The Relationship between the Characteristics of a Risk Management Committee and the Issuance of a Modified Audit
Opinion in the Jordanian Context
Saleh Zaid Alkilani1*, Wan Nordin Wan Hussin1, Basariah Salim2
1 Othman Yeop Abdullah Graduate School of Business, Universiti Utara Malaysia, Sintok, Malaysia
2 Tunku Intan Shafinaz Accounting School, Universiti Utara Malaysia, Sintok, Malaysia
*Corresponding Author: [email protected] Accepted: 1 July 2020 | Published: 15 July 2020
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Abstract: Because of the failures that have occurred in the wake of the financial crises worldwide, many studies and researchers have recommended establishing separate risk committees at the level of the board of directors to manage the risks and supervise the risks faced by companies, as well as work to prevent excessive risks. This study investigated whether any differences exist in the companies that have risk committees from those in which do not have risk committees. The main research question of this study was whether the risk committees impact the quality of financial reports in Jordanian industrial and service companies, and another examined the relationship between characteristics including size, qualifications, meeting frequency, and independence and the issuance of a modified opinion.
In this study, the quality of financial reports was measured through the issuance of a modified opinion by an external auditor. The sample of the study consisted of all companies (industrial and service) that were listed on the Amman Stock Exchange between 2015 and 2018. The results found a negative relationship between characteristics of the risk committees, including the existence of a committee, qualifications of members, and frequency of meetings and the issuance of a modified audit opinion. The results indicated that the independence of the risk committees had a significant and positive impact on the issuance of a modified opinion, which indicates that it did not reduce the likelihood that a Jordanian company would receive a modified audit opinion. This study did not find any significant effect of the size of a risk committee on the issuance of a modified opinion. The results of this empirical study provided substantial evidence of the importance of the existence of risk committees in companies and their characteristics to raise the quality and efficiency of financial reports. Because risk committees in industrial and service companies can reduce the likelihood that a company would receive a modified audit opinion for risk-related reasons, policymakers and regulators should note the importance of the existence and characteristics of separate risk committees industrial and service companies.
Keywords: corporate governance; risk committee; modified audit opinion; Jordan
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1. Introduction
This research examines the presence of risk committees in Jordanian companies and their characteristics, as important mechanisms for corporate governance and the relationship between the presence of risk committee and its characteristics with the issuance of a modified opinion in Jordanian industrial and service companies. The failure of many financial and non- financial institutions in major companies has made headlines for many years (Elamer &
Benyazid, 2018; Elamer, Ntim, & Abdou, 2017; Core, Guay, & Rusticus, 2006). In no small measure, these failures have occurred because of management corruption, collusion with external auditors, and the woeful neglect of corporate governance (http://www.ccd.gov.jo/2017). Consequently, the performance, behaviour and accountability of companies in the industrial and service sectors regarding the issue of risk management have become the subjects of further scrutiny.
Indeed, weaknesses corporate governance systems have identified as a major cause of financial crises (Elamer & Benyazid, 2018). Al-Othman and Al-Zoubi (2019) pointed out that Jordanian corporate governance systems are inadequate, including the weakness of the board's control over the management of companies. In addition to weak risk management practices in Jordanian complicated and unclear structures have created issues for Jordanian companies. Abdullatif, Ghanayem, Amin, Al-shelleh, and Sharaiha (2015) indicated audit committees are traditionally considered being responsible for overseeing financial reporting, auditing, in addition to risk management practices. However, doubts exist about the ability and effectiveness of audit committees in companies to work on issues related to risk management, despite the value of these committees for a company (Badriyah, Sari, & Basri, 2015). Weak and false financial reports, as well as erroneous practices in Jordan, have increased awareness of the importance of the existence of risk committees in companies, particularly with respect to the many disasters that have occurred in modern companies and in addition to the unexpected failures of companies. Some previous studies have indicated that the establishment of a risk committee separate from a company’s board of directors will enable companies to do their jobs better as well as reduce agency problems (Moore and Brauneis, 2008; Elamer and Benyazid, 2018).
Consequently, many Jordanian companies have established a risk committee separate from the board of directors, with the primary functions of reviewing, updating, and changing risk policies to counter any possible events or situations a company might face. Besides, correctly identifying risk management can lead to valuable opportunities for a company. In addition, a risk committee assesses and follows up on the various types of risks that a company may be exposed to, establishes risk management policy, and follows up upon that policy annually (JCGC, 2017).
Consequently, a risk management committee can contribute in several ways. First, a risk management committee that contains independent members with enough knowledge can maintain financial effectiveness at a reasonable risk level. Second, a risk management committee can contribute to corporate governance by auditing existing policies and making recommendations to the boards of directors regarding risk management plans and policies and the level of reasonable risks. Third, a risk management committee can evaluate and analyse the effectiveness of the risk management policies and strategies in companies to identify risks, determine their quantity, direct and control them.
A corporate risk management committee has a supervisory role in the development and updating, as well as monitoring and implementation of the risk management policies on behalf of a company's board of directors. This committee also reports to a company’s board of directors regularly concerning the risk management situation and status. As Choi (2013) noted, a risk committee has the following duties: 1) developing a comprehensive risk management strategy to ensure that a risk management committee can achieve its goals and implement risk management policies, 2) ensuring that a company's management has put in
place a comprehensive and integrated risk management system, and 3) reviewing the procedures and risk management policies of the company and evaluating and managing them appropriately at every level of an organization. Notably, the role of a risk committee is only to recommend and supervise the policies that have been put in place by a company's management and not to take decisions, as decision-making authority rests with the boards of directors in companies.
