Audit Committees and Earnings Management – Evidence from the German Two-Tier Board System

This study investigates whether audit committees of German firms and their characteristics are related to earnings management. This issue is of particular interest, as it reveals the effectiveness of voluntarily established audit committees in a two-tier board system. In contrast, most prior research focuses on the characteristics of mandatory audit committees in one-tier board systems. We use a sample from German listed firms between 2005 and 2009, and accrual-based earnings management serves as a proxy for audit committee effectiveness. The results suggest that the existence of an audit committee is related to a lower degree of earnings management. Using a differences-in-differences approach, we also provide evidence that the level of earnings management decreases after the formation of an audit committee. Moreover, the results show that the participation of financial experts in audit committees and the increase in audit committee meetings are associated with less earnings management, i. e. these characteristics seem to enhance the effectiveness of audit committees. With respect to meeting frequency, 4–5 meetings per year seem to represent an effective number of meetings in order to reduce the level of earnings management.