1,561,076
6.970
2.814
Standard
deviation
214
280
115
231
220
No
2.707
1.225
8.991
0.188
0.000
0.000
0.000
0.000
1.000
0.000
0.000
61
19.130
10.730
Minimum
43.320
56.680
23.279
46.761
44.534
1.578
19.490
2.232
9.760
3.000
100.000
3.000
100.000
6.000
6.000
100.000
14,929,000
110.170
36.490
Maximum
2013 AFAANZ
179
133
92
87
57
243
494
494
494
494
494
494
Expt_CEOjt
ACCONLYjt
CEOONLYjt
BothExptjt
DUALITYjt
Industryjt
36.235
26.923
18.623
17.611
11.538
49.190
70.526
75.258
77.000
78.000
84.000
2004
2005
2006
2007
2008
56.842
59.739
66.000
68.000
70.000
Expt_Accjt
34.737
36.082
37.000
35.000
38.000
Expt_CEOjt
20.000
26.804
26.000
29.000
33.000
ACCONLYjt
16.666
20.408
19.000
16.000
21.000
CEOONLYjt
315
361
402
407
437
251
No
16.842
14.432
18.000
20.000
19.000
BothExptjt
63.765
73.076
81.377
82.388
88.462
50.810
All continuous variables (except log transformed variables) are winsorised at one per cent and 99 per cent. Refer to Appendix 1 for the denition
of variables.
Exptjt
Year
Panel C: Presence nancial experts proportion of sample rms over 5 years
Yes
Pooled
sample
Variable
Panel B: Dichotomous variables
Table 2 (continued)
nonaccounting nancial expertise (see Expt_CEOjt). In addition, a total of 263