This study examines the relationship of the presence of a risk committee that is separate from the boards of directors and their characteristics with the issuance of a modified opinion by an external auditor in the Jordanian context. The JCGC has stressed the need for public shareholding companies to establish a risk committee, as one of the essential elements of corporate governance practices to guarantee that the board of directors practice risk management well. In managing its assigned tasks, a risk management committee must possess strong attributes and characteristics. This study focused on a risk committee as the primary variable and used several indicators to measure the effectiveness of that committee, which included the issuance of a modified audit opinion issued by the external auditor. Based on the data collected from the annual reports of companies from 2015 to 2018, 150 companies received a modified audit opinion for risk-related reasons. This figure shows the importance of risk management committees as well as the issuance of a modified audit opinion.
The International Standards on Auditing (240, 315, 330) indicated that an external auditor has the responsibility to work to assess the risks of material misstatements (whether due to errors or fraud) in financial statements. In addition, an external auditor must understand a company's internal control system, before issuing an opinion in a professional audit.
Consequently, an external auditor must work to provide a basis for the implementation and design of risk responses that have been assessed for material misstatements (ISA 700, 705, 570). There are many risks that auditors must address during the corporate auditing process, like a client's business risk, a going-concern risk, and audit risk (inherent, control and detection risk) that are related to a client's internal control system. As guided by ISA 700 and ISA 705, an external auditor issues a modified opinion to the companies when a material misstatement is present in the financial statements resulting from matters related to the customer's internal control system, including fraud, the client's business operations and its environment. These phenomena create a link between the risk management committee and an auditor's professional opinion, especially for a modified audit opinion, specifically due to reasons related to risks.
This study defined and classified modified audit opinion as unqualified with explanatory paragraph, qualified, adverse and disclaimer that a company received. Only the reasons for the risks like going-concern issues and fraud that contributed to the issuance of a modified audit opinion were chosen for this study. Other reasons related to the issuance of a modified audit opinion, such as the limited scope of an audit by the auditors and inadequate disclosure were not chosen in this study.
Despite the growing interest in the role of corporate governance, few studies have examined the relationship between the existence of separate risk committees in companies or their characteristics and the receipt of a modified audit opinion. Although many studies have examined the relationship of the characteristics of boards of directors, as well as the characteristics of audit committees in companies with the issuance of a modified ( Alkilani,
Hussin & Salim, 2019; Ishak & Yusof, 2015; Pucheta‐Martínez & García‐Meca, 2014;
Rusmin, Tower, Brown & Van der Zahn, 2009; Farinha and Viana, 2009; Pucheta-Martinez and Fuentes, 2007; Ballesta & García‐Meca, 2005), few have examined the relationship with a risk committee. Typically, these studies have related several board and audit committee characteristics to the issuance of an audit opinion.
The Jordanian Code on Corporate Governance (JCCG, 2009; 2017) concerning best practices clearly state the board has principle responsibility for "identifying principal risks and ensuring the implementation of appropriate systems to manage these risks.” This is an indicator of the importance of risk management and the oversight function of the board of director, even though no mandatory requirement exists for the establishment of a risk management committee. Although the Jordanian corporate governance code of 2009 did not require industrial and service companies to set up risk management committees separately, the code did recommend that a company should have such a committee. Later, the Securities Commission issued new instructions for corporate governance of joint-stock companies so that the rules of corporate governance were binding. The commission pointed to the increasing importance of applying the principles of corporate governance in managing companies in light of globalization and economic openness, and the crises resulting from mismanagement practices, as previous years had shown that many companies had faltered due to their lack of appropriate governance. The absence of the mechanisms has caused considerable damage and losses that led to major financial crises, the liquidation of some companies or the transfer of several them to the judicial authorities. Corporate governance rules in the instructions were updated to align with the new principles of corporate governance that the Organization for Economic Cooperation and Development (OECD) issued in 2015. Among the most important things included in the new instructions was the obligation of joint-stock companies to have two permanent committees emanating from the board of directors, namely the governance committee and the risk management committee. In 2017, the Securities Commission issued new principles related to corporate governance, which would improve corporate governance practices. It stressed the need for risk committees separate from the board of directors as well as a robust internal control system that would work to evaluate a company's policies and monitor the framework risk management work and its implementation effectively. In addition, these principles stressed the need for independent members of these committees (JCGC, 2017).
Therefore, the principal research problem lies in the fact that many reports claim that a risk management committee which is independent of the corporate board of directors enable that committee to improve risk management, and thus avoid financial crises, but the empirical evidence remains limited. Consequently, this research aims to measure how the characteristics of the risk management committee affect the issuance of a modified audit opinion by an external auditor, with a focus on the industry and services sectors in the Jordanian context. Because poor corporate risk management is a symptom of poor corporate governance practices, a company’s board of directors should work to identify the principal risks and ensure that an appropriate system for managing these risks is implemented. The main issue is whether a risk management committee can focus on the risk profile and manage risk well. In addition, when the risks in a company are appropriately managed, then these risks can be reduced, and the likelihood of receiving a modified audit opinion would be reduced.
To examine this issue, this study investigates the relationship between the presence of risk
committees in Jordanian companies and several characteristics of risk committees and the issuance of a modified audit opinion. Also, the study looks at the differences between Jordanian companies that have a risk committee, and those that do not have a risk committee relative to the issuance of a modified opinion. In Jordan, some companies have collapsed, and others have not. One factor may be that corporate audit committees are unable to deal with risk management effectively because they have much other work to do, such as preparing financial reports and responsibilities related to internal control (Choi, 2013).
The remainder of this study is organized as follows: The second section reviews the literature related to corporate risk management committees and the modified opinion. The third section reviews the study design and the measurement of the variables, and the fourth section will review the study’s results. Finally, the fifth section contains the conclusion along with suggestions for future research.
