Internal monitoring mechanisms and earnings quality: Empirical evidence from Malaysia

Earnings quality reflects the integrity and quality of financial reporting which minimizes the information asymmetry and agency conflicts among management, owners, and majority and minority shareholders. The issue of earnings quality has
become a concern, especially in respect of corporate governance as an internal monitoring mechanism to ensure the financial reporting quality. The objective of the study is to examine the relationship between internal monitoring mechanisms, namely, board of directors, audit committee, internal audit function, and earnings
quality based on agency theory and resource dependence theory. Furthermore, this study examines the moderating effect of audit committee between the internal audit function and earnings quality. The sample of the study is 2,036 firm-year
observations on the Main Market of Bursa Malaysia for the period of 2009 to 2012. Two discretionary accruals models were used to measure earnings quality. This study reveals that board size, audit committee financial expertise, investment in internal audit function, and outsourcing of internal audit function increase the quality of
earnings. However, board independence, board financial expertise, audit committee’s chairman audit partner, audit committee meeting, and audit committee score reduce earnings quality. The hierarchical regression results show that audit committee size, independence, meetings, and audit committee score moderate the relationship between investment in the internal audit function and earnings quality. In addition, audit committee independence, financial expertise, meetings, and audit committee score moderate the relationship between sourcing arrangements of the internal audit
function and earnings quality. The results of this study have implications to investors, regulators, and market participants. Policy makers might use the findings regarding earnings quality to recognize the important roles played by both the
internal audit and audit committee in enhancing the earnings quality in Malaysian companies.