(or 53.24 per cent) rm-year observations have independent directors
(Expt_Indjt) on the audit committee deemed as having nancial expertise.
About 26.92 per cent of the rm-year observations have only one accounting
nancial expert on the audit committee (ACCONLYjt), whilst 17.61 per cent of
the rm-year observations have both accounting and nonaccounting experts on
the audit committee (BothExptjt).
With respect to control variables, the average size of an audit committee
(ACSIZEjt) within the pooled sample is 3.16. The average percentage of
independent audit committee members is 54.63 (%ACINDjt). Approximately
88 per cent of the rm-year observations have a chairman who is not a current
CEO (DUALITYjt). The average (median) total assets (BVTAjt) are
$562,016,000 ($38,683,000) for the pooled sample, whilst average market-tobook ratio (MTBjt) for the pooled sample is 3.51, indicating the presence of
growth opportunities for the sample rms. The average (median) leverage
(LEVjt) for the pooled sample is 2.24 (1.85) indicating that rms in the pooled
sample are at various stages of rm risk.
Table 3 presents a correlation matrix reporting correlation results for all the
variables utilised in this study. Values reported in the bottom-left corner are
based on Pearsons correlations, whilst those in the top-right corner are based
on Spearmans correlations.
The correlation matrix indicates that two of the three audit committee
nancial expertise measures (Exptjt and Expt_Accjt) are positively and significantly (for both Pearsons and Spearmans correlations) associated with Xjt and
ACCjt. Expt_CEOjt is shown to be positively and signicantly associated with
ACCjt but not with Xjt for both the Pearsons and Spearmans correlations. In
general, correlations between the dependent and independent variables suggest
that audit committee eectiveness components are, in the main, signicantly
associated with the asymmetric timeliness of earnings conservatism.
The dependent and independent variables are also signicantly correlated
with several control variables. For instance, Xjt and ACCjt are positively and
signicantly associated with audit committee independence (ACINDjt) and rm
size (LnBVTAjt) for both the Pearsons and Spearmans correlations, whilst
Exptjt and Expt_Accjt are positively and signicantly correlated with audit
committee size (ACSIZEjt), audit committee independence (ACINDjt) and rm
size (LnBVTAjt) but negatively and signicantly correlated with CEO duality
(Dualityjt).
4.2. Multivariate regression results
4.2.1. Timeliness of earnings to news
Table 4 reports the results of a series of pooled regressions estimating the
eects of audit committee nancial expertise on the asymmetric timeliness of
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0.590**
0.095***
0.256**
0.031
0.096
0.335**
0.077
0.397**
0.141**
0.068
0.033
Xjt [1]
ACCjt [2]
Exptjt [3]
Expt_Accjt [4]
Expt_CEOjt [5]
ACSIZEjt [6]
ACINDjt [7]
Dualityjt [8]
LnBVTAjt [9]
MTBjt [10]
LEVjt [11]
Industryjt [12]
0.148**
0.244**
0.085
0.039
0.306**
0.080
0.406
0.122**
0.049
0.051
0.641**
[2]
0.494**
0.415**
0.121**
0.261**
0.095***
0.279**
0.015
0.090***
0.062
0.135**
0.156**
[3]
0.062
0.159**
0.462**
0.158**
0.509**
0.086
0.005
0.034
0.317**
0.341**
0.494**
[4]
0.168**
0.113***
0.132**
0.233**
0.002
0.058
0.068
0.071
0.140**
0.415***
0.062
[5]
0.225**
0.531**
0.027
0.030
0.026
0.336**
0.372**
0.261**
0.462**
0.113***
0.045
0.034
0.078
0.133**
0.156**
0.180**
0.058
0.119**
0.154**
0.018
0.030
0.035
[7]
[6]
0.355**
0.076
0.035
0.124**
0.125**
0.219**
0.095***
0.158**
0.132**
0.136**
0.225**
[8]
0.110***
0.008
0.001
0.552**
0.676**
0.284**
0.516**
0.226**
0.147**
0.536**
0.330**
[9]
0.042
0.097***
0.035
0.140**
0.049
0.012
0.110***
0.039
0.131**
0.136**
0.004
[10]
0.052
0.202**
0.266**
0.154**
0.132**
0.143**
0.073
0.118**
0.027
0.313
0.035
[11]
0.202
0.086
0.062
0.034
0.068
0.069
0.026
0.124
0.007
0.054
0.004
[12]
Tests are two-tailed. ** and *** denote signicance at the 5 per cent and 1 per cent condence levels, respectively. Refer to Appendix 1 for the
denition of variables.
[1]
Variables
Table 3
Pearsons and Spearmans correlation analyses
2013 AFAANZ
0.056
0.124
0.111
0.256
Intercept
DRjt
RRAjt
RRAjt*DRjt
Expt_ACEjt
DRjt*Exptjt
RRAjt*Exptjt
RRAjt*DRjt*Exptjt
Expt_Accjt
DRjt*Expt_Accjt
RRAjt*Expt_Accjt
RRAjt*DRjt*Expt_Accjt
Expt_CEOjt
DRjt*Expt_CEOjt
RRAjt*Expt_CEOjt
RRAjt*DRjt*Expt_CEOjt
Control Variables
Yeark
Adjusted-R2
N
F-Statistic
(2.661)***
(0.846)
(0.384)
(1.966)**
(1.231)
(2.211)**
(4.110)***
(3.602)***
0.501
0.238
0.096
0.660
0.047
0.072
0.060
0.362
0.485
0.239
0.103
0.579
0.027
0.102
0.005
0.394
Included
Included
0.637
494
25.735***
Included
Included
0.634
494
25.387***
(Expt_Accjt)
(Exptjt)
(2.681)***
(0.877)
(0.421)
(1.746)*
(0.546)
(1.368)
(0.067)
(2.366)**
Column III
Column II
(2.343)**
(1.078)
(0.113)
(1.928)*
0.011 (0.236)
0.083 (1.223)
0.047 (0.780)
0.147 (1.231)
Included
Included
0.637
494
25.699***
0.448
0.304
0.030
0.361
(CEOjt)
Column IV
(2.371)**
(1.040)
(0.028)
(1.789)*
0.050 (1.176)
0.081 (2.466)**
0.062 (4.199)***
0.368 (3.549)***
0.010 (0.225)
0.086 (1.242)
0.050 (0.827)
0.461 (1.215)
Included
Included
0.635
494
22.959***
0.472
0.306
0.007
0.464
(Both Expt_Accjt
and CEOjt)
Column V
*, ** and *** denote signicance at the 10 per cent, 5 per cent and 1 per cent condence levels, respectively. Coecient values are shown outside
the parentheses with t-statistics (robust and clustered) values shown inside the parentheses. Results presented in Columns IV are based on
Equations (1) and (2). Refer to Appendix 1 for the denition of variables.
Included
Included
0.115
494
22.427***
(2.214)**
(2.933)***
(7.128)
(3.678)***
(Base model)
Variables
Column I
Table 4
Regression analysis using the timeliness of earnings to news measure (Basu, 1997)
earnings. All reported results are based on HuberWhite robust standard errors
clustered at both year and rm level. Results in Table 4 Column I based on the
original Basu (1997) asymmetric timeliness of earnings model (without
inclusion of independent and control variables) indicate the existence of
conservatism in general as the b3 coecient on the two-way interaction term
RRAjt*DRjt is signicant and positive.
With respect to the variable of interest, audit committee overall nancial
expertise, Table 4 Column II results indicate that the coecient (i.e. k4) on
RRAjt*DRjt*Exptjt is signicant at the 5 per cent level. Table 4 Column III
results indicate that RRAjt*DRjt*Expt_Accjt is signicant when examining the
relationship between only accounting nancial expertise (Expt_Accjt) and
conservatism. However, when accounting nancial expertise (Expt_Accjt) is
replaced with nonaccounting nancial expertise (Expt_CEOjt), the coecient
on RRAjt*DRjt*Expt_CEOjt is not signicant (see Table 4 Column IV). In
contrast, the coecient on RRAjt*DRjt*Expt_Accjt (see Table 4 Column V) is
positive and statistically signicant at the 1 per cent level when both Expt_Accjt
and Expt_CEOjt are included in the model. Overall, Table 4 results suggest that
accounting nancial expertise is the primary type of expertise that promotes the
asymmetrical timeliness of earnings (i.e. swifter recognition of economic losses
relative to gains).
With respect to control variables, audit committee size and independence are
negatively associated with the asymmetrical timeliness of conservatism across
Table 4 Columns IIV. Duality, rm size and leverage are not signicant in any
of the regression results. In contrast, a rms growth options are found to be
positively and signicantly associated with conservatism across all regressions
reported in Table 4. Finally, Table 4 Columns IIV results show that the
adjusted R2 ranges from 11.5 per cent for the base model to over 63 per cent for
the augmented models.
4.2.2. Accrual-based loss recognition
Table 5 presents regression results based on the accrual-based asymmetric
timeliness of accruals measure developed by Ball and Shivakumar (2005) and
modied to measure the incremental conservatism associated with audit
committee nancial expertise. Results shown in Table 5 Column I utilise the
base model derived by Ball and Shivakumar (2005) as dened in Equation (3).
The directionality (i.e. positive) of the coecient on CFOjt*DCFOjt (i.e. b3) is
as predicted. The coecient is statistically signicant indicating that when
accruals are lower, cash ows are higher, suggesting the presence of earnings
conservatism. The b3 coecient is positive and statistically signicant across
the remaining regressions shown in Table 5 Columns II V after the inclusion
of independent and control variables.
With regard to the audit committee nancial expertise measure, the d4
coecient on the three-way interaction term CFOjt*DCFOjt*Exptjt is
2013 AFAANZ
2013 AFAANZ
(1.506)
(0.468)
(1.613)
(3.080)***
0.183
0.078
0.252
0.987
Included
Included
0.958
494
324.796***
(0.735)
(1.170)
(11.190)***
(2.515)**
0.091
0.132
2.255
1.470
(0.828)
(1.341)
(11.868)***
(2.739)***
0.020 (0.624)
0.022 (0.545)
0.135 (3.213)***
0.136 (0.994)
Included
Included
0.957
494
314.970***
0.120
0.147
2.297
1.587
(CEOjt)
Column IV
(0.814)
(1.234)
(11.557)***
(2.566)**
0.017 (1.369)
0.051 (0.359)
0.242 (1.405)
0.937 (2.868)***
0.019 (0.482)
0.019 (0.469)
0.132 (2.893)***
0.122 (0.884)
Included
Included
0.958
494
289.782***
0.100
0.138
2.303
1.506
(Both Expt_Accjt
and CEOjt)
Column V
Equations (34). Refer to Appendix 1 for the denition of variables.
Included
Included
0.727
494
436.969***
(0.416)
(1.325)
(11.412)***
(2.633)***
(0.228)
(1.146)
(0.264)
(1.844)*
Included
Included
0.957
494
312.648***
0.052
0.147
2.275
1.554
0.008
0.104
0.035
0.758
(0.262)
(1.731)*
(32.364)***
(12.784)***
0.009
0.084
1.097
1.588
Intercept
DCFOjt
CFOjt
CFOjt*DCFOjt
Expt_ACEjt
DCFOjt*Exptjt
CFOjt*Exptjt
CFOjt*DCFOjt*Exptjt
Expt_Accjt
DCFOjt* Expt_Accjt
CFOjt*Expt_Accjt
CFOjt*DCFOjt*Expt_Accjt
Expt_CEOjt
DCFOjt*Expt_CEOjt
CFOjt*Expt_CEOjt
CFOjt*DCFOjt*Expt_CEOjt
Control Variables
Yeark
Adjusted-R2
N
F-Statistic
(Expt_Accjt)
(Exptjt)
(Base model)
Column III
Column II
Variables
Column I
Table 5
Regression analysis using the accrual-based loss recognition measure (Ball and Shivakumar, 2005)
positive and statistically signicant at the 10 per cent level in regression