2. Empirical Literature and Hypotheses Development
2.1 The Existence of a Risk Committee
Panda and Leepsa (2017), Aebi et al. (2012), Bhagat and Bolton (2008), and Jensen and Meckling (1976) indicated that the formation of separate risk committees in companies would work to monitor the behaviour of managers in companies relative to risk management, in addition to ensuring that investments in companies align with the strategic objectives that the administration sets to avoid financial crises. Unfortunately, Ali, Besar, and Mastuki (2017) indicated that the presence of risk committees in companies often provided fewer benefits than what policymakers and regulators expected in preventing financial restatements and that the presence of risk committees in companies might not have any role in helping the board of directors to reduce financial restatements. Abdullatif, Ghanayem, Ahmad-Amin, Al-shelleh, and Sharaiha (2015) had indicated audit committees had been responsible for overseeing financial reporting, auditing and, in addition, risk management practices. However, the majority of studies on the topic of risk committees have indicated that the presence of risk committees separate from the board of directors will lead to improvements in the performance of companies and reduce agency problems (Moore & Brauneis, 2008; Elamer &
Benyazid, 2018). Therefore, setting up separate risk committees may reduce the workload of the audit committees, which bear responsibility for accounting transactions (Bates & Leclerc, 2009; Lawlor, 2012). They added that a risk management committee should have a broader focus on risk, while members of audit committees could focus more on tasks like preparing financial reports based on their accounting skills and expertise.
The concept of risk management is considered broad because it includes the internal and external risks that companies face, and external risks are more complex than the internal risks because they relate to the environmental risks of a company's business. The business risks of companies have been complicated by assigning them to audit committees. In the end, setting up separate risk committees at the boardroom level is the best way to overcome this problem (Protiviti, 2010). Kallamu, Saat, and Senik (2013) indicated that the presence of a risk management committee significantly and positively moderated the relationship between nontraditional strategy and firm performance. Zemzem and Kacem (2014) showed that the existence of a risk committee within a firm had a negative and significant impact on performance. Abdullah, Shukor, and Rahmat, (2017) showed that the presence of a risk management committee and audit committee activeness increased voluntary risk management disclosure. Their findings provided evidence that the establishment of a risk management
committee could increase risk management disclosure among companies in Malaysia. The presence of separate risk committees in companies with their powers and focus on the risks that a company may work to reduce the level of external or internal risks in a company. Thus, the following hypothesis is posited.
H.1. The existence of risk management committee existence will have a negative impact on the issuance of a modified audit opinion.
2.2 Risk Committee Independence and a Modified Audit Opinion
The members on the corporate risk committees are an essential indicator of effective monitoring in relation to the risk issues that companies face (Fama & Jensen, 1983). Dionne and Triki (2005) indicated that risk committees are more efficient in performing their duties when they include independent members or if members come from abroad because they have strong incentives to develop their reputation as experts. In fact, external managers are considered to have a distinct ability to monitor company performance because their careers are not related to a company’s CEO. Consequently, they are considered as free to make decisions and act without the need to fear for their positions or future compensations (Dionne
& Triki, 2005). Besides, Fama, (1980) and Fama and Jensen (1983) said that these external managers are considered to have greater incentives to build a good reputation as experts and to carry out monitoring of corporate decisions, and, therefore, they can maintain appropriate control over the top management of companies. One essential factor for external managers from the viewpoint of the board of directors is that the external board members will not collude with internal board members to sabotage the interests of shareholders, This is because external board members have incentives to build and enhance their reputation as experts, and therefore they are more likely to work to maintain appropriate control over the company's senior management (Carter, Simkins & Simpson, 2003; Yu, Wang & Wang, 2018).
Agency theory posits that independent members of the board of directors, a risk committee, and an audit have enough capacity to contribute to objectivity and expertise that will reduce opportunistic behaviours of managers (Fama & Jensen, 1983). Therefore, the majority of researchers have assumed that independent members of such committees are more effective tools of monitoring and controlling activities like disclosing the risks that a company may face such as members who are not independent (Ahmad, Abdullah, Jamel, & Omar, 2015).
Abdulmalik (2015) and Alkilani, Hussin and Salim (2019) found that independent committees improve and enhance the quality and efficiency of financial reports. This argument is based on the idea that the independence of the members of the committees of companies leads to the enhancement of the efficiency and quality of monitoring, and thus will lead to a reduction of information asymmetry. Salleh, Stewart, and Manson (2006) argued that an independent risk committee is free of management influences when dealing with external auditors and that an independent risk committee encourages the selection of high- quality auditors. In other words, agency costs can be reduced when an independent board member sits on the board of directors.
Several scholars have studied risk committee independence and various relationships with company performance, but the results have been mixed. Elamer and Benyazid (2018) found a negative relationship between risk committee independence and financial performance in the United Kingdom. Zemzem and Kacem (2014) found a positive relationship between the financial performance of Tunisian lending companies and the independence of members of
the risk committees. Armaya’u, Rohaida, and Redhwan (2018) showed that a risk management committee and independent directors reduced the desire of management to manipulate reported earnings.
H2: The independence of a risk management committee is negatively associated with the probability that the company will receive a modified audit report.
2.3 Risk Committee Size and a Modified Audit Opinion
Previous studies conducted on risk committees have revealed that these committees can have either negative or positive results. In a study of UK companies, Elamer and Benyazid (2018) found a negative relationship between the presence, size, independence, and frequency of meetings of a risk committee and corporate financial performance. However, they also argued that an effective risk committee would work to enhance the quality of corporate risk policies and procedures by constraining the ability of management to engage in excessive risk-taking behaviour, which may affect financial performance negatively. In addition, a risk committee could improve the communication process between stakeholders and management regarding risk management, thereby reducing agency costs.
