The Effect of Audit Committees on Earnings–Return Association: Evidence from Foreign Registrants in the United States

Manuscript Type: Empirical Research Question/Issue: This study examines whether foreign registrants that choose not to establish audit committees in the US have generally lower earnings–return associations. Research Findings/Insights: Our empirical results indicate that earnings–return associations for foreign registrants without audit committees are significantly lower compared with those of their US‐matched firms which are required to establish audit committees. This result is even more pronounced after the introduction of new audit committee rules in 1999 aimed at increasing the responsibilities of audit committees. In addition, earnings–return associations of foreign registrants are found to increase following the establishment of audit committees. Overall, our results are consistent with the idea that the establishment of audit committees may be related to higher earnings–return associations. Theoretical/Academic Implications: Our empirical results suggest that foreign registrants that have chosen to establish audit committees have better earnings–return associations. This implies that the effectiveness of the audit committee in resolving agency problems is applicable to foreign companies, even though their home countries adopt non‐Anglo‐American corporate governance systems. Practitioner/Policy Implications: This study offers important insights to foreign firms listed in the US. As the choice not to form an audit committee may increase the cost of capital in the US, but save the cost of establishment in home market, the managers of foreign registrants should weigh the costs and benefit of the options and make a choice accordingly.