Modern Economy, 2012, 3, 856-872 Published Online November 2012 (
Audit Committee Mechanism to Improve Corporate
Governance: Evidence from a Developing Country
Madan Lal Bhasin
Bang College of Business, KIMEP University, Almaty, Republic of Kazakhstan
Received June 19, 2012; revised July 22, 2012; accepted August 10, 2012
Nowadays, an audit committee (AC) is being looked upon as a distinct culture for CG and has received a wide-pub-
licity across the globe. Government authorities, regulators and international bodies all have indicated that they view an
AC as a potentially powerful tool that can enhance the reliability and transparency of financial information. Being
mandatory under Security Exchange and Board of India (SEBI’s) Clause 49 of the Listing Agreement, an AC can be of
great help to the board in implementing, monitoring and continuing “good” CG practices to the benefit of the corpora-
tion and all its stakeholders. This study performs a “content” analysis on the AC reports of the top 500 listed companies
in India during 2005 to 2008 to determine the information content of these reports and the extent to which these reports
conform to the Clause 49 requirements of the SEBI. Also, discussed are the various trends about an AC characteristics
viz., size, composition, activity, as well as, the extent of non-audit services provided by auditors in the top 500 listed
Indian companies. No doubt, it is essential for the Indian corporations to accept and continue with the CG reforms that
are “demarcated” by the challenges of the “new” millennium.
Keywords: Corporate Governance; Audit Committee; SEBI Clause 49; Sarbanes-Oxley Act; Listing Agreement; Board
of Directors; Financial Reporting; India
1. Introduction
A corporation is a “congregation” of various stake-
holders, namely, customers, employees, investors, ven-
dor-partners, government and society. The relationship
between shareholders and corporate managers is fraught
with “conflicting” interests that arise due to the sepa-
ration of ownership and control, divergent management
and shareholder objectives, and information “asymme-
try” between managers and shareholders. Due to these
conflicting interests, managers have the incentives and
ability to maximize their own utility at the expense of
corporate shareholders. As a result, corporate governance
structures evolve that help in mitigating these agency
conflicts (Dey 2008) [1]. Simply stated, “Corporate go-
vernance (henceforth, CG) is the system by which busi-
nesses are directed and controlled.” In fact, CG deals
with conducting the affairs of a corporation in such a
way that there is “fairness” to all stakeholders and that its
actions benefit the “greatest” number of stakeholders.
CG is the acceptance by management of the inalienable
rights of shareholders as the “true” owners of the corpo-
ration, and of their own role as “trustees” on behalf of the
shareholders. This has become imperative in today’s
globalized business world where corporations need to
access “global” pools of capital, need to attract and retain
the “best” human capital from various parts of the world,
need to “partner” with vendors on mega collaborations,
and finally, need to live in “harmony” with the commu-
CG is beyond the realm of law; it stems from the cul-
ture and mindset of management and cannot be regulated
by legislation alone (Cohen et al., 2008) [2]. Corpora-
tions, therefore, need to recognize that their growth re-
quires the cooperation of all the stakeholders; and such
cooperation is enhanced by the corporation adhering to
the “best” CG practices. In this regard, the management
needs to act as “trustees” of the shareholders at large and
prevent “asymmetry” of information and benefits be-
tween various sections of shareholders, especially be-
tween the owner-managers and the rest of the sharehold-
ers. While large profits can be made taking advantage of
the asymmetry between stakeholders in the short-run,
balancing the interests of all stakeholders alone will en-
sure survival and growth in the long-run. Thus, CG is a
key element in improving the economic “efficiency” of a
firm. Indeed, corporations pool capital from a large in-
vestor base, both in the “domestic” and in the “interna-
tional” capital markets. In this context, “investment is
ultimately an act of faith in the ability of a corporation’s
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M. L. BHASIN 857
management.” In this regard, investors expect manage-
ment to act in their best interests at all times and adopt
good CG practices. The failure to implement “good”
governance can have a “heavy” cost beyond regulatory
problems. Evidence suggests that corporations that do
not employ meaningful governance procedures can pay a
significant risk premium when competing for scarce
capital in the public markets (Aguilera et al., 2009) [3].
During the last two decades, an “audit committee”
(henceforth, AC) has become a very common “mecha-
nism” of CG internationally. An AC is expected to
monitor the reliability of the corporation’s accounting
and auditing processes in order to protect shareholder
interests (Agoglia et al., 2011) [4] and prevent attempts
to manipulate earnings numbers (Klein, 2002) [5]. Also,
an AC serves as a mechanism to hold “external” auditors
accountable for the scope, nature and quality of their
work (Dignam, 2007) [6]. The duties of an AC often in-
clude recommending the appointment of external audi-
tors, reviewing the corporation’s financial statements,
taking action on items and concerns raised by the audi-
tors, mediating between the auditor and management,
and advising on any significant findings in the external
and internal audit investigations (Caskey et al., 2010) [7].
According to Beasley et al., (2009) [8], “An AC is in-
creasingly responsible for the quality of financial report-
ing and oversight of the audit processes in large public
companies.” In 2002, the United States enacted the Sar-
banes-Oxley (SOX) Act, requiring that all US publicly
traded companies establish an “independent” AC. De-
spite immediate public criticism of SOX’s AC require-
ments, there has been a noticeable increase in the number
of countries now “mandating” their use. When SOX was
signed into law, only 10 of the world’s 40 largest capital
markets had mandatory AC requirements. A significant
number of countries amended their laws, regulations, or
listing rules over the next 7 - 8 years to require that their
own listed corporations establish an AC. As Fichtner
(2010) [9] concludes: “In total, 31 of the world’s 40
largest capital markets now mandate that certain catego-
ries of listed corporations utilize an AC,” as shown in
Table 1.
The AC function has evolved in India over the years
with recommendations of the Confederation of Indian
Industries (CII), Kumaramanglam Birla Committee, new
rules of the Securities and Exchange Board of (SEBI)
and Company Law. Now-a-days, an AC is viewed as an
“oversight function of CG, financial reporting process,
internal control structure, and audit functions.” Govern-
ment authorities, regulators and international bodies (for
example, IOSCO and the OECD) have indicated that
they view an AC as a potentially powerful tool that can
enhance the reliability and transparency of financial in-
formation (UNCTAD, 2006) [10]. The SOX Act, 2002
Table 1. Audit committee requirements for the 40 largest
capital markets.
Capital Markets with “Mandatory”
AC Requirements and Date of
Capital Markets with
“No Mandatory”
AC Requirements
1) Canada (1975) 1) Brazil
2) Nigeria (1990) 2) Iran
3) Hong Kong (1999) 3) Ireland
4) Thailand (1999) 4) Italy
5) India (2000) 5) Japan
6) Indonesia (2000) 6) Norway
7) Korea (2000) 7) Saudi Arabia
8) Mexico (2001) 8) Switzerland
9) Argentina (2001) 9) Venezuela
10) United States (Sarbanes-Oxley, 2002)
11) Spain (2002)
12) Turkey (2002)
13) Australia (2004)
14) Colombia (2005)
15) Austria (2006)
16) Portugal (2006)
17) South Africa (2006)
18) Russia (2007)
19) Finland (2008)
20) France (2008)
21) The Netherlands (2008)
22) Romania (2008)
23) Sweden (2008)
24) United Kingdom (2008)
25) Belgium (2009)
26) China (2009)
27) Czech Republic (2009)
28) Denmark (2009)
29) Germany (2009)
30) Greece (2009)
31) Poland (2009)
Source: J. R. Fichtner, “The Recent International Growth of Mandatory
Audit Committee Requirements,” International Journal of Disclosure and
Governance, Vol. 7, No. 3, 2010, p. 234.