Several studies have addressed the size of a risk committee. Al‐Hadi, Hasan, and Habib, (2016) studied the size of risk committees in Gulf companies and indicated a significant and positive relationship with a company’s disclosure of market risks, supporting the resource- based view that a larger sized committee increased market risk disclosures. Erkens et al.
(2012) and Smith (2003) indicated that the risk committees should contain at least three members to ensure the adequate progress of work. According to agency theory, an increase in the size of corporate risk committees would lead to a concomitant increase in available skills and knowledge. As a consequence, this will ensure that investments in companies will comply with all strategic goals that have been set and reduce the negative and ethical risks that could affect the performance of companies (Aebi et al., 2012; Jensen and Meckling, 1976; Yatim, 2010).
Therefore, the larger the size of risk committees in Jordanian companies, the better the quality and efficiency of financial reports, which will reduce the possibility that a Jordanian company will receive a modified opinion. The following hypothesis is posited.
H3: The size of the risk management committee is negatively associated with the probability that a company will receive a modified audit report.
2.4 Diligence of Risk Management Committee and Modified Audit Opinion
The Jordanian Code of Corporate Governance of 2017 said that the risk committees of the Jordanian companies listed must meet at least two meetings per year and record the minutes of these meetings diligently. The main objective of establishing risk committees in companies was to manage risk procedures without there being any delay (Elamer & Benyazid, 2018).
The agency theory posits that periodic meetings serve an essential role in monitoring corporate boards, and the number of meetings has been used as a metric to measure the effectiveness and intensity of oversight and institutional discipline (Lipton & Lorsch 1992;
Jensen 1993). In this context, a higher meeting rate could bring about a more efficient supervisory role. One viewpoint is that efficiency is gained because meeting more often results in a higher level of monitoring of internal control systems and financial reporting process and communication and orderliness among board of directors members in carrying
out their duties as supervisory management (Saftiana, Putri, and Ferina, 2018). De Andrés Suárez, García, Méndez, and Gutiérrez (2013) concluded that the frequency of meetings was directly related to improvements in the quality of accounting information.
One rationale for using the frequency of meetings as a metric is that this frequency s indicative of the amount of effort made to meet responsibilities and complete tasks (Elamer &
Benyazid, 2018). The expectation is that active risk committees will perform their duties more responsibly than those committees that never meet rarely or never commit to meetings (Deloitte, 2014). Moreover, when meetings are held often, issues related to risk management, internal accounting controls and process of financial reporting can be deliberated in more detail (Abbott, Parker, Peters, & Raghunandan, 2003; Mohd Saleh et al., 2007). Many previous studies assume that the meetings that risk committees hold will have a positive and significant impact on the performance of these committees.
A limited number of empirical studies have examined the relationship between the number of meetings held by risk committees and the receipt of a modified opinion. Alkilani et al. (2019) said that a higher frequency of audit committee meetings does not reduce the possibility of a company receiving a qualified audit opinion. Elamer and Benyazid (2018) found a significant and negative relationship between the meetings of the corporate risk committees and financial performance.
Considering the above, the current study argues that more frequent risk management committee meetings will lead to more frequent and enlightened discussions of the many issues related to risk management, resulting in a lessened probability of a company receiving modified audit opinion. Besides, more frequent audit committee meeting may help in streamlining the communication of risk management issues (Tao & Hutchinson, 2013), that may also improve the quality of financial reporting. Thus, the following hypothesis is posited:
H4: The diligence of a risk management committee is negatively associated with the probability that a company will receive a modified audit report.
2.5 Risk Management Committee Qualification and Modified Audit Opinion
Al‐Hadi, Hasan, and Habib (2016) pointed out that when risk members possess the necessary qualifications and extensive knowledge in financial and accounting matters, they will have a better understanding of the issues related to risks. This knowledge will allow them to participate better in risk management processes, through better supervision of risk management and notification of risks on time. Moreover, agency theory indicates that when there are qualified members of risk committees, this inclusion will lead to an improvement in the administrative control process in companies (Cabedo & Tirado, 2004). Several studies have pointed out that the increased skills and more profound experiences of members of company risk committees will lead those committees to choose the most relevant information to report to management. In turn, this will enable corporate boards to understand better the main risks that companies will face (Abdullah, Shukor, & Rahmat, 2017; Brown et al. 2009;
FRC 2011). Dionne et al. (2015) argued that individuals with finance and accounting background must handle a company’s risk management. Dionne et al. (2015) stated that education in finance and accounting would increase the effectiveness of risk management.
Also, Krishnan (2005) opined that education in finance and accounting would improve the quality of audit committee members in undertaking a company’s internal control tasks.
Alzoubi et al. (2012) and Pucheta‐Martínez and García‐Meca (2014) pointed out that members of audit committees with accounting and financial experience would increase the monitoring ability of the committee and thus increase the confidence and credibility of financial statements. This increase will ultimately lead to a boost in the quality and efficiency of financial reports, and all of this will lead to a reduction of the likelihood that a corporation will receive a modified opinion.
Brown et al. (2009), Fraser and Henry (2007), and Abdullah, Shukor, and Rahmat (2017) pointed out that the function of corporate risk committees only relates to the risks that companies will face, and this, in turn, will lead to the strengthening and improvement of focused control over those risks. Bates and Leclerc (2009) and Abdullah, Shukor, and Rahmat, (2017) noted that corporate risk management committees are expected to attract members who have extensive knowledge and excellent skills in the risk management process.