results reported in Table 5 Column II. Similarly, the coecient on
CFOjt*DCFOjt*Expt_Accjt is also positive and statistically signicant at the
1 per cent level indicating a greater association between accounting nancial
expertise and conservatism. The coecient on CFOjt*DCFOjt*Expt_CEOjt is
positive but statistically insignicant (see Table 5 Column IV). In contrast,
the coecient on CFOjt*DCFOjt*Expt_Accjt is positive and statistically
signicant at the 1 per cent level when both accounting expertise and
nonaccounting nancial expertise are included in the model. Table 5
Columns II V results relating to the three measures of audit committee
nancial expertise suggest that the presence of members on the audit
committee with accounting nancial expertise has a greater association with
asymmetrical loss recognition through accruals rather than gain recognition
(i.e. indicating greater conservatism).
With respect to control variables, audit committee size is found to be
signicant and positively associated with conservatism across all regressions
reported in Table 5 Columns II V. However, audit committee independence and duality are not signicant in any of the regression results.
Findings reported in Table 5 Columns II V also highlight a signicant
negative association between the asymmetric timeliness of accruals and rm
size. In contrast, a rms growth options and leverage are shown to be
positively and signicantly associated with the asymmetric timeliness of
accruals. Industry type is also found to be positively and signicantly
associated with swifter recognition of bad news via accruals. Finally, Table 5
Columns IIV results also show that the adjusted R2 ranges from 72.7 per
cent to 95.8 per cent.
In summary, results are mostly consistent with hypotheses. Specically,
ndings (reported in Tables 4 and 5) indicate a signicant association between
audit committee overall nancial expertise and both measures of conservatism
providing support for H1. When the analysis is limited to accounting nancial
expertise, the positive association with earnings conservatism becomes
stronger. Results therefore also provide support for H2a. Both Tables 4 and
5 results suggest an insignicant association between the asymmetrical
timeliness of conservatism (via both earnings and accruals) and audit
committee nonaccounting nancial expertise providing therefore no support
for H2b.
4.3. Additional tests
4.3.1. Independence of financial experts
Prior research (Klein, 2002) indicates that the ability (and potential
willingness) of an audit committee nancial expert to contribute positively to
the subcommittees eectiveness hinges on that individuals relationship with
2013 AFAANZ
the rm (i.e. executive, nonexecutive or independent director). Corporate