Copyright © 2012 SciRes. ME
has expanded the formal responsibilities of an AC. The
status of an AC report has evolved from non-existence to
voluntarily and now mandatory for publicly traded com-
panies under the SEBI and Companies Act jurisdiction in
India. Therefore, this paper seeks to “contribute to our
understanding of the value and potential of an AC as a
CG mechanism in a developing country like India.” It
seeks to examine the structure and functions that are cur-
rently performed by an AC in the Indian corporate world.
2. Literature Review
Both, an AC and auditor “independence” have been im-
portant areas of research in the accounting literature. In
the past, various studies on an AC have focused on the
independence, activity and on the financial expertise of
an AC member. Recently, the research on auditor inde-
pendence have focused on the extent of “non-audit” ser-
vices provided by the “external” auditor as well audit-
firm tenure, both of which are generally seen as “hin-
drances” to auditor independence. In fact, renewed inter-
est on CG and an AC have emerged in light of the “new”
regulations that were enacted in the wake of the major
corporate “scandals”, and the consequent enactment of
the SEBI’s Clause 49 in India and SOX regulations in the
US and in other parts of the world.
A significant number of researchers, primarily from
the Western and European countries, have studied vari-
ous dimensions of an AC and its “effectiveness”. These
studies have led to a lively debate as to the proper com-
position of the membership of an AC. For example,
Romano (2005) [11] argues that an AC composed solely
of independent directors, or even a majority of inde-
pendent directors, do not limit the occurrence of ac-
counting “improprieties”, while Prentice and Space
(2007) [12] refutes this argument by citing numerous
studies confirming that an “independent” AC improves
the financial reporting.
Despite the continuing “hot” debate as to whether “in-
dependent” directors are a necessary component of an
AC, an overwhelming number of studies establish that
the mere formation of an AC results in substantial bene-
fits. For example, Knapp (1987) [13] concluded that an
AC can improve auditing because “an AC member tend
to support auditor, rather than management, when audit
disputes occur.” On the other hand, Beattie (2007) [14] in
his research found that the presence of an AC is a very
significant factor in enhancing the third-party perceptions
of auditor independence. However, Wild (1996) [15]
found evidence that establishment of an AC enhances
earnings quality, and Goodwin-Stewart and Kent (2006)
[16] found that an AC is associated with “higher-quality”
audits. Similarly, De Fond et al., (2005) [17] study re-
vealed that “over-statements of earnings are less likely
among firms that have an AC,” while Dechow et al.,
(1996) [18] study found that “corporations manipulating
earnings are more likely to have boards of directors
dominated by managers and less likely to have an AC.”
Williams and Tower (2004) [19], however, conducted a
comprehensive simultaneous analysis of the association
between five AC composition and operational character-
istics features and earnings management based on a sam-
ple of 485 Singapore publicly traded organizations.
Moreover, in a study undertaken by McMullen (1996)
[20], the author concluded that “firms with an AC are
associated with fewer shareholder lawsuits alleging fraud,
fewer quarterly earnings restatements, fewer SEC en-
forcement actions, fewer illegal acts and fewer instances
of audit turnover when there is an audit-client disagree-
ment.” By and large, while a vast majority of the studies
conclude that an AC provides substantial benefits to the
corporation, a handful of studies question their “true”
value. In particular, Beasley (1996) [21] study disputes
whether an AC actually reduces the likelihood of fraud.
Likewise, in a study of an AC in Spain, Pucheta-Marti-
nez and de Fuentes (2007) [22] determined that “the
mere presence of an AC does not reduce the occurrence
of error and non-compliance qualifications.” However,
the same study also determined that other factors, such as
the size and independence of an AC did have a signifi-
cant impact on certain aspects of financial reporting.
Unfortunately, very little research work has been done,
both in India and abroad, on the role of an AC in im-
proving CG. For example, Al-Mudhaki and Joshi (2004)
[23] examined the composition, focus and functions of an
AC and the effects of the meetings and the criteria used
in the selection of members by the Indian listed corpora-
tions based on 73 “questionnaire” responses in 2002.
Similarly, Agarwal (2006) [24] stated that “an AC of the
board is today seen as a key fulcrum of any corporation.
Being mandatory under Clause 49, an AC can be of great
help to the board in implementing, monitoring and con-
tinuing good CG practices to the benefit of the corpora-
tion and its stakeholders.” Moreover, Cohen et al., (2010)
[25] expressed that CG issues have grown more salient in
the light of the alleged corporate accounting scandals.
Sandra (2005) [26] conclude by saying that “comprehen-
sive regulatory changes, brought on by recent CG re-
forms, have broadly redefined and reemphasized the
roles and responsibilities of all the participants (espe-
cially the AC) in a public corporation’s financial report-
ing process.”
Researchers recently have deepened the study of gov-
ernance and auditing outcomes with more recent evi-
dence on auditor selection and retention, findings that
governance characteristics influence auditors’ risk as-
sessments and planning decisions, some conflicting re-
sults related to governance and auditor fees (audit and
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M. L. BHASIN 859
non-audit), and evidence that internal audit budgets are
associated with governance characteristics (Carcello et
al., 2011) [27]. Other recent insights include the impor-
tance of an AC accounting expertise over broader finan-
cial expertise; the apparent potential for an AC compen-
sation methods to influence an AC member judgments;
the existence of substantive, ceremonial, and informal
AC processes; a deeper understanding of an AC member
evaluation of accounting disagreements and adjustments;
and the serious consequences to directors when a com-
pany experiences accounting trouble.
Over the past two decades, the CG literature in ac-
counting and auditing has grown rapidly. In the present
study, our CG focus is primarily on the various “dimen-
sions” of an AC. Documented evidence on effectiveness
of an AC in enhancing “good” CG has focused on vari-
ous aspects, but the issue of interest in this study is the
support of an AC in enhancing “auditor” independence.
Hinzpeter et al., (2009) [28], for example, found that “an
AC is more likely to support across members of an AC.
This is true regardless of whether the member is in a
full-time (or part-time) position, such as corporate man-
agers, academicians, and retired partners of certified
public accounting firms.” Similarly, Pearson (1980) [29],
and Dockweiler et al., (1986) [30] showed that “an audi-
tor’s reliance on management is reduced due to the direct
communication with an AC.” However, Lam (2000) [31]
found that “the appearance of independence of an AC
would enhance auditor independence and improve trans-
parency in financial reporting.” Beattie et al., (1999) [32]
also reported that “audit partners, finance directors, and
financial journalists believed that an AC with independ-
ent non-executive directors strongly encourages auditor
independence. Independent directors of an AC are ex-
pected to increase the quality of monitoring because they
are not associated with the corporation either as an offi-
cers or employees; thus, they would act as the share-
holder’s watchdog.” Similarly, Raghunandan and Rama
(2007) [33] revealed that “an AC that consists of quail-
fied independent directors is better able to contribute
towards auditor independence.” To sum up, the extant
literature provides “strong” empirical support that both
an independent AC and higher-levels of audit independ-
ence have a significant beneficial effect on enhancing the
quality of disclosures, in reducing discretionary earnings
management, increasing the informativeness of earnings,
and in general enhancing the value of the firm.
From the above description, it is amply clear that India
(being a developing country) presents an ideal case for
the analysis of improving CG through making an effect-
tive use of an AC practices followed by the corporate-
sector because the economy has been undergoing rapid
economic transformation in the financial services, tour-
ism, information-technology sectors, and the “niche”
manufacturing gaining momentum too. In the Indian-
context, there has been very limited number of AC stud-
ies, as compared to its Western and European counter-
parts. However, just two studies are available on the
theme of an AC in India, which were done by Al-Mud-
haki and Joshi and Agarwal, as stated above. The fore-
going discussion suggests that the literature on the de-
terminants of an AC disclosure in the Indian CG context
is very “limited and inconclusive”. Thus, our present
study builds on the previous literature of an AC practice
and overall CG scenario in the Indian corporate-sector.