The expertise and skills in risk management are also expected to be developed through the experience gained by risk management in executing repeated routine risk management tasks (Abdullah, Shukor, and Rahmat, 2017).
Al‐Hadi, Hasan, and Habib (2016) indicated that members of the corporate risk committee who have financial and accounting expertise are expected to make a note of any information is not disclosed and make judicious decisions about those missing details. Therefore, effective risk management committees should possess members with high professional qualifications to ensure the disclosure of risks in the information facing the company. In the same context and as a corollary, companies should include members of their boards of directors who have the appropriate qualifications and experience in accounting and finance to understand the issues related to auditing operations, as well as knowledge of the risks facing the company and disclosure of risks (DeZoort & Salterio, 2001). In addition, Alzoubi and Selamat (2012) stressed the necessity of members of the audit committees having the required qualifications and experience to boost their ability to monitor the financial statement preparation process, which, in turn, will increase the quality and efficiency of financial reports.
Based on the above, the assumption is that a corporate risk management committee must include members who have the appropriate qualifications to ensure their ability to disclose any risks (Al‐Hadi, Hasan, & Habib, 2016). Dionne, Chun, and Triki (2019) pointed out a significant relationship existed between the independence and financial experience of directors and firm value and added that, when risk committee members have experience, this experience will lead to an increase in the performance of the company through appropriate risk management. Also, this process is strengthened by the presence of independent members who have the appropriate expertise. Al‐Hadi, Hasan, and Habib (2016) found a significant and positive relationship between the qualifications of the risk committees and the disclosure of market risks.
The expectation is that members of the risk management committees who have the appropriate qualifications and experience will perform the tasks and duties assigned to them, especially those related to identifying risks. One recommendation is that most risk management committee members should have accounting and finance backgrounds because this type of qualification gives them the needed knowledge. Therefore, the following hypothesis is posited:
H5: Risk management committee qualifications are negatively associated with the probability that the company will receive a modified audit report.
3. Research design
This study investigated the relationship between the presence of risk committees in companies and their characteristics and the receipt of modified opinion in the Jordanian context. This research used all service and industrial companies listed on the Amman Stock Exchange from 2015 to 2018 to address the research problem and answer the research questions. The sample included 109 companies (with 436 firm-year observations). The year 2015 was the starting point for this study because Jordanian companies were obligated to have risk committees from that year onwards (JCGC, 2017).
3.1 Definitions of the variables
Table 1 contains the descriptions of the variables.
Table 1. Definitions of the Variables
Variable Abbreviation Description
Modified audit opinion MAO 1 if a company received a modified audit and 0 if otherwise.
Risk committee
independence
RMCIND The number of independent non-executive members divided by the total number of RMC members.
Risk committee size RMCSIZE Total number of directors on the committee.
Risk committee meetings RMCMEET Total number of meetings held in a year.
Risk committee
qualification
RMCQUAL The figure was generated by the total number of risk committee members with a qualification (accounting and finance) divided by the total number of members sitting on the RMC.
Risk committee existence RMCEXIST 1 if there is Risk Committee in the company and 0 if otherwise.
Leverage LEV The ratio of total debts to total assets.
Net income LOSS 1 for a company reporting a loss in either or both two previous financial years and a 0 if otherwise.
Prior year opinion PYO 1 if a company had received a modified audit opinion for the prior financial year's audit and a 0 if a company received a clean audit opinion for the prior financial year's audit.
Audit quality BIG4 1 if a Big 4 firm audited a company and 0 if otherwise.
Firm size Total assets Firm total assets.
3.1 Research Model
Logistic regression analysis (univariate - and multivariate) was used because the study model contains binary dependent variables. Therefore, the data in this study were analyzed using the STATA program, which provides a logistical basis for regression analysis (univariate variables and multivariate), and was applied to the research design used in this study and is
also appropriate for the logistic regression model.
MAO = β0 + β1 RMCIND+ β2 RMCSIZE+ β3 RMCMEET+ β4 RMCQUAL+ β5 RMCEXIST+ β6 LEV+ β7 LOSS+ β8 PYO+ β9 BIG4+ β10 Total assets + e
4. Findings and Discussion
4.1 Descriptive Statistics
Table 2 shows the results of the descriptive statistics of the study sample of Jordanian industrial and service sector companies between 2015 and 2018. The data show that 29% of the companies studied received a modified external audit report, which is like the results of other studies of Jordan. For example, Alkilani et al. (2019) found that about 32.9% of the Jordanian companies that they studied from 2012 to 2017 had received a modified audit opinion. However, this was much higher than in Britain at 2.96%, Chinese listed companies at 11.0%, and other East Asian economies at 2.01% (Alkilani et al., 2019).
The table also shows that 72% of Jordanian industrial and service companies had separate risk committees. In comparison to companies in Malaysia, Abdullah, Shukor, and Rahmat (2017) found 47% of companies in Malaysia had a risk committee, Ali, Besar, and Mastuki, (2017) found that 39.2% of companies had a risk committee, Yatim (2010) found that 35.7%
of companies had a risk committee. Larasati, Ratri, Nasih, and Harymawan (2019) found that 18% of companies in Indonesia had a risk committee.
Table 2 shows that the independence of risk committees was on average of 53.0%, which can be compared with other relevant studies. For example, Elamer and Benyazid (2018) indicated that the average independence of the risk committee among financial institutions in the United Kingdom was 53.8%. Al‐Hadi, Hasan, and Habib, (2016) found an average independence of corporate risk committees of financial firms in Gulf Cooperation Council Countries of 12%.
