Monitoring Mechanisms and Earnings Informativeness in the Saudi Stock Market

The impact of monitoring mechanisms on financial reporting continues to be a topic of debate among academics, regulators and practitioners. This study focuses on whether internal and external monitoring mechanisms are related to financial reporting credibility. The study seeks to answer the main research question-to what extent are board of directors and audit committee characteristics, disclosure of internal control weaknesses, audit quality and institutional and bank monitoring associated with financial statement credibility. The study also examines whether some control mechanisms substitute or complement other control mechanisms. Hence, this study also attempts to answer the research question - to what extent board of directors, audit committee characteristics and audit quality influence the disclosure of internal control weaknesses. This study utilized a pooled sample of Saudi listed companies in the years 2007 and 2008. Two proxies of earnings informativeness are used to measure the credibility of reported earnings, namely (i) volatility of stock returns during the earnings announcement period and (ii) announcement period cumulative excess returns. The findings support the hypotheses on the association between board independency, audit quality, internal control system, and institutional ownership and earnings informativenss. The finding fails to support a direct impact of audit committee independence on earnings informativeness. However, the result shows that audit committee independence has significant impact on the disclosure of internal control system weaknesses and the disclosure of internal control system weaknesses has significant impact on earnings informativeness. This implies the indirect effects of audit committee independence on the credibility of reported earnings, consistent with the explanation that controls are complementary. The study extends the limited literature on earnings informativeness in Saudi Arabia, and assists the regulators in understanding the effects of monitoring mechanisms on the credibility of financial statement.