governance advocates, regulators and scholars frequently argue that an audit
committee with a higher proportion of outside directors is less likely to be
compromised in undertaking the subcommittees roles and responsibilities.
Furthermore, a more independent audit committee is argued to be better able
enhance earnings quality (Klein, 2002; Agrawal and Chadha, 2005). Thus, to
further explore the nancial expert/earnings conservatism linkage in recognition of the importance of audit committee member independence, each of the
three variables representing nancial expertise is replaced by two dummy
variables where one is coded 1 if the audit committee includes at least one
accounting or nonaccounting nancial expert (i.e. Exptjt, Expt_Accjt and
Expt_CEOjt, respectively) who is independent (Ind_Exptjt, Ind_ACCjt and
Ind_CEOjt) and the other is coded 1 if the audit committee includes at least
one accounting or nonaccounting nancial expert who is nonindependent
(Non_Ind_Exptjt, Non_Ind_ACCjt and Non_Ind_CEOjt). The denition of
independence used is consistent with ASX CGC (2003) requirements and
recommendations10 and prior related corporate governance empirical research
(Lim 2010). The following regressions are estimated to examine the inuence of
the independence of the various types of audit committee nancial experts on
conservatism for both Basu (1997) and Ball and Shivakumar (2005):
Xjt b0 b1 DRjt b2 RRAjt b3 RRAjt DRjt d1 Ind Exptjt
d2 DRjt Ind Exptjt d3 RRAjt Ind Exptjt
d4 RRAjt DRjt Ind Exptjt h1 Non Ind Exptjt
h2 DRjt Non Ind Exptjt h3 RRAjt Non Ind Exptjt
h4 RRAjt DRjt Non Ind Exptjt
X
Control Variables
d Yeark ejt
k1 k
ACCjt b0 b1 DCFOjt b2 CFOjt b3 CFOjt DCFOjt d1 Ind Exptjt

d2 DCFOjt Ind Exptjt d3 CFOjt Ind Exptjt
d4 CFOjt DCFOjt Ind Exptjt h1 Non Ind Exptjt
h2 DCFOjt Non Ind Exptjt h3 CFOjt Non Ind Exptjt
h4 CFOjt DCFOjt Non Ind Exptjt Control Variables