As for the size of the risk committee’s council among Jordanian companies, Table 2 shows that the average size of the risk committees was 2.6. These results were less than the results of Elamer and Benyazid (2018), who found an average size of risk committees in financial institutions in the United Kingdom of 3.87. Al‐Hadi, Hasan, and Habib (2016) reported an average size of a risk committee in Gulf Cooperation Council Countries of 7.1.
In the current study, the average number of annual risk committee meetings was 1.41, which is lower than the rate that Elamer and Benyazid (2018) found for the companies that they studied in England, which was 3.98.
As for the expertise and scientific qualifications of members of the risk committees in industrial and service companies in Jordan, the average was 55%, which was much higher than the result that Al‐Hadi, Hasan, and Habib (2016) reported at 6.8%.
Table 2: Descriptive Statistics (n=436)
Variable Mean Std. Dev. Minimum Maximum
MAO 0.291 0.455 0 1
RMCEXIST 0.720 0.449 0 1
RMCIND 0.534 0.388 0 1
RMCSIZE 2.626 1.440 0 5
RMCMEET 1.411 1.314 0 5
RMCQUAL 0.554 0.236 0 0.667
LOSS 0.484 0.500 0 1
BIG4 0.656 0.476 0 1
LNTOTALASS~S 10.215 1.456 5.768 14.394
PYO 0.188 0.391 0 1
4.2 Correlation Matrix
The results related to the correlation matrix are displayed in Table 3. Examining the explanatory variables helps to ensure that no variables that are too closely related to each other. The benchmark for too close of a relationship is 0.80 or more. A correlation that crosses this threshold is indicative of problems in the linear interrelationships that are likely to occur between the independent variables (Hair, Black, Babin, Anderson, & Tatham, 1998;
Cooper & Schindler, 2003). Judge, Hill, Griffiths, Lütkepohl, and Lee (1988) indicated that the correlations between independent variables whose value was less than 0.80 would be less likely to result in multicollinearity. In this current study, the correlation values in the matrixes for the variables in the modified opinion model were less than 0.80. This indicates that no multicollinearity problems existed.
Table 3: Correlation Matrix
MAO
RMCE XIST
RMCI ND
RMCS IZE
RMC MEET
RMC
QUAL LOSS BIG4
LNTO TALAS
SETS PYO
1
RMCEXIST -.241** 1
RMCIND -.099* .562** 1
RMCSIZE -.198** .765** .633** 1
RMCMEET -0.035 .366** .192** .322** 1 RMCQUAL -.163** .098* .118* .150** -.315** 1 LOSS MAO .127** -.204** -.164** -.195** -0.093 -0.002 1 BIG4 .103* -0.021 -0.052 0.000 0.002 0.083 -.139** 1 LNTOTALASS
ETS -0.083 0.025 0.017 .135** 0.054 -0.001 -0.087 .183** 1
PYO .634** -.158** -.107* -.132** -0.048 -0.001 .227** 0.077 0.013 1
Notes: This table presents the correlation results. This table shows the following variables: modified audit opinion (MAO), RC existence (RMCEXIST), RC independence (RMCIND), RC size (RMCSIZE), RC meetings (RMCMEET), RC qualification (RMCQUAL), leverage (LEV), Net income (LOSS), Prior year opinion (PYO), Audit quality (BIG4), Firm size (Total assets). See Table 2 for the definitions of each variable. **denotes significant at the 1% level and *denotes significant at the 5% level.
Table 4 below presents the results of the regression analysis. The first hypothesis posited was that the existence of risk management committee existence would have a negative impact on the issuance of a modified audit opinion. The analysis shows that the presence of a risk committee was statistically significant at the 1% level and followed the hypothesised direction. This finding indicates the importance of having separate risk committees in the companies. Besides, if Jordanian industrial and service companies have separate risk committees, then the probability that a company will receive an unmodified audit opinion is very high, and this, in turn, also will increase the quality of financial reports. This result supports the argument of Subramaniam et al. (2009) that the presence of corporate risk
committees will increase the efficiency of internal control in relation to the risks facing companies. Consequently, this will reduce the likelihood that a company will receive a modified audit opinion, especially in matters related to risk management. Abdullah, Shukor, and Rahmat (2017) emphasized that setting up risk committees in Malaysian companies would help to increase the disclosure of risk management between companies.
The result of the first hypothesis aligns with the requirements set out in Jordanian corporate governance law, which clearly states that the board of directors of the companies holds primary responsibility for the risk management process, including determining the main risks facing the company until the implementation of an appropriate system for managing these risks. Consequently, the establishment of a separate risk committee as a sub-committee of the board could work to enhance the efficiency and effectiveness of the risk control function of the board of directors. This means that the existence of a separate risk management committee will have a significant impact on Jordanian companies so that they are less likely to receive a modified auditor's report. More importantly, this result answered the aim of the study in assessing the importance of having a separate risk committee relative to receiving a modified audit opinion.
The results of the analysis in Table 4 indicate that the independence of the risk committees had a significant impact on a modified audit opinion at the 5% level. Interestingly, however, the direction of influence was positive. This result means that the independence of the risk committees in Jordanian industrial and service companies increases the possibility of them receiving a modified audit opinion. This finding contrasts with the hypothesis that the independence of risk committees would have a negative impact on the modified audit opinion. Consequently, the conclusion can be reached that the independence of the risk committees does not reduce the possibility that a Jordanian company will receive a modified audit opinion.
Compared to previous studies on risk committees in companies, the result of this study is contradictory to several studies. For example, Elamer and Benyazid (2018) indicated a significant and negative relationship between the independence of risk committees in financial institutions and financial performance in the United Kingdom. Furthermore, Armaya’u, Rohaida, and Al-dhamari (2018) found that the presence of independent members of risk committees was linked negatively and significant to earnings management in Nigeria.