The scope of this study has been confined to top 500 In-
dian “listed” corporations, and a “content” analysis was
performed on their annual reports for four years, namely,
2005-06 and 2008-09 respectively. The present study
also contributes to the literature in an important sense
that it analyzes data from a developing country and an
emerging capital market, which has not been widely
studied before on the role of an AC in the context of CG
3. Corporate Governance and Audit
Committee Initiatives in India :
An Overview
During the last two decades, an AC has become a com-
mon “mechanism” of CG internationally. Originally,
“non-mandatory” structures used by a “minority” of cor-
porations, more recently numerous “official” profess-
sional and regulatory committees in many countries have
recommended their more “universal” adoption and have
advocated “expanded” roles for an AC. Often, increased
attention on CG is a result of “financial” crisis. For in-
stance, the Asian financial crisis brought the subject of
CG to the “surface” in Asian countries. To quote Lin et
al., (2009) [34], “Recent scandals disturbed the otherwise
placid and complacent corporate landscape in the US.
These scandals, in a sense, proved to be serendipitous.
They spawned a new set of initiatives in CG in the US,
and triggered a fresh debate in the European Union, as
well as, in the Asian countries.” Long renowned for their
opaque business practices, Asian corporations have
undergone a dramatic transformation on the CG front.
Jamie Allen (2008) [35], for example, states that “most
of the countries/markets in the Asian region had taken
the initiative long-back in 1990s by formulating and im-
plementing an official code of CG,” which is summa-
rized in Table 2.
Beginning in the late 1990s, the Indian government
started implementing a significant “overhaul” of the
country’s CG system. As described by Afsharipour (2009)
[36], “These CG reforms were aimed at making boards
and AC more independent, powerful and focused moni-
tors of management, as well as, aiding shareholders, in-
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Copyright © 2012 SciRes. ME
Table 2. Development of CG codes in the Asian countries.
Country Date of Main Code(s)Are Independent
Director’s required? Are Audit Committees
China 2002/2005 Yes Yes
Hong Kong 1993/2004 Yes Yes
India 1999/2005/2007 Yes Yes
Indonesia 2001/2006 Yes Yes
Japan 2003/2004 Optional Optional
South Korea 1999/2003 Yes Yes (Large Firms)
Malaysia 2001/2007 Yes Yes
Philippines 2002 Yes Yes
Singapore 2001/2005 Yes Yes
Taiwan 2002 Yes (Certain Firms) Yes (Certain Firms)
Thailand 1999/2006 Yes Yes
Source: Jamie allen, Asian Corporate Governance Association: Corporate Governance Seminar, Organized by
Chubb Insurance and Solidarity, Bahrain, 16 April 2008, p. 10.
cluding institutional and foreign investors, in monitoring
management.” There have been several leading CG ini-
tiatives launched in India since the mid-1990s. The first
was by the Confederation of Indian Industry (CII), which
came up with the first “voluntary” code of CG in 1998
( In 1996, the CII took a special ini-
tiative on CG—the first institutional initiative in Indian
industry. In April 1998, the country produced the first
substantial code of best practice on CG after the start of
the Asian financial crisis in mid-1997. Titled “Desirable
Corporate Governance: A Code”, this document was
written not by the government, but by the CII (1997) [37].
It is one of the few codes in Asia that explicitly discusses
domestic CG problems and seeks to apply best-practice
ideas to their solution. In the late 1999, a government-
appointed committee, under the leadership of Kumar
Mangalam Birla (Chairman, Aditya Birla Group), re-
leased a draft of India’s first “national” formal code on
CG for listed companies. The committee’s recommenda-
tions (many of which were “mandatory”) were closely
aligned to the international “best” practices on CG—and
set “higher” standards than most other parts of the region
at that time. However, the code was approved by the Se-
curities and Exchange Board of India (SEBI) in early
2000, and was implemented in stages over the following
two years (applying first to “newly” listed and “large”
companies). It also led to changes in the BSE and NSE
stock exchange listing rules.
The next move was also by the SEBI, now enshrined
as Clause 49 (very similar to US Sarbanes-Oxley Act,
2002) of the listing agreement. The Naresh Chandra
Committee and Narayana Murthy Committee reports
followed it in 2002. Based on some of the recommenda-
tion of these two committees, SEBI revised Clause 49 of
the listing agreement in August 2003. The SOX has re-
ceived mixed (and increasingly “negative”) response in
the US. However, Clause 49 and SOX share “similarities
but different responses by market.” Perhaps, only some
CG changes valuable and some CG changes positive in
one environment and not others (Balasubramanian et al.,
2008) [38]. Also, genesis of changes differs: Clause 49
was introduced by “industry” initiative in India, but SOX
was introduced in US due to Enron like scandals. While
SEBI proceeded to adopt considerable CG reforms, the
implementation and enforcement of such reforms in fact,
have lagged behind.
Reform of “central” public-sector enterprises (CPSEs)
is also high on the Indian government’s agenda. Strong
PSEs would be better prepared to enter the capital market
to raise funds, which means practices must be in place to
ensure accountability. The push by the government has
resulted in some guidelines, which were issued by the
Department of Public Enterprises (2007) [39] (www. in June. Even though these guidelines are
voluntary, all CPSEs (both listed and non-listed) are
meant to follow them, with compliance of these guide-
lines to be referred to in the Directors’ report, Annual
report and the chairman’s speech during the Annual
General Meeting. The Department will grade the corpo-
rations on the basis of their compliance with the guide-
lines. Issued on an experimental basis for a year, they
will be revised “in the light of experience gained”. Thus,
in CG practices, India can be proud of what it has
achieved so far, initially voluntarily and later under
guidance of various regulators, while recognizing that
obviously much more needs to be done.
M. L. BHASIN 861
4. Audit Committee Mechanism in India
There has been growing recognition in recent years of the
importance of CG in ensuring sound financial reporting
and deterring fraud. The audit serves acts as a monitoring
device and is thus, part of the CG mosaic (Kaushik, 2009)
[40]. It is claimed that the auditing system in India is
“comprehensive and well supported by law, which en-
sures that impartiality, objectivity and independence
of statutory auditors are maintained” (Giridharan, 2004)
[41]. However, experience has shown that certain weak-
nesses and lacunae do exist in the Indian system. In this
context, Ganguly (2001) [42] asserts, “Various types of
accounting manipulations, irregularities and leakages go
unnoticed to the detriment of the public and sharehold-
ers.” However, over the years, this arrangement was felt
inadequate in view of the changing business scenario and
it is felt that a greater interaction and link between the
auditors and the top echelon of management is needed.
The series of accounting “scandals” have intensified
“pressure” from the stakeholders and the regulators on an
AC to do the jobs, for which they were hired. Even
though most corporations have an AC, “their role has
been limited due to the lack of expertise and time.” An
“active” AC is important because it indicate the com-
mitment to the issues of interest because of the reports it
release about the activities undertaken during the finan-
cial year and the efforts made to ensure adequate internal
control (Chatterjee, 2011) [43]. In addition, an AC must
be given the role to approve and review audit fees, thus
neutralizing the bias of management influence on the
negotiations with the auditors. Of equal importance,
auditor “independence” can be safeguarded if an AC is
composed of a majority of independent and non-execu-
tive directors and this might indicate that their inde-
pendent status would contribute to auditor independence
through bridging communication networks and neutral-
izing any conflict between the management and the
auditor (Puri et al., 2010) [44]. Indeed, an AC can go a
long-way in “enhancing the credibility of the financial
disclosures of a corporation and promoting transpar-
ency.” Thus, it is essential for the Indian corporations to
accept and continue with the reforms that are “demar-
cated” by the challenges of the “new” millennium.