X
d Yeark ejt
k1 k
10
According to ASX CGC 2003 Recommendation 2, an independent director is a nonexecutive director who is not a member of management and who is free of any business
or other relationship that could materially interfere with or could reasonably be
perceived to materially interfere with the independent exercise of their judgement (ASX
Corporate Governance Council, 2003).
2013 AFAANZ
Ind_Exptjt and Non_Ind_Exptjt in Equations (5) and (6) are replaced with
Ind_ACCjt/Non_Ind_ACCjt and Ind_CEOjt/Non_Ind_CEOjt when measuring
the inuence of independent/nonindependent accounting nancial expertise and independent/nonindependent nonaccounting nancial expertise on
conservatism. Finally, to determine incremental eects, Ind_Exptjt and
Non_Ind_Exptjt in Equations (5) and (6) are replaced with both Ind_ACCjt/
Non_Ind_ACCjt and Ind_CEOjt/Non_Ind_CEOjt concurrently. See Appendix 1
for the denition of all variables.
Tables 6 (timeliness of earnings to news model) and 7 (accruals-based loss
recognition model) present results considering the impact of independent and
nonindependent audit committee nancial experts on conservatism. The results
from both Table 6 Column I and Table 7 Column I reveal that independent
overall nancial expertise is positively associated with conservatism. Results
from Columns II and IV of both Tables 6 and 7 suggest that the association
between conservatism and accounting expertise is most pronounced when the
audit committee accounting expert/s are also independent. However, nonaccounting nancial experts are consistently not associated with conservatism
regardless of their level of independence. Results suggest that accounting
nancial experts who are independent are most likely to promote conservative
accounting practices.
4.3.2. Alternative measures of earnings conservatism
Several robustness and sensitivity tests are undertaken to check the resilience
of the main results reported in Tables 4 and 5. Past studies (Givoly and Hayn,
2000; Khan and Watts, 2009) suggest that a limitation of using the Basu (1997)
and Ball and Shivakumar (2005) models is an over reliance on the calculation
of average measures of conservatism for both time and across rms reducing
the generalisability of ndings.
To further test the strength of the association between audit committee
eectiveness and conservatism, the C-SCORE approach developed by Khan
and Watts (2009) is used, where a higher C-SCORE indicates greater
conservatism. Consistent with the main ndings presented in Table 4, results
(untabulated) using the Khan and Watts (2009) C-SCORE approach
continue to show a signicant association between conservatism and the
presence of audit committee members with overall nancial expertise
(t = 2.011) and accounting nancial expertise (t = 3.362). In addition, to
further corroborate the main ndings, a second accrual-based approach
(CON-ACC) developed by Givoly and Hayn (2000) is used. This approach
is measured as income before extraordinary items less cash ows from
operations plus depreciation divided by average total assets, averaged over a
ve-year period before year t. Using the Givoly and Hayn (2000) approach,
a lower CON-ACC indicates the existence of conservatism. When the CONACC measure is used, results (untabulated) show that presence of audit
2013 AFAANZ
2013 AFAANZ
(0.681)
(1.515)
(0.258)
(3.053)***
(0.316)
(0.035)
(0.144)
(0.404)
0.063
0.026
0.028
0.618
0.018
0.003
0.023
0.106
(2.171)**
(0.521)
(0.005)
(0.205)
0.025 (0.405)
0.023 (0.242)
0.003 (0.033)
0.003 (0.018)
0.034 (0.562)
0.001 (0.006)
0.079 (1.041)
0.097 (0.690)
Included
Included
0.642
494
21.524***
0.440
0.170
0.001
0.135
Column III
(2.243)**
(0.429)
(0.511)
(0.084)
0.098 (0.899)
0.156 (1.023)
0.086 (0.578)
0.766 (2.999)***
0.049 (0.579)
0.039 (0.306)
0.132 (0.995)
0.040 (0.132)
0.007 (0.083)
0.041 (0.357)
0.075 (0.697)
0.079 (0.963)
0.040 (0.650)
0.001 (0.016)
0.099 (1.274)
0.111 (0.703)
Included
Included
0.641
494
23.668***
0.048
0.148
0.151
0.059
Column IV
Equation (5). Refer to Appendix 1 for the denition of variables.
Included
Included
0.620
494
28.503***
Included
Included
0.632
494
26.821***
(2.385)**
(0.267)
(0.217)
(0.276)
0.475
0.080
0.062
0.170
0.222
0.032
0.042
0.155
0.056
0.011
0.042
0.656
0.066
0.042
0.028
0.732
Intercept
DRjt
RRAjt
RRAjt*DRjt
Ind_Exptjt
DRjt*Ind_Exptjt
RRAjt*Ind_Exptjt
RRAjt*DRjt*Ind_Exptjt
Non_Ind_Exptjt
DRjt*Non_Ind_Exptjt
RRAjt*Non_Ind_Exptjt
RRAjt*DRjt*Non_Ind_Exptjt
Ind_ACCjt
DRjt*Ind_ACCjt
RRAjt*Ind_ACCjt
RRAjt*DRjt*Ind_ACCjt
Non_Ind_ACCjt
DRjt*Non_Ind_ACCjt
RRAjt*Non_Ind_ACCjt
RRAjt*DRjt*Non_Ind_ACCjt
Ind_CEOjt
DRjt*Ind_CEOjt
RRAjt*Ind_CEOjt
RRAjt*DRjt*Ind_CEOjt
Non_Ind_CEOjt
DRjt*Non_Ind_CEOjt
RRAjt*Non_Ind_CEOjt
RRAjt*DRjt*Non_Ind_CEOjt
Control Variables
Yeark
Adjusted-R2
N
F-Statistic
(1.706)*
(0.215)
(0.186)
(0.392)
(1.982)**
(0.347)
(2.471)**
(2.829)***
(2.334)**
(1.434)
(1.794)*
(1.104)
Column II
Column I
Variables
Table 6
Regression analysis using the timeliness of earnings to news (Basu, 1997) and the independence of nancial experts
0.142
0.029
1.047
1.679
0.148
0.295
0.066
1.389
0.146
0.238
0.119
0.376
Intercept
DCFOjt
CFOjt
CFOjt*DCFOjt
Ind_Exptjt
DCFOjt*Ind_Exptjt
CFOjt*Ind_Exptjt
CFOjt*DCFOjt*Ind_Exptjt
Non_Ind_Exptjt
DCFOjt*Non_Ind_Exptjt
CFOjt*Non_Ind_Exptjt
CFOjt*DCFOjt*Non_Ind_Exptjt
Ind_ACCjt
DCFOjt*Ind_ACCjt
CFOjt*Ind_ACCjt
CFOjt*DCFOjt*Ind_ACCjt
Non_Ind_ACCjt
DCFOjt*Non_Ind_ACCjt
CFOjt*Non_Ind_ACCjt
CFOjt*DCFOjt*Non_Ind_ACCjt
Ind_CEOjt
DCFOjt*Ind_CEOjt
CFOjt*Ind_CEOjt
CFOjt*DCFOjt*Ind_CEOjt
Non_Ind_CEOjt
DCFOjt*Non_Ind_CEOjt
CFOjt*Non_Ind_CEOjt
CFOjt*DCFOjt*Non_Ind_CEOjt
Control Variables
Yeark
Adjusted-R2
N
F-Statistic
2013 AFAANZ
(1.891)*
(0.342)
(0.054)
(5.743)***
(1.264)
(0.091)
(0.905)
(1.402)
0.159
0.036
0.005
1.088
0.115
0.010
0.114
0.657
Included
Included
0.967
494
378.126***
(0.745)
(0.539)
(7.511)
(6.562)***
0.151
0.069
0.912
1.629
Column II
(0.023)
(0.428)
(23.745)***
(7.393)***
0.071 (0.803)
0.034 (0.255)
0.155 (1.388)
0.447 (0.782)
0.006 (0.052)
0.003 (0.016)
0.024 (0.238)
0.066 (0.121)
Included
Included
0.902
494
376.032***
0.009
0.038
1.043
1.811
Column III
(0.697)
(0.598)
(5.739)***
(6.056)***
0.122 (1.262)
0.020 (0.170)
0.061 (0.495)
1.060 (5.600)***
0.059 (0.511)
0.026 (0.177)
0.003 (0.015)
0.567 (1.394)
0.115 (1.052)
0.040 (0.305)
0.155 (1.031)
0.104 (0.294)
0.015 (0.130)
0.089 (0.665)
0.052 (0.521)
0.173 (0.687)
Included
Included
0.966
494
376.954***
0.145
0.090
1.023
1.626
Column IV
Equation (6). Refer to Appendix 1 for the denition of variables.
Included
Included
0.944
494
372.918***
(0.247)
(0.246)
(24.584)
(6.709)***
(1.343)
(0.769)
(0.739)
(3.780)***
(1.349)
(0.640)
(1.245)
(0.929)
Column I
Variables
Table 7
Regression analysis using the accrual-based loss recognition measure (Ball and Shivakumar, 2005) and the independence of nancial experts
committee members with overall nancial expertise (for a one-tailed test,