This linkage meant that the presence of independent members of the risk committees led to lessening the administration's desire to manipulate the reported earnings. Additionally, previous studies like Aebi et al. (2012) and Elamer and Benyazid (2018). argued that independent managers of risk committees could work to increase the value of a company through better monitoring and providing their expertise and improve the performance of financial institutions by limiting risky behaviour during times of crisis.
Al‐Hadi, Hasan, and Habib (2016) did not find a significant relationship between the independence of members serving the risk committees and the disclosure of market risks, which is inconsistent with agency theory. They argued that contextual factors, including institutional settings, like ownership concentration, may have an adverse impact. In the context of Jordan, one plausible explanation is that most companies are family companies.
This ownership structure could lead to the appointment of risk committee who are not truly independent because they may have a strong business, or friendly relations with board members directors, which negatively influences their independence and weaken their
monitoring role. Thus, they lack the ability to control management's opportunistic behaviour.
All that leads to a decrease in the quality of financial reporting in Jordanian corporations, thereby leading to an increase in the prospect that a Jordanian corporation will receive a modified audit opinion.
Table 4 shows the results of hypothesis 3, which posited that the size of the risk management committee would be negatively associated with the probability that a company would receive a modified audit report, was insignificant even at the 10% level. This result indicates that the number of members on the risk committees does not help in reducing the prospect of Jordanian listed companies receiving a modified audit opinion. This result contracts this study’s stated hypothesis that expected a negative and significant relationship between risk committee size and a modified audit opinion. Thus, hypothesis H2 was not accepted.
This result is consistent with several prior empirical studies on modified audit opinion, including Farina and Viana (2009), Sanchez-Ballesta and Garcia-Meca, (2005), and Firth et al. (2007), who failed to uncover any association between board of directors size and a modified audit opinion. Conversely, the result of the current study is inconsistent with Rusmin et al. (2009), who found that board of directors size had a negative relationship with the probability of a company receiving a modified audit opinion.
The non-existence of a relationship between risk committee size and modified audit opinion in this study could be attributable to the fact that board of directors is stronger in determining the likelihood of a Jordanian public listed company receiving a modified audit opinion.
Perhaps the boards of directors in Jordan did not allocate responsibilities related to the risk issues to the risk committees. Furthermore, members of risk committees typically might not have the necessary savvy to either conduct or fulfil their responsibilities effectively.
The result for hypothesis 4, which was that the diligence of a risk management committee as reflected in the number of meetings was negatively associated with the likelihood that a company would receive modified audit report, was negative and significant at the 1% level.
Thus, hypothesis H4 is accepted, and the conclusion can be reached that frequency of risk committees meeting is related to an increase in the quality of financial reporting, thereby, reducing the prospect of obtaining a modified audit opinion. Some previous studies have had the same findings. For example, Farinha and Viana (2009) found that the number of risk committee meetings had an essential role in influencing the effectiveness of work in the risk issues facing a company.
Additionally, de Andrés Suárez, García, Méndez, and Gutiérrez (2013) indicated that the increased activity of corporate committees would increase the quality of the financial reports, and, therefore, would serve to reduce and avoid the qualifications in the reports of an external auditor. Elamer and Benyazid (2018) argued that the existence of effective risk committees could constrain the ability of management to engage in excessive risk-taking which, in turn, would enhance the quality of risk management policies and procedures in companies. In addition, the meeting frequency might lead to an improvement in the communication process between management and the various stakeholders with respect to managing risks and reducing agency conflicts
The reason for the negative relationship of meeting frequency with the issuance of a modified opinion in this current study may be that more frequent meetings might allow risk committee
meetings to discuss issues related to risk in-depth, and, thus, these issues will be handled well. Based on this argument, issues related to the risks that a company faces are discussed in detail in the meetings of the risk committees, and continuous and decisive measures may be taken by the departments and parties involved in the companies to solve these problems.
Therefore, the risks that a company faces are correctly handled and managed, which would lead to better internal control in the company. In turn, this better control would lead to better financial report quality, and, thereby, reduce the prospect of receiving a modified audit opinion.
Hypothesis 5 posited that risk management committee qualifications would be negatively associated with the probability that the company will receive a modified audit report. The results of this current study were statistically significant and negative at 1% level. This indicates that if the members of the risk committees in Jordanian companies have an accounting and/or financial background, then the likelihood that a company will not receive a modified audit opinion is high.
Among the reasons for this finding are that members with such qualifications will lead to an increase in the quality of financial reports among Jordanian companies. Indeed, Alzoubi and Selamat (2012) stated that audit committees with members who have financial or accounting expertise would increase the committee's ability to monitor and will also increase the quality of financial reports. Al‐Hadi, Hasan, and Habib (2016) indicated that effective risk committees should include qualified members who have an accounting or financial background to ensure the proper disclosure of information about risks.
Table 4. Results of the Regression Analysis
Variable Expected Sig. Coef. z P>z
MAO
RMCEXIST - -1.280 -2.71 0.007***
RMCIND - 1.120 1.95 0.051**
RMCSIZE - -0.105 -0.56 0.576
RMCMEET - -0.016 -0.12 0.019**
RMCQUAL - -2.424 -3.9 0.000***
LOSS + -0.270 -0.86 0.392
BIG4 + 0.658 2.02 0.044**
LNTOTALASSETS + -0.255 -2.47 0.014**
PYO + 4.184 9.76 0.000***
_cons 2.290 2.04 0.041
Number of obs 436
Log likelihood = -157.298
LR chi2(9) 211.48
Prob > chi2 0.000
Pseudo R2 0.402
Correctly Classified (%) 86.9 Cox & Snell R Square 0.384 Nagelkerke R Square 0.548
5. Conclusion
5.1 Summary
Despite the growing interest in the corporate governance role, few studies have investigated the relationship between risk committees and the issuance of a modified audit opinion, especially in the context of Jordan. This study provides empirical evidence on the importance of the relationship between the presence of risk committees in Jordanian companies and the characteristics of these committees (independence, size, meeting, qualification) and a modified audit opinion. A sample was taken from the Jordanian companies listed on the Amman Stock Exchange from 2015 to 2018.