4.1. Legal Framework for an Audit Committee
Public corporations in India face a “fragmented” regula-
tory structure. The Companies Act, 1956 is administered
by the Ministry of Corporate Affairs (MCA) and is cur-
rently enforced by the Company Law Board (CLB). The
MCA, the SEBI, and the stock exchanges jointly share
jurisdiction over the “listed” corporations, with the MCA
being the “primary” government body charged with ad-
ministering the Companies Act, while SEBI has served
as the securities market “regulator” since 1992. Likewise
the CG standards in the US and the UK, India’s CG re-
forms followed a “fiduciary and agency cost model.”
With a focus on the agency model of CG, the Clause 49
reforms included detailed rules regarding the role and
structure of the corporate board and internal control sys-
An AC has been prescribed as a part of CG mecha-
nism to be followed by the “listed” corporations, under
clause 49 of the Listing Agreement, and by certain “pub-
lic” corporations under the Companies Act, 1956. Now-
a-days, an AC is an important tool to consider and decide
on all financial parameters and policies, internal controls,
review of auditing, project implementation, reconstruct-
tion, merger and amalgamation, and any financial ir-
regularities. It is noteworthy to know “how the constitu-
tion of an AC generally takes place and the so called di-
rectors being members of an AC are really independent
and discharge their fiduciary duties entirely in an unbi-
ased and unobtrusive manner.”
4.1.1. The Indian Companies Act, 1956
Section 292A was inserted in the Companies Act, 1956
with effect from December 13, 2000, providing that
“every public corporation having a paid-up capital of not
less than Rs. 5 crore shall constitute a committee of the
board of directors known as an AC.” Further, it provides
an AC should have discussions with the auditors peri-
odically about internal control systems, the scope of audit
including the observations of the auditors and review of
half-yearly and annual financial statements before sub-
mission to the board, and also ensure compliance of in-
ternal control systems. The supremacy of an AC is rec-
ognized in the manner that recommendations of an AC
on any matter relating to financial management including
audit report shall be binding on the board and, if the
board does not accept the recommendations of an AC, it
shall record the reasons therefore, and communicate such
reasons to the shareholders. In the event of default of the
provisions of Section 292A, the corporation and every
officer in default shall be punishable with imprisonment
for a term up to one year or with fine up to Rs. 50,000 or
with both. The offence is compoundable under section
621A of the Act. A non-banking financial corporation
(NBFC) having assets of Rs. 50 crore and above as per
its last audited balance sheet is required to constitute an
AC, consisting of not less than 3 members of its Board of
Directors. The AC constituted by an NBFC under section
292A of the Companies Act, 1956 shall be the AC for
this purpose.
4.1.2. SEBI Cl ause 4 9 of Li st i ng Agreement
Based on the recommendations of the Committee headed
by Mr. Kumarmangalam Birla on CG in “listed” corpo-
Copyright © 2012 SciRes. ME
rations, the SEBI amended the Listing Agreement on
February 21, 2000 by providing therein Clause 49 on CG.
On October 29, 2004a “revised” Clause 49 was intro-
duced, which was finally made effective from December
31, 2005. All existing listed-corporations having a paid-
up share capital of Rs. 3 crore and above or net worth of
Rs. 25 crore or more at any time in the history of the
corporation, have to comply with the same. The corpora-
tions seeking listing for the “first” time have to comply at
the time of seeking “in-principle” approval for such list-
ing. The clause 49 provides for appointment of inde-
pendent directors, AC and several other parameters for
disclosure to and for protection of interest of sharehold-
5. Research Methodology
Annual reports are an ideal place to apply an AC frame-
work because they allow us to compare AC positions and
trends across different corporations, industries and coun-
tries. They are an instrument for “communicating issues
comprehensively and concisely, and they are produced
regularly, so they can be used to analyze management
attitudes and policies across reporting periods.”
The main objective of the present research study is “to
survey the prevailing practices of an AC disclosure made
by the corporate-sector in India over a four year period
from 2005-06 to 2008-09.” Accordingly, the sample-size
of this study consists of top-500 listed corporations from
India in terms of their market capitalization, as on March
31, 2008. The annual reports and other relevant informa-
tion of the selected corporations were obtained from the
two databases, first one provided by SANSCO—Annual
Reports Library Services (, and second
by Directors Database—a CG initiative of Bombay Stock
Exchange prepared in association with Prime Database
Reports on the AC were subjected to a “content”
analysis to identify the title and format of such reports.
The content analysis of annual reports involves “codifi-
cation” of qualitative and quantitative information into
“pre-defined” categories in order to derive “patterns” in
the presentation and reporting of information. The “cod-
ing” process also involved reading the annual report of
each corporation and coding the AC information accord-
ing to pre-defined categories. Over the last decade, con-
tent analysis has been used by several leading researchers
to study the performance and reporting (Beattie, 2007)
[14]. Therefore, as part of the present study, “content”
analysis has been used to analyze the extent of an AC
disclosures made by the top 500 listed companies in In-
dia. By looking at the disclosures made within their an-
nual reports, one can examine the extent to which Indian
corporations “publicly” document the presence (or im-
portance) of an AC. Specifically, the paper covers the
following aspects related to an audit committee: 1) The
structure and composition of an AC; 2) The criteria used
to select an AC members; 3) Examining the importance
of functions currently performed by an AC and also to
analyze any differences in the practices of corporations in
this regard; 4) The areas of an AC review focus; and 5)
The effects of meetings on an AC functions. Finally, as
part of this study, an attempt will be made to examine
and analyze the trends about various characteristics of an
AC, such as, their size, composition and activity, as well
as, extent of non-audit services provided by the auditors
in the top 500 listed Indian corporations.
6. Findings of Study and Analysis of Results
The SEBI’s Clause 49 (2004) [45] and other regulatory
changes have put tremendous demands on an AC. Hav-
ing the right directors on an AC—with mandated inde-
pendence and financial literacy combined with integrity,
healthy skepticism and judgment, knowledge of the cor-
poration and industry, and the courage to challenge deci-
sions—is an important driver of an AC “effectiveness”.
The AC members must learn “how to work smarter and
to allow enough time to complete their ever-lengthening
list of duties.” In fact, given their “pumped-up” workload,
they are struggling to know what to put at the top of the
list. As Heffes (2007) [46] lucidly puts it: “The AC has a
lot on their plates and so they need help to ensure they
see the forest, not just the trees. While they should re-
view information carefully and challenge management
when necessary; they should not be resolving everyday
issues or making management decisions.”
This section presents detailed trends about various
characteristics of an AC, such as, their size, composition
and activity, as well as, extent of non-audit services pro-
vided by the auditors in the Indian corporations. These
trends are presented for the top 500 listed corporations in
India, based on their market capitalization as on March
31, 2008, for four years covering the financial years
2005-06 to 2008-09. As stated earlier under the research
methodology, all the required annual reports and other
secondary sources of information in respect of the top
500 listed corporations were outsourced and extracted
from the private database maintained by SANSCO ser-
vices ( and Directors Database (www. Moreover, Tables 3-8 are con-
structed based on the disclosures made in the “Corporate
Governance Reports” filed by these corporations. In fact,
the year 2006 marks the year when all the listed firms
were required to comply with the revised provisions of
the SEBI’s Listing Clause 49, which were first notified
on October 29, 2004 but came into effect from January 1,
2006. Table 3 summarizes distribution of corporations
Copyright © 2012 SciRes. ME
Copyright © 2012 SciRes. ME
Table 3. Distribution of corporations according to size of audit committee.
Size of Audit Committee (AC) 2005-06 2006-07 2007-08 2008-09
2 0.30 2.19 0.51 1.25
3 57.19 50.27 51.39 49.87
4 29.64 33.61 34.43 36.84
5 7.78 9.02 9.87 8.02
6 2.99 3.83 3.04 3.26
7 2.10 0.55 0.51 0.50
8 0.00 0.27 0.00 0.25
9 0.00 0.27 0.25 0.00
Average Size of AC 3.62 3.66 3.66 3.62
No. of Corporations 334 336 395 399
Source: Annual Reports of Top 500 Listed Corporations in India, SANSCO.
according to size of an AC.