t = 1.620) and accounting nancial expertise (t = 3.681) and are signicantly
associated with increased levels of conservatism. Results using both
alternative measures of conservatism therefore validate the main ndings
of this study.11
4.3.3. Alternative measures of financial expertise
Various alternative proxies are used to measure nancial expertise and
regressions are rerun to determine whether the main results are robust to
these alternative proxy measures of nancial expertise. Specically, three
dichotomous variables are utilised, namely ACCONLYjt, CEOONLYjt and
BothExptjt. ACCONLYjt captures instances where at least one member of
the audit committee is dened as an accounting nancial expert but none of
the remaining audit committee members are dened as a nonaccounting
nancial expert. In contrast, CEOONLYjt captures instances where at least
one member of the audit committee is dened as a nonaccounting nancial
expert but none of the remaining audit committee members are dened as
an accounting nancial expert. Finally, the variable BothExptjt captures
instances where the audit committee includes both accounting and nonaccounting nancial experts. Regressions are reperformed for both Basu (1997)
and Ball and Shivakumar (2005) models using these three types of nancial
expertise. Untabulated results show that earnings conservatism is positively
associated with the presence of (i) an accounting expert only (t = 2.705 and
2.142 for Basu (1997) and Ball and Shivakumar (2005) measures, respectively) and (ii) both experts on the audit committee (t = 1.976 and 1.832 for
Basu (1997) and Ball and Shivakumar (2005) measures, respectively).
However, the results fail to nd any association between earnings conservatism and the presence of only nonaccounting experts on the audit
11
The main tests are also reperformed using alternative proxies for key variables
underpinning the Basu (1997). Researchers (Ahmad-Zaluki et al., 2007) argue that
listed rms that constitute the whole market represent a variety of characteristics that
cannot be easily captured by a single index. Following Ahmad-Zaluki et al. (2007),
market-adjusted returns are recalculated using three alternative indices in an eort to
better control for size and industry biases. First, market-adjusted returns are
calculated using the ASX 200 Index. Second, to better control for size, marketadjusted returns for rms included in the (i) 1st quartile are based on the All
Ordinaries Index, (ii) 2nd quartile are based on the ASX 200 Index, (iii) 3rd quartile
are based on the Mid-Cap 50 Index and (iv) 4th quartile are based on the Small
Ordinaries Index. Finally, in relation to industry dierences, market-adjusted returns
are calculated using an industry index relevant to the major industry sector of each
rm. In addition, regression results are also reperformed using raw returns. Tests
performed using alternative measures provide results highly similar to Table 4
ndings.
2013 AFAANZ
committee. These results are consistent with the main ndings tabulated in
Tables 4 and 5.12
4.3.4. Controlling for endogeneity bias
A concern expressed in the corporate governance literature during the past
decade involves the issue of endogeneity between governance factors and other
contracting mechanisms (Larcker and Richardson, 2004; Brown et al., 2011).13
Based on the corporate governance literature (Beekes et al., 2004; Lim, 2011),
ndings from this study may be subject to omitted variable biases resulting
from the possible omission of other governance mechanisms that can inuence
nancial reporting quality. Although the main ndings of this study are robust
to various control variables, additional tests were performed to identify any
endogenous determination of audit committee nancial expertise that impacts
its relationship with conservative accounting practices.
Consistent with Frankel et al. (2006) and Sun and Cahan (2012), a two-stage
least squares (2SLS) approach is adopted to control for potential endogeneity
problems. The 2SLS requires the identication and use of an instrument
(exogenous variable) in the rst stage which has an impact on the conservative
accounting practices of rms only through audit committee nancial expertise
without any direct inuence on levels of conservatism (Wooldridge, 2010).14
12
Tests were reperformed using continuous proxy measures (i.e. proportion of overall/
accounting/nonaccounting nancial expertise to the total number of audit committee
members) for nancial expertise of audit committee members. Also, a more restrictive
criterion is applied when dening a nancial expert. Specically, each rm is given a
score of 1 only if at least two audit committee members are nancial experts (including
overall, accounting and nonaccounting expertise). Results of additional tests are
qualitatively the same when alternative measures for the audit committee nancial
expertise are used. In addition, further tests are conducted using other control variables
(e.g. board size, board independence, board expertise, board tenure, audit committee
diligence). Again, tests using the additional measures yield highly consistent ndings to
those reported in Tables 4 and 5.
13
Endogeneity can arise either from simultaneous causality where causality runs in both
directions between the dependent and predictor variables or from unobserved
heterogeneity where important predictor variables are omitted from the regression
model (Wooldridge, 2010; Brown et al., 2011). It is unlikely that this study suers from
endogeneity problems arising from simultaneous causality as it is improbable that
conservatism accounting practices will inuence the eectiveness of audit committee
nancial expertise.
14
In the corporate governance literature, it is virtually impossible to obtain a perfect