This paper analyzed the relationship between the important characteristics of the risk committees and the potential for companies to receive the modified audit opinion by the external auditor, in the Jordanian context. The results of this study indicated a significant and negative relationship between the presence of the risk committee, the qualifications of the risk committee, and the risk committee meeting on the likelihood that a Jordanian company would receive a modified opinion. Regarding the size of the risk committee, this study did not find any link between it and the possibility of companies in Jordan receiving the modified opinion. However, in this study, the results of the analysis from the logistic regression show that the independence of the risk committee had a significant impact on Jordanian companies receiving the modified audit opinion at the 5% level. However, the direction of influence was positive. This indicates that the independence of the risk committee will increase the likelihood that Jordanian companies will receive a modified opinion. As a result, this indicates that the independence of the risk committees in Jordanian companies will lead to an increase in their obtaining the modified opinion. This finding contradicts the hypothesis and the theoretical framework of the study, which indicated a negative relationship between the independence of the risk committees over the modified opinion. Therefore, it is possible to infer that the hypothesis was not supported.
5.2 Contributions
5.2.1 Practical Contributions for Managers
This study makes several contributions. First, important information is provided on industrial and service companies in the context of Jordan and the establishment of so that it is possible to measure whether and how a risk management committee was actually performing its functions or merely adding costs. Third, this study might contribute to the standardisation of risk management procedures and policies. This will ensure that corporate risk management committees are adequately performing their responsibilities.
5.2.1 Contributions to the Literature
This study provides new information and knowledge of the correlation that combines the presence and characteristics of risk committees on modified opinion. Where the study documented that the presence and characteristics of risk committees have a substantial impact on the issuance of a modified opinion by an external auditor. Consequently, this discovery will contribute to the literature and knowledge that the presence and characteristics of risk committees have essential implications for the modified opinion, especially in the Jordanian environment. The presence and characteristics of risk committees may reduce the issuance of the modified opinion by an external auditor. These results are consistent with the hypotheses that were imposed in this study. As the presence and characteristics of corporate risk committees may successfully influence the minimization of risk factors to which companies
are exposed, and thus will affect the issuance of a modified opinion, especially in matters related to risk.
5.2.3 Contributions for policymakers
Second, this study might lead policymakers and regulators to mandate the disclosure of risk management practices in annual corporate reports to help shareholders better understand risk management practices. Consequently, the results of this study have practical implications.
The results of this study will help regulators and policymakers in the Jordanian environment to become more aware of the importance of having these separate risk management committees. This study provides evidence of the importance of the presence and characteristics of risk committees and their role in reducing the possibility of companies obtaining a modified opinion, especially because of risks.
In reading the results, policymakers and regulators might be inspired to standardize risk procedures in companies by revealing the current practices of Jordanian companies.
Additionally, policymakers could use the results to develop better reporting frameworks to help shareholders and users of financial statements better understand the practices and risks to which companies are exposed. Additionally, they could ensure better risk-related disclosure in the annual reports of companies.
5.3 Limitations
As are all studies, the current research had several limitations. The first is a limitation in terms of the generalizability of the study’s findings. This research was conducted in the specific national context of large Jordanian industrial and service sector firms. Thus, the findings may be inapplicable to other industries or cultural contexts. Consequently, the results must be interpreted with caution concerning generalizing them. A second limitation is that this study did not compare and contrast different ownership structures like family, institutional, or foreign ownership or ownership concentration. A third limitation is that this study examined only the specific period from 2015 to 2018; thus it was not possible to determine how effective the most recent regulations have been in creating risk committees compared with previous periods as would a longitudinal study would have been. Fourth, the study only examined large firms leaving unsettled the question of the factors studied in Small and Medium-sized companies, which are engines of an economy.
5.4 Suggestions for Future Study
Several suggestions can be made for future research. First, this study used secondary data from Datastream and annual reports for a quantitative study. Future quantitative could use surveys to collect primary data from members of risk committees. In addition, qualitative data could be collected via interviews with external auditors or members of the risk committees in companies.
Second, this study used the modified opinion as a dependent variable. Consequently, future researchers could use the going-concern opinion, or qualified audit opinion as a dependent variable, as they differ from the modified opinion. Thus, the treatment for each type of audit report varies; also, different results may be obtained if different types of audit reports are used.
Third, this study examined industrial and service sector companies. Future studies could examine financial sector companies and the variables related to receiving an adverse opinion
in Jordan.
Fourth, the study was confined to Jordanian companies. Future studies could examine other MENA countries, which have different legal frameworks and different cultural systems.
5.5 Conclusion
The results of this empirical study provided substantial evidence of the importance of the existence of risk committees in companies and some of their characteristics to raise the quality and efficiency of financial reports. Because risk committees in industrial and service companies can reduce the likelihood that a company would receive a modified audit opinion for risk-related reasons, policymakers and regulators and companies should note the importance of the existence and characteristics of separate risk committees industrial and service companies and work to establish more effective risk committees to create a more stable and efficient investment climate in Jordan.
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