According to Carcello et al., (2002) [47], “The AC
plays an important role overseeing and monitoring the
financial reporting process, internal controls, and the
external audit. They provide a communication bridge
between management and the internal and external audi-
tors.” No doubt, to maintain integrity of their monitoring
functions, an AC is required to perform their response-
bilities “diligently”. As per Clause 49, “A qualified and
independent AC shall be set up. The AC shall have
minimum three directors as members. Two-thirds of the
members of AC shall be independent directors.” Judged
in the context of Clause 49 regulations requiring listed
corporations to have an AC with a minimum of 3 mem-
bers, Table 3 shows that nearly all (98.75 percent) cor-
porations have complied with this regulation. However, a
large majority of the corporations have already consti-
tuted their AC, with the minimum size required under the
regulations; however, with one-third (36.84) of the cor-
porations adding one “extra” member. In fact, there are
very few Indian corporations (just 4 percent) that have an
AC with more than 5 members in 2008-09.
In fact, an AC has been formed to act both as a “con-
duit” of information supplied by the management to the
auditors, and at the same time to “insulate” the auditor
from the pulls and pressures of the management (Sharma,
2007) [48]. An AC is, therefore, required to be “inde-
pendent” of the management and has the “key” response-
bility of deciding the scope of work, including the fixa-
tion of audit fees and the determination of the extent of
non-audit services. As Sarkar and Sarkar (2010) [49]
very aptly pointed out, “The basic idea is to make the
auditor not to be dependent on “inside” management,
both in terms of discharge of its functions as well as in
terms of its survival.” Tables 5 and 6 summarize the
trends regarding a AC independence in the Indian cor-
porate-sector. Recalling that Clause 49 require an AC to
have at least 2 to 3 of its members as “independent” di-
rectors, Table 4 shows that the “mean” of independent
directors to be 79 over these four years from 2005-06 to
2008-09. Surprisingly, 15.32 percent of the Indian listed
corporations did not comply with Clause 49 regulations
in 2006. However, by and large, corporations in India
seem to be making a serious effort to comply with the
regulations, with the extent of non-compliance signify-
cantly decreasing from 15.32 percent in 2006-07 to 10.35
percent in 2008-09.
A striking observation with regard to independence of
an AC is “the steady decline in the percentage of corpo-
rations with fully independent AC.” While during 2005-
06 more than half of the corporations (54.98) had “vol-
untarily” chosen to have a fully independent AC, this
percentage has steadily declined, surprisingly, to just
over one-third (37.88) by 2008-09. What is instead ob-
served is a very steady move to have an AC, which are
just in accordance with the minimum independence re-
quirement that is prescribed under the law. Given the size
distribution of an AC, a fraction between 2/3 and less
than 1 implies a “mandatory” compliance under the
Clause 49 regulations.
This is further borne out by the steady “increase” in
the proportion of corporations that have an “executive”
(or management) director present in an AC from 2006 to
2008. Recall that until 2006, when the revised Clause 49
came into effect, an AC was required to consist only of
non-executive directors, with majority of them being
independent. The revised Clause 49, shockingly removed
the non-executive director requirement and instead
specified that an AC to have a minimum of three mem-
bers, with two-thirds of themeing independent. Given b
Table 4. Trends in audit committee indepe nde nce: distribution of corporations.
Fraction of Independent Directors 2005 2006 2007 2008
f < 2/3 8.16 15.32 12.76 10.35
2/3 f < 3/4 18.43 18.11 22.45 23.48
3/4 f < 1 18.43 22.84 25.51 28.28
f = 1 54.98 43.73 39.29 37.88
No. of Corporations 334 366 395 399
Fraction of Independ en t Di re ctors (ID) 0.85 0.78 0.78 0.79
Fraction with Managing Director (MD) in the
Audit Committe e (AC) (%) 19.51 19.70 19.90 22.47
Source: Annual reports of top 500 listed corporations in India, SANSCO.
the specification of a minimum size of three, however,
the move from the majority to two-thirds rule did not
impose any extra independence burden. The only effect
of the revised Clause 49 regulations was that “manage-
ment directors could now be part of an AC.” Unfortu-
nately, what we observe since then is a change in AC
composition that seems to be a direct response to the
change in the regulation. The steady decline in fully in-
dependent AC is also consistent with this change in
regulation, as non-executive directors are more likely to
be also “independent” directors. Moreover, “non-ex-
ecutive” directors could be “independent” directors, or
“gray” directors. “Gray” directors are those who are re-
lated to the executive directors or have a financial inter-
est in the corporation. It should be noted that corpora-
tions belonging to “business groups very often have fam-
ily members serving as “gray” directors on corporation
After the CG scandals of early 2000, policy-makers all
around the world have responded by creating “codes” to
improve “ethical” standards in business. A common
theme in these guidelines is the “independence of the
boards of directors that oversee corporate managers.” For
example, in 2002, the NYSE and NASDAQ submitted
proposals that required boards to have a majority of in-
dependent directors with no material relationships with
the corporation (Magilke et al., 2009) [50]. An “inde-
pendent” director is defined as someone who has never
worked at the corporation or any of its subsidiaries or
consultants, is not related to any of the key employees,
and does not/did not work for a major supplier or cus-
tomer. The rationale for this “policy” recommendation is
that board members with close business relationships
with the corporation or personal ties with high-ranking
officers may not assess its performance dispassionately,
or may have vested interests in some business practices.
To quote Ravina and Sapienza (2009) [51], “Some criti-
cize the emphasis on independent board members,
claiming that while they are independent in their scrutiny,
they have much less information than insiders. If the ex-
ecutives want to act against the interest of the sharehold-
ers, they can simply leave outsiders in the dark. Thus,
since the independent board members have very limited
information, their monitoring could be extremely inef-
Table 5 describe the “fraction” of independent direc-
tors on the AC of corporations in India as a measure of
AC independence, and how this has changed over the 4
years time period from 2005-2009 for the Indian corpo-
rations. This is shown for corporations with different
sizes of audit corporations, where the size is 3, 4, 5, or 6.
The trends in independence presented in Table 5 for dif-
ferent sizes of AC confirms that “the decline in fully in-
dependent AC is true for of all sizes, though the decline
is more pronounced for an AC which is bigger in size.”
Unfortunately, the bigger-size AC has higher “non-com-
pliance” with the Clause 49 requirements. For example,
in 2008, almost one-third (31.25) of the AC with size of
5 did not have the requisite number of independent di-
rectors required under Clause 49.
Undoubtedly, an AC plays a “vital” role in ensuring
the independence of the audit process. In a recent study
conducted by Sharma et al., (2011) [52], the author con-
cludes as: “This study is the first to demonstrate that an
AC can moderate threats to auditor independence thus,
protecting the quality of financial reporting.” To main-
tain integrity of their monitoring function, an AC is re-
quired to perform their responsibilities “diligently”. Be-
cause diligence is extremely difficult to observe directly,
research uses an AC meeting “frequency” as a proxy for
diligence (Raghunandan and Rama, 2007) [37]. Prior
research by Vineeta Sharma et al., (2009) [53], however,
focuses on the consequences of an AC meetings and very
clearly demonstrates “greater” meeting frequency is usu-
Copyright © 2012 SciRes. ME
M. L. BHASIN 865
ally associated with a “reduced” incidence of financial
reporting problems, and “greater” external audit quality.
SEBI’s Clause 49 requires the AC “to have, at least, 4
meetings per year with not more than four months of gap
between two successive meetings.” Accordingly, Table 6
(shown below) presents the distribution of corporations
according to the number of meetings held. It can be very
clearly observed that “there is a steady improvement in
compliance with this requirement; only 6.28 percent of
the corporations holding less than 4 meetings in 2008-
09.” Moreover, the “average” number of meetings held is
nearly five (4.82) in the last two years, namely 2007-08
and 2008-09 respectively. It appears that many corpora-
tions are “more” frequently holding their meetings, as per
their individual requirements, and were not simply fol-
lowing the “dictates” of the law.
