Audit Committee Effectiveness in the Banking Industry: How Effective Are Audit Committees in the Banking Industry? the Answer to That Question May Hinge on Who Is on the Auditing Committee

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EXECUTIVE SUMMARY: The objective of this study was to analyze the value that audit committees added to small commercial banks. The authors were able to evaluate specific internal control questions that assessed the benefit of having an audit committee. The findings of this study, for the most part, are aligned with the findings of the 1999 Committee of Sponsoring Organizations study. This study finds that institutions with audit committees report more internal controls in place on most questions than institutions without audit committees. The most important finding of this study is that institutions with audit committee members who had banking or financial experience reported significantly more effective internal controls than institutions without this expertise on their audit committee.

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The 1992 report by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) defined internal control as a "process, effected by an entity's board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories:

* Effectiveness and efficiency of operations.

* Reliability of financial reporting.

* Compliance with applicable laws and regulations." (1)

In 1999, COSO published Fraudulent Financial Reporting: 1987-1997, An Analysis of U.S. Public Companies. The authors of this study analyzed fraudulent financial reporting alleged by the SEC in Accounting and Auditing Enforcement Releases for 204 companies. Companies committing financial statement fraud were small in size (median assets, $16 million), had senior executives involved in the fraud, and had a board of directors and audit committee that were not functioning properly. Study results showed that approximately 60% of directors were either insiders or …