instrument (Brown et al., 2011; Sun and Cahan, 2012). Therefore, Hentschel and
Kothari (2001) and Sun and Cahan (2012) recommend that a relatively crude measure of
an endogenous variable can, nevertheless, be used as an instrumental variable because it
is likely to capture the level of the variable, but not the endogenously determined
variation around those levels.
2013 AFAANZ
Consistent with Matolcsy et al. (2012), this study uses nomination committee
(i.e. existence, size and independence of nomination committee) characteristics
as instrumental variables. This is because it is more likely that a nomination
committee is associated with audit committee characteristics (including
nancial expertise) without having a direct eect on a rms accounting
practices as the nomination committee is primarily responsible for appointing
board and board subcommittee members (including the audit committee) with
the requisite skills and competencies. The 2SLS regressions are run for all three
models based on the three dierent measures of audit committee nancial
expertise (Exptjt, Expt_Accjt and Expt_CEOjt). In the rst stage, it is estimated
whether each of the three types of audit committee expertise is associated with
nomination committee characteristics. Then, the predicted values (denoted
PExptjt, PExpt_Accjt and PExpt_CEOjt) are obtained for each type of nancial
expertise measure. Subsequently, the predicted values of nancial expertise
from the rst stage are then regressed against conservatism in the second stage
of the 2SLS.
The 2SLS tests yield results signicantly comparable with main results
reported in Tables 4 and 5. Specically, untabulated statistics for Basu (1997)
timeliness of earnings to news measure are t = 1.986 for PExptjt, 2.232 for
PExpt_Accjt and 1.304 for PExpt_CEOjt, respectively. With respect to the Ball
and Shivakumar (2005) accrual-based loss recognition model, the untabulated
statistics are t = 1.843 for PExptjt, 2.610 for PExpt_Accjt and 1.117 for
PExpt_CEOjt, respectively. Thus, results of the second-stage regressions are
largely unchanged after allowing for endogeneity.
Overall, robustness and sensitivity tests provide further support to the main
ndings reported in Tables 4 and 5 having yielded similar results.15
5. Conclusion
In response to major corporate scandals (e.g. HIH, Enron, WorldCom,
One.Tel), the Australian Securities Exchange Corporate Governance Council
introduced a best practice guide known as the Principles of Good Corporate
Governance and Best Practice Recommendations placing greater responsibil15
The time period (i.e. 20042008) of this study transcends the International Financial
Reporting System (IFRS) adoption by Australian rms in 2005. Thus, to control for the
eect of IFRS adoption on the association between audit committee nancial expertise
and earnings conservatism, another robustness test was performed where it is
investigated whether rms in the pre-IFRS period were more conservative than in the
post-IFRS period. The data are partitioned between pre-IFRS (20042005) and postIFRS (20062008) periods and regressions are rerun. Regressions are also rerun using
IFRS as an indicator variable that equals 1 for scal years 20062008 and 0 for scal
years 20042005. Results remain signicantly similar to the main results reported
suggesting that IFRS adoption did not change the demand for conservative accounting
practices by Australian rms.
2013 AFAANZ
ity on a rms audit committee in ensuring the integrity of nancial reporting

(ASX Corporate Governance Council, 2003). Specically, adopting a narrower
denition of nancial expert than its international counterpart (i.e. SEC
2003), the ASX CGC 2003 mandates disclosure, by rms, whether their audit
committees include a nancial expert. This study seeks to examine whether
ASX CGC 2003 is achieving its objective (i.e. safeguarding the integrity in
nancial reporting) by mandating the presence of only accounting nancial
experts on audit committees or whether ASX CGC 2003 should adopt a
broader denition of nancial expertise.
In essence, a major motivation of this study is to identify the type of nancial
expertise most likely to enhance audit committees eectiveness. Using a sample
of 494 rm-year observations from the ASX, ndings of this study suggest that
the eectiveness of an audit committee is likely to be enhanced if members
appointed have accounting nancial expertise. Although results are signicant
for overall nancial expertise, further analysis suggests that accounting
nancial expertise is driving main results rather than overall nancial expertise.
Furthermore, ndings from this study suggest that accounting nancial experts
on the audit committee perform their monitoring role and promote conservative accounting practices only when they are independent. Results are robust to
alternative measures of conservatism, nancial expertise, alternative control
parameters and endogeneity bias. Overall, ndings suggest that independent
audit committee members with accounting nancial expertise are most
inuential in ensuring conservative accounting practices, and in turn, improving the quality of nancial reporting by rms.
Findings add to the growing literature on the association between audit
committee nancial expertise and other measures of nancial reporting quality
(e.g. accruals quality), specically within the Australian context. Findings also
have clear implications for regulators, corporate boards, investors and
researchers. Specically, ndings from this study reveal that improvements in
audit committee eectiveness are likely to be best achieved using a narrower
denition of nancial expertise as opposed to a broader denition. ASX CGC
2003 guidelines therefore by mandating the presence of an accounting nancial
expert on audit committees are achieving their objective by helping audit
committees safeguard integrity in nancial reporting (ASX Corporate
Governance Council, 2003). An implication for rms is that having accounting
nancial experts (as opposed to nonaccounting experts) on the audit committee
will provide greater benet in improving nancial reporting quality. Another
implication for boards is that the appointing accounting nancial experts who
are also independent is most likely to maximise the eectiveness of the audit
committee.
Although this study makes a number of contributions to the growing
literature, it is not without limitations. For instance, the study examines a single
capital market within a selective timeframe (i.e. 20042008). Further, although
IFRS adoption of Australian rms was controlled for, it is not feasible to
2013 AFAANZ
provide a detailed picture of the eect of IFRS adoption on the relationship

between earnings conservatism and audit committee nancial expertise due to
the time period of this study. Once IFRS is established over time and current
data become available, future research could examine whether results of this
study persist or change in the post-IFRS period.
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Appendix 1: Definition of variables

Variables
Denition
Xjt
Operating prot after tax of rm j deated by market value of equity