As per the “spirit” of the SEBI’s listing requirements,
an AC needs to meet at appropriate times throughout the
year, thus, ensuring that they have enough time to discuss
various issues fully. While AC meetings are “occurring
more frequently and for longer periods, chairs should
ensure the AC has time to reflect on issues and not just
Table 5. Trends in audit committee indepe nde nce: distribution of corporations.
Size = 3 Size = 4
Fraction of Independent
Directors 2005 2006 2007 2008 2005 2006 2007 2008
f < 2/3 7.41 7.73 8.50 6.53 6.06 15.97 10.29 9.72
2/3 f < 3/4 28.04 32.04 39.50 42.21 0.00 0.00 0.00 0.00
3/4 f < 1 0.00 0.00 0.00 0.00 48.48 52.10 61.76 62.50
f = 1 64.55 60.22 52.00 51.26 45.45 31.39 27.94 27.78
No. of Firms 189 181 200 199 99 119 136 144
Size = 5 Size = 6
2005 2006 2007 2008 2005 2006 2007 2008
f < 2/3 23.08 30.30 38.46 31.25 11.11 28.57 16.67 15.38
2/3 f < 3/4 0.00 0.00 0.00 0.00 33.33 35.71 58.33 61.54
3/4 f < 1 50.00 51.52 38.46 59.38 0.00 21.43 8.33 15.38
f = 1 26.92 18.18 23.08 9.38 55.56 14.29 16.67 7.69
No. of Firms 26 33 39 32 9 14 12 13
Source: Annual reports of top 500 listed corporations in India, SANSCO.
Table 6. Meetings held by an audit committee (AC)—distribution of corporations.
No. of Meetings Held 2005 2006 2007 2008
0 0.93 0.56 1.03 0.50
1 0.62 3.36 1.28 0.25
2 2.17 1.96 1.28 1.01
3 11.46 6.16 3.59 4.52
4 39.94 43.14 44.10 45.23
5 24.46 23.81 25.13 26.88
6 9.91 11.48 12.31 11.31
7 10.53 9.52 11.28 10.30
Average No. of Meetings Held 4.67 4.62 4.83 4.82
Number of Corporations 323 357 390 398
Source: Annual reports of top 500 listed corporations in India, SANSCO.
Copyright © 2012 SciRes. ME
comply with legal requirements.” Undoubtedly, an im-
portant issue with respect to meetings is the “duration” of
the AC meeting, and the “preparation-time” that is given
to the AC members to have “meaningful” discussions
about the financial operation of the corporations. For
instance, FICCI and Thornton (2009) [54] conducted a
CG review of 500 mid-sized Indian corporations which
show that “in 50 percent of the corporations AC meetings
lasted for less than two hours, while in only 9 percent of
the corporations did the meetings went beyond four
hours. The majority of the corporations gave an “average”
preparation time of up to 7 days to the AC members in
terms of mailing them the agenda of the meetings, while
only 6 percent gave time of more than two weeks.”
An important dimension of an AC “effectiveness” that
has gained the attention of regulators and academics is
the “financial expertise” of the AC members. However,
both the SOX and SEBI’s Clause 49 mandates the dis-
closure of whether or not an AC includes a “financial”
expert. However, the operationalization of who is a fi-
nancial expert was and still is a controversial issue. For
example, Krishnan and Visvanathan (2008) [55] have
argued that effective AC members are those who have
“general management” experience rather than those who
have an “accounting or financial” background. The SEC,
initially, proposed a “narrow” definition to include only
accounting financial experts—that is, directors with ex-
perience as a CPA, auditor, CFO, controller, or chief
accounting officer. However, subsequently the SEC de-
fined financial expert “broadly” to include non-account-
ing financial experts, such as directors with experience as
a CEO or president. Was the SEC correct in defining
financial experts to include both accounting and non-
accounting experts? Because an AC is the ultimate
“monitor” of the financial reporting process, an AC fi-
nancial expertise is a key determinant of its “effective-
ness”. However, Krishnan and Lee (2009) [56] in another
study found that “firms with higher litigation-risk are
more likely to have an accounting financial expert on
their AC. This association occurs for firms with rela-
tively strong governance but not for those with weak
Additional characteristics of an AC for the 500 top-
listed corporations in India are presented in Table 7 for
the financial year 2008-09, which presents key measures
of AC “quality” that have been the focus of reform initia-
tives. Among these are: 1) the presence of members with
accounting degree; 2) the number of directorships held
by an independent director; 3) the tenure of the inde-
pendent director; and 4) the mean age of independent
director serving on the AC. While an AC independence
is of paramount importance for ensuring the integrity of
the financial reporting process, there is a growing recog-
nition that “what is perhaps more important is the finan-
cial literacy and commitment of the AC members to dis-
charge the various functions entrusted to them by the
As Dhaliwal et al., (2010) [57] succinctly puts it:
“While SOX proposes a “narrow” definition of financial
expertise, to include individuals with experience in ac-
counting or auditing, the SEC controversially adopted a
“broader” definition of financial expertise that includes
accounting and certain types of non-accounting (finance
and supervisory) financial expertise.” Motivated by the
SOX requirement that “public” companies disclose
whether they put a financial expert on their AC, we test
Table 7. Audit committee characteristics (sample means): 2008-2009.
Various Characteristics of an Audit Committee Mean Score
Size of Audit Committee (Nos.) 3.65
Size of Board of directors (Nos.) 8.92
Audit Committee has a member with an accounting degree (%) 63.00
Board of directors has a member with an accounting degree (%) 95.00
Number of Audit Committee members with an accounting degree (Nos.) 1.35
Number of Board of director members with accounting degree (Nos.) 2.78
Percentage of Audit Committee members with an accounting degree (%) 40.13
Percentage of Board of director members with an accounting degree (%) 31.82
Total Number of directorships of independent directors serving in the AC (Nos.) 2.61
Median tenure of independent directors serving in the Audit Committee (Yrs.) 6.53
Median age of independent directors serving in the Audit Committee (Yrs.) 58.29
Source: Annual reports of top 500 listed corporations in India, SANSCO; directors database, Bombay stock ex-
Copyright © 2012 SciRes. ME
M. L. BHASIN 867
whether the market reacts favorably to the appointment
of directors with financial expertise to the AC. We find a
positive market reaction to the appointment of account-
ing financial experts assigned to an AC but no reaction to
non-accounting financial experts assigned to AC, consis-
tent with accounting-based financial skills, but not
broader financial skills, improving the AC ability to en-
sure high-quality financial reporting (Firth and Rui, 2007)
[58]. According to SEBI’s Clause 49, “All members of
an AC shall be financially literate and at least one mem-
ber shall have accounting or related financial manage-
ment experience.” For example, Bindal (2011) [59] very
appropriately pointed out, “While Clause 49 does not
require all AC members to possess accounting degrees, it
can be hardly imagined that an AC will be able to do
justice to its role without any of its members having a
formal training on the complexity of the accounting
process and the various accounting and auditing stan-
dards that confront today’s corporations.” There is no
doubt that all “fresh-appointed” AC members need a
“robust” orientation-program, allowing them to under-
stand their role and the corporation’s financial reporting
process, so that they can “add” value to the AC sooner.
In addition, Johnstone et al., (2011) [60] very strongly
observes as: “Internal controls have long been recognized
as important in ensuring high-quality financial report-
ing.” The AC is formed to regularly review processes
and procedures to ensure the effectiveness of internal
control systems so that the accuracy and adequacy of the
reporting of financial results is maintained at high-level
at all times. To discharge their responsibility, it is impor-
tant for the members of an AC to have “formal” knowl-
edge of accounting and financial management, or ex-
perience of interpreting financial statements. The Listing
Agreement (Clause 49) requires “all members of an AC
shall be financially literate and at least one member shall
have accounting or related financial management exper-
tise.” Clause 49, by way of explanation, defined the term
“financially” literate as “the ability to read and under-
stand basic financial statements, e.g., balance sheet,
profit and loss account and statement of cash flows. Fur-
ther, a member will be considered to have accounting or
related financial management expertise if he/she pos-
sesses experience in finance or accounting, or requisite
professional certification in accounting, or any other
comparable experience or background which results in
the individual’s financial sophistication, including being
or having been a chief executive officer, chief financial
officer or other senior officer with financial oversight
responsibilities.” Unfortunately, the explanations given
above are not free from some ambiguity. Table 7 shows
that 63 percent (about two-thirds) of the top 500 Indian
listed corporations had an AC with at least one member
with an accounting degree. However, where an AC did
not have a member with an accounting knowledge, it was
very likely the board had one such a member. On an av-
erage, 40.13 percent of the AC members had an ac-
counting degree. Similarly, percentage of board members
with an accounting degree was 31.82. However, “me-
dian” tenure and “age” of independent directors serving
in the AC during 2008-09 was 6.63 and 58.29 years, re-
Another fundamental condition which needs to be ful-
filled by all AC members is their ability to devote “suffi-
cient-time” to effectively discharge all the functions as-
signed to them by law (Ward, 2009) [61]. For instance,
Emmerich et al., (2006) [62] advises as: “To be sure,
prospective AC members must understand that more will
be required of them—more time and more efforts—than
may have been demanded in the past. It seems clear that
all aspects of the “legal” system are likely to place a
heavier emphasis on independence and to demand greater
attention and involvement (that is, greater commitment)
from corporate directors in general, but especially from
AC members, than in the past.” The legal standards for
measuring the independence and the duties of an AC
member, by-and-large, have not changed. As we have
seen, the current SEC regulations discourage directors
with more than three directorships to be members of an
AC because “over the commitment that comes with too
many directorships might hamper the ability of the di-
rectors to dutifully carry out all the functions expected of
him/her.” In this context, it is encouraging to note from
Table 7 that the “average” number of directorships held
by the independent directors in the top 500 listed Indian
corporations during 2008-09 was 2.61, less than three.
This is a welcome development and will hopefully per-
sist in the coming years. In this context, Zabihollah et al.,
(2003) [63] states: “Having the right directors on the
AC—with mandated independence and financial literacy
combined with integrity, healthy skepticism, knowledge
of the corporation and industry, and the courage to chal-
lenge decisions—is an important driver of AC effective-
In the past, some Western researchers have examined
the relation between CG characteristics and the audit fees.
Strong governance could increase the demand for audit-
ing (thereby increasing fees) and/or reduce auditors’ as-
sessments of risk (thereby reducing fees). For example,
Krishnan and Visvanathan (2009) [55] in their study
found that “audit fees are negatively associated with ac-
counting expertise on the AC but only in corporations
with strong governance. Audit fees increase with board
size, board meetings, AC meetings, and CEO duality.
Also, the relation between audit fees and AC accounting
expertise is negative, when earnings management risk is
low, but positive when the earnings management risk is
high.” Thus, an AC with accounting experts appears to
Copyright © 2012 SciRes. ME
demand more “extensive” auditing when “risk” is higher.
Conversely, research by Lassila et al., (2010) [64] finds
that “the use of the auditor for tax services is positively
related to CG strength—composite of board size, board
independence, audit committee size, audit committee in-
dependence, shareholders’ rights, and institutional owner-
Now, moving over to issues relating to auditor inde-
pendence and non-audit fees, Table 8 presents some
relevant statistics for the top 500 Indian listed corpora-
tions for two years, viz., 2006-07 and 2007-08. It can be
observed that in 80 and 79.40 percent of the corporations
in 2006-07 and 2007-08 respectively, the statutory audi-
tor was also rendering non-audit services. During these
two years, there is virtually no significant change. Com-
parative figures available for the US in 2000, which pre-
dates the passage of the SOX Act, shows that out of the
16,700 corporations, which were registered with the SEC,
only 4100 (or 25 percent) purchased non-audit services
from the external auditor. According to a study con-
ducted by Abbott et al., (2007) [65], “Our results are
consistent with firms with independent, active, and ex-
pert AC being less likely to outsource routine internal
auditing activities to the external auditor. However, the
outsourcing of non-routine internal audit activities, such
as, special projects and EDP consulting are not nega-
tively related to effective AC.”
Indeed, interesting differences surface during 2007-08
when the “aggregate” picture is broken down into “own-
ership” groups. Two important observations can be made
on Table 8. First of all, nearly 85 percent of corporations
belonging to “business” groups (either domestic or for-
eign) buy “non-audit” services from the “statutory” audi-
tor. For the same period, the percent for “standalone”
firms, who bought “non-audit” services from the “statu-
tory” auditor was 70.54 (domestic) and 62.96 (foreign),
respectively. Secondly, the percentage of “foreign” group
corporations buying “non-audit” services shows an “in-
crease” (from 84.21 to 88.24) from 2007 to 2008, while
“Indian” standalone corporations exhibit a “decline”
from 75.73 to 70.54 percent.
Furthermore, Table 8 also presents the extent of non-
audit fees relative to audit fees earned by auditing firms
for top 500 listed Indian corporations. Current regula-
tions require that “non-audit fees not to exceed audit-
fees.” As the data in the table demonstrates, “the extent
of non-audit fees in both years was well below the statu-
tory limit.” More encouragingly, the extent of non-audit
to audit fees has declined for all corporations under study
from 46.67 percent in 2006-07 to 35.65 in 2007-08. De-
composition by ownership groups shows that extent of
non-audit fees (56.38 percent) to be much higher for for-
eign corporations than for domestic corporations (34.88
percent) in 2007-08. On an average, the ratio of non-
Table 8. Non-audit services and non-audit fees.
Services rendered by Auditors 2006-07 2007-08
Corporations where Auditors
rendered Non-audit Services (%) (%)
Indian Business Groups 83.90 85.15
Indian Standalone 75.73 70.54
Foreign Business Groups 84.21 88.24
Foreign Standalone 70.37 62.96
All Corporations 80.00 79.40
Non-audit to Audit Fees by
Ownership Groups (Median) (%) (%)
Indian Business Groups 42.00 34.88
Indian Standalone 39.54 26.30
Foreign Business Groups 53.92 56.38
Foreign Standalone 79.42 86.89
All Corporations 46.67 35.65
Non-audit to Audit Fees by Size
(Median) (%) (%)
Small (<750 crores) 48.33 35.42
Medium (>750 and <3400 crores) 41.43 33.50
Large (>3400 crores) 55.36 44.44
All Corporations 46.67 35.65
Source: Annual reports of top 500 listed corporations in India, SANSCO.
audit to audit fees were 42 percent in 2006-07 compared
to 53.92 percent for foreign group corporations and 79.42
percent for foreign standalone corporations. More strik-
ingly, while “domestic” corporation exhibits a decline in
the non-audit fee percentage from 42 to 34.88 percent,
with the decline being more pronounced for “standalone”
corporations (from 39.54 to 26.30 percent), “foreign”
corporations exhibit a marginal increase from 53.92 to
56.38 percent. However, there was a sharp increase from
79.42 to 86.89 percent in the case of foreign standalone
firms. Furthermore, decomposition with respect to “size”
shows that the extent of non-audit fees to be higher
(55.36 and 44.44 percent) in the “larger” bigger corpora-
tions for both years. However, all corporations, irrespec-
tive of their size, showed a significant decline in non-
audit fee from 46.67 to 35.65 percent in 2008.