[MVEt1 - market capitalisation of rm j at beginning of the scal year t] of
rm j at beginning of the scal year t
Indicator variable where rm j is scored 1 if RRAjt is negative, 0 otherwise
Annual share returns for rm j from 3 months after the previous scal year
t-13 months after the current scal year t [i.e. [PtPt1]/Pt1 where Pt is
the price of shares for rm j 3 months after the end of the scal year t and
Pt1 is the price of shares for rm j 3 months after the end of the scal
year t1] adjusted for the All Ordinaries Index over the same period
Accruals (i.e. dierence between operating prot and cash ow from
operations) of rm j in scal year t scaled by the book value of total assets
of rm j at the beginning of the scal year t
Indicator variable where rm j is scored 1 if CFOjt is negative, 0 otherwise
Cash ow from operating activities of rm j in scal year t scaled by the
book value of total assets of rm j at the beginning of the scal year t
Indicator variable where rm j in year t is scored 1 if at least one member
of the audit committee is dened as either an accounting nancial expert
or a nonaccounting nancial expert, 0 otherwise
of the audit committee is dened as an accounting nancial expert,
0 otherwise
of the audit committee is dened as a nonaccounting nancial expert,
0 otherwise
Indicator variable where rm j in year t is scored 1 if at least one
independent member of the audit committee is dened as an overall
nancial expert, 0 otherwise
nonindependent member of the audit committee is dened as an overall
independent member of the audit committee is an accounting nancial
expert, 0 otherwise
nonindependent member of the audit committee is an accounting nancial
expert, 0 otherwise
DRjt
RRAjt
ACCjt
DCFOjt
CFOjt
Exptjt
Expt_Accjt
Expt_CEOjt
Ind_Exptjt
Non_Ind_Exptjt
Ind_ACCjt
Non_Ind _ACCjt
2013 AFAANZ
Appendix 1 (continued)
Variables
Denition
Ind_CEOjt

independent member of the audit committee is a nonaccounting nancial
expert, 0 otherwise
nonindependent member of the audit committee is a nonaccounting
Number of audit committee members of rm j at year t with accounting
expertise
Percentage of audit committee members of rm j at year t with accounting
expertise
Number of audit committee members of rm j at year t with nonaccounting
expertise
Percentage of audit committee members of rm j at year t with nonaccounting
expertise
of the audit committee is an accounting nancial expert but none of the
audit committee members are nonaccounting nancial experts, 0 otherwise
of the audit committee is a nonaccounting nancial expert but none of
the audit committee members are accounting nancial experts, 0 otherwise
of the audit committee is an accounting nancial expert and at least one
member of the audit committee is a nonaccounting nancial expert,
0 otherwise
Total number of audit committee members of rm j at year t
Percentage of the audit committee of rm j at year t comprised of
independent directors
Indicator variable where rm j in year t is scored 1 if the chief executive
ocer serves as the chairman of the board, 0 otherwise
Book value of total assets of rm j at end of year t
Natural logarithm of the book value of total assets of rm j at end of year t
Market-to-book ratio of rm j for year t measured as a ratio of market
value of equity and book value of equity
Sum of long-term debt and current liabilities of rm j at the end of year t
deated by total assets of rm j at the start of year t
Indicator variable where rm j is scored 1 if dened as being within an
Industrials or Materials ASX GICS business sector, 0 otherwise
Series indicator variables controlling time temporal dierences of reporting
periods for rm-year observations with rm j scored 1 if nancial data
correspond to year t, 0 otherwise
Non_Ind _CEOjt
#Expt_Accjt
%Expt_Accjt
#Expt_CEOjt
%Expt_CEOjt
ACCONLYjt
CEOONLYjt
BothExptjt
ACSIZEjt
ACINDjt
DUALITYjt
BVTAjt
LnBVTAjt
MTBjt
LEVjt
Industryjt
Yeark
2013 AFAANZ

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Accounting and Finance 55 (2015) 279310

Earnings conservatism and audit committee nancial

School of Accounting, Curtin University, Perth, WA, Australia

subcommittees eectiveness have been central themes in the corporate

committees with members who have accounting nancial expertise is more

positive and statistically signicant at the 10 per cent level in regression

constraining earnings management. Agrawal and Chadha (2005) nd that the

3. Sample and method

nonaccounting nancial expertise). In the case of accounting nancial

audit committee independence, duality, rm size, leverage, growth options and

earnings conservatism research, measures of earnings conservatism focusing on

RRAjt*DRjt*Exptjt is expected to be positive and signicant. Equation (2) is

Consistent with past published literature on conservatism, a number of interaction

To examine H1, Equation (4) is developed. If audit committee members with

Panel B: Dichotomous variables

Panel A: Continuous variables

Panel C: Presence nancial experts proportion of sample rms over 5 years

Panel B: Dichotomous variables

nonaccounting nancial expertise (see Expt_CEOjt). In addition, a total of 263

positive and statistically signicant at the 10 per cent level in regression

the rm (i.e. executive, nonexecutive or independent director). Corporate

ACCjt b0 b1 DCFOjt b2 CFOjt b3 CFOjt DCFOjt d1 Ind Exptjt

h4 CFOjt DCFOjt Non Ind Exptjt Control Variables

committee members with overall nancial expertise (for a one-tailed test,

In the corporate governance literature, it is virtually impossible to obtain a perfect

ity on a rms audit committee in ensuring the integrity of nancial reporting

provide a detailed picture of the eect of IFRS adoption on the relationship

Appendix 1: Definition of variables

Operating prot after tax of rm j deated by market value of equity

Indicator variable where rm j in year t is scored 1 if at least one

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RRAjtDRjtExptjt is expected to be positive and signicant. Equation (2) is