To sum up, the above analysis of the empirical trends
about an AC, and auditor independence in the context of
top 500 listed Indian corporations present a “mixed” pic-
ture. We observe an increasing trend in compliance with
the Clause 49 regulations; there is a tendency to gravitate
to the minimum standards with respect to an AC compo-
sition. However, there is a little “voluntary” move to
Copyright © 2012 SciRes. ME
M. L. BHASIN 869
compose a “fully” independent AC. Instead, what we
observe is “an increasing trend of “inside” management
being present in the AC. Compared to this, the trends in
auditor independence are better. The data with respect to
non-audit services and extent of non-audit fees tend to
suggest that domestic standalone corporations, which are
also likely to be relatively smaller in size, are very stead-
ily moving towards the notion of auditor independence
envisaged under the regulations.
7. Conclusions
With the rapidly growing instances of corporate failures
and the rising dissatisfaction with the functioning of the
corporations gave rise to the need of reassuring the
stakeholders. As a result, the emphasis was laid on im-
proving the CG practices across the globe. Post-Satyam
scandal in India, however, the investors’ confidence in
the CG system is VERY low. Undoubtedly, in India the
concept of CG has already been embedded in the statutes,
viz., Company Act, 1956 and SEBI’s Clause 49 of the
listing agreement. However, the listing agreement is “a
weak instrument, as its penal provisions are not hurting
enough.” Several “regional” stock exchanges, where a
large number of corporations are listed, lack effective
organization and skills to monitor effective compliance
with CG requirements as stipulated by SEBI. Moreover,
a vast majority of corporations, which are not listed on
any of the stock exchanges, will remain outside the pur-
view of SEBI’s measures. It is, therefore, desirable that
the Companies Act needs to be amended suitably for
enforcing “good” CG practices in India. Being “manda-
tory” under Section 292A of the Company Act, 1956 and
Clause 49 of the listing agreement, “an AC can be a fa-
cilitator of board to implement, monitor and continue
good CG practices for the benefit of the corporation and
its stakeholders.” Moreover, an AC is empowered to
function, on behalf of the board of directors, by assuming
an important “oversight” role in the CG intended to pro-
tect investors and thereby ensure corporate accountability.
Besides, an AC has “oversight” responsibility over the
CG, the financial reporting process, internal control
structure, internal audit functions, and external audit ac-
Over the past 70 years, the AC concept has grown
from a committee designed to nominate and arrange the
deal of engagement with the auditor to a committee re-
sponsible for overseeing the integrity of the corporation’s
financial reporting process. As the responsibilities of an
AC grew, so did the number of countries “mandating”
the use of an AC in corporate boardrooms. No doubt,
after the passage of the Sarbanes-Oxley in July of 2002,
the number of major capital market countries requiring
an AC has more than tripled. Even though the member-
ship requirements for an AC vary, it is very clear that the
majority of major capital market countries view an AC as
a critical component of the financial reporting process.
As part of this research study, we examined top 500
listed corporations in India in terms of market capitalize-
tion as on March 31, 2008. Accordingly, we summarized
the trends about various characteristics of an AC, their
size, composition, activity, as well as, the extent of non-
audit services provided by the auditors in the Indian cor-
poration sector from 2005-06 to 2008-09. Results of this
study indicate that all corporations examined have
adopted AC charters that are published at least once
every three years. In addition, an AC should have in their
charters the oversight of “disaster” planning. All studied
corporations currently include a report of an AC in their
annual report or proxy statement. The majority of an AC
composition, structure, meetings, and qualification are in
compliance with the requirements of the SEBI and or-
ganized stock exchanges. The report of an AC is in-
tended to ensure that financial statements are legitimate,
the audit was thorough, and the auditors have no flagrant
conflicts of interest that may jeopardize their objectivity,
integrity, and independence. It is expected that more ef-
fective AC disclosures in conformity with the provisions
of the Clause 49 of listing rules and Sarbanes-Oxley Act
of 2002 (e.g. charter, report) improve the trust and con-
fidence in CG, the financial reporting process, and audit
However, the above analysis of the empirical trends
regarding an AC, and auditor independence presents a
“mixed” picture. On the one hand, we observe an “in-
creasing” trend in compliance with the Clause 49 regula-
tions. However, at the very same time, we also observe a
tendency to gravitate to the “minimum” standards with
respect to an AC composition. Moreover, there is a little
“voluntary” move to compose a fully-independent AC.
Instead, what we observe is an increasing trend of “in-
side” management being present in an AC. Compared to
this, the trends in auditor independence are far better.
The data with respect to non-audit services and extent of
non-audit fees tend to suggest that “domestic standalone
corporations, which are also likely to be relatively
smaller in size, are very steadily moving towards the
notion of auditor-corporation independence envisaged
under the regulations.” Without any hesitation, we per-
sonally feel this is a very welcome development on the
front of AC and auditor independence in the Indian cor-
porate sector. These results should be of direct interest to
policy makers and stock exchange regulators throughout
the world, who seek to enhance auditor independence by
means of general regulatory change.
Currently auditor independence in India, especially
with respect to rendering non-audit services and presence
of conflict of interest, is largely dependent on “self-
Copyright © 2012 SciRes. ME
regulation”. The Companies Act of 1956 has little to of-
fer in this regard. Under the existing regulations, there
are many unresolved CG issues with respect to auditor
and AC independence in India. The Companies Bill
(2009) has incorporated many of these recommendations.
For investors to have confidence in the independence of
the auditor, the Bill needs to be enacted quickly into law.
However, notwithstanding the passage of the Corpora-
tions Bill, some issues that have not been incorporated
into the Bill will remain as a matter of concern. Unfortu-
nately, there is a lot of resistance from industry circles
for further reforms as evidenced from dropping of the
Bill and revision of clause 49 on their demand. If this
trend continues, the useful contributions from recent
committees and the time spent by their expert members
in this regard will not reap any benefits. It is essential for
the Indian corporate-sector to accept and continue with
the reforms that are demanded by the challenges of the
new millennium. If it is operationally difficult to do fur-
ther modifications to the statutes in the immediate future,
then the respective Stock Exchanges should explore the
possibility of incorporating these additional standards of
independence in their Listing Agreement.
The series of accounting scandals have intensified
pressure from stakeholders and regulators on an AC to do
the jobs for which they were hired. Though most corpo-
rations have an AC, their role has been “limited” due to
“lack of expertise and time.” An “active” AC is impor-
tant because it indicate the commitment to the issues of
interest because of the reports it release about the active-
ties undertaken during the financial year and the efforts
made to ensure adequate internal control. Of equal im-
portance, auditor independence can be safeguarded if an
AC were composed of a majority of independent and
non-executive directors and this might indicate that their
independent status would contribute to auditor inde-
pendence through bridging communication networks and
neutralizing any conflict between the management and
the auditor (Cohen et al., 2007) [66]. Thus, an AC
“mechanism” can go a long-way in enhancing the credi-
bility of the financial disclosures of a corporation and
promoting transparency. Those who do not require an
AC in listed corporations are in a “shrinking” minority.
As a result, corporate managers in “developing” coun-
tries (like India), who are considering a move into a “lar-
ger” capital market will most likely need to establish an
AC before their stock may be traded on a listed market.
To sum up, adequate, relevant and high-quality dis-
closures are one of the most powerful tools available in
the hands of “independent” directors, shareholders, regu-
lators, and outside investors to monitor the performance
of a corporation. This is particularly important for an
emerging economy like India, where there is “insider”
dominance. To this extent, “measures that strengthen
auditor independence and enhance the powers, functions,
and the independence of an AC will be crucial in the
governance of the Indian corporations.” Governance
“risk” is a key determinant of market-pricing of “listed”
securities. A high perceived “independence quotient” of
a corporation’s auditing process can be reassuring to out-
side shareholders that can help reduce the risk premium
of raising capital, thereby providing a strong business
case for strengthening both an auditor and the AC inde-
pendence. No doubt, it is essential for the Indian corpo-
rations to accept and continue with the CG reforms that
are “demarcated” by the challenges of the “new” millen-
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