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Introduction Economic scandals highlighting accountingmanipulation have damaged investors’trust in both U.S. and European financialmarkets. The investment community’s claimof having launched measures to improvemarket transparency focuses attention onthe role of audit committees in improving thequality of financial statements. The Securitiesand Exchange Commission (SEC) has beenrecommending U.S. listed companies to formaudit committees since 1972, and indeed thishas been a requisite for listing since 1978(Goddard and Masters, 2000). However, thepersistence of accounting scandals has led toprofound reconsideration of the workings ofaudit committees, with special attention beingpaid to their composition and independencefrom managerial teams. The Treadway Com-mission (1987), the Cadbury Report (1992), theAmerican Law Institute (1994) and the BlueRibbon Committee (1999) all recommendedthat independent directors with an adequatebackground in auditing activities should siton audit committees. The Sarbanes-Oxley Act(2002) not only imposes the independence ofmembers of audit committees but also stipu-lates that at least one member of an audit com-mittee should have far-reaching experience inthe field of finance.As also happened in the U.S. market,Spanish companies have been subject in recentyears to ever-tighter financial control andpressure to encourage the formation of inde-pendent audit committees. The Spanish Codeof Best Practices (the 1998 Olivencia Code)recommends setting up audit committees toverify companies’ financial statements andinternal audit systems. When Spain’s 2002Financial System Reform Law was passed,audit committees became mandatory forall listed companies as of January 2003. TheAldama Report recommends forming auditcommittees entirely of external directors (i.e.,independent directors and large shareholder_representatives) in a proportion similar tothat of the board of directors. Independent presidents for audit committees are alsorecommended. 1Given that audit committees are essential toimproving market transparency and to restor-ing the investment community’s confidence,this study sets out to analyse the factors thataffect their activities. 2 To approximate auditcommittees’ supervisory efforts, the studyuses meeting frequency to measure the degreeand intensity of activity, with high meetingfrequency being seen as an indicator of anaudit committee’s firm control.Our study will hopefully contribute toextending empirical research into audit com-mittee functioning in the Spanish market,which is a special case, one hallmark ofwhich is an institutional framework thatclearly differs from that of its Anglo-Saxoncounterparts. It may not, in fact, be wise toextrapolate empirical evidence from Anglo-Saxon markets to their Spanish counterpartsfor several reasons: Spanish stock marketsplay a far lesser role than British or Americanmarkets do, and are markedly less developed.Unlike in America and Britain, banks are notonly a major source of funding and financingfor the country’s business fabric but also holdstrong positions as company stockholders.Against this backdrop, it is no surprise thatlarge companies are neither quoted on thestock exchange nor seek funding there. Afurther spin-off of a less developed stockmarket is that the ownership structure ofSpanish firms is concentrated in the hands oflarge controlling shareholders, in the guiseof either family groups, financial organisa-tions, or other companies in other sectors.Boards of directors dominated by the repre-sentatives of these large shareholders are theoutcome of such share ownership clustering.This, in turn, can lead to conflicts of interestbetween large and small shareholders, andalso to agency problems no longer focusingon the issue of separating ownership andcontrol but instead on the quest for privatecontrol benefits by the large shareholders. Yetanother hallmark of the Spanish situation isthat legal protection of shareholders is infe-rior to that of Anglo-Saxon markets, so smallshareholders can easily fall victim to theexpropriatory actions of either their largercounterparts or of management. According to Leuz et al. (2003), earningsmanagement is more intense in countries likeSpain with weak legal protection for investors,where insiders and even large shareholdersenjoy large private control benefits. Therefore,the quality of financial information could beseverely damaged by accounting manipula-tion practices, especially in countries such asSpain where the litigation risk is low. Consis-tent with this idea is the necessity of fosteringthe formation of active audit committees.For this reason, coaxed by a trend towardsregulation to increase control of opportunisticbehaviour whilst also offering minorityshareholders greater protection, our financialmarkets have recently witnessed some devel-opment. Enhanced transparency of informa-tion and more efficient control mechanismsare the main concern of legislators tryingto safeguard investors’ interests, therebypushing auditing processes – a cornerstone ofreliable financial information – to the forefrontof importance. Reliable financial information isa sine qua non for protecting shareholders’interests and will foster stock market develop-ment in the long run. However, auditing pro-cesses in Spanish firms have their ownparticular idiosyncrasies. First, the fact that it isa relatively new discipline means that it doesnot rest on tradition or enjoy its support. 3 Fur-thermore, there is a paucity of legal instru-ments to uphold auditor independence. 4Finally, incentives implemented in countrieswith more of a tradition of auditing to helpmaintain high auditing quality are fairlylimited in Spain (Ruiz Barbadillo et al., 2004,p. 599). Differences both in the corporate gov-ernance systems of Spanish firms and theSpanish auditing system highlight the futilityof extrapolating for Spain from studies of theAnglo-Saxon markets. The latter boast a tradi-tion of auditing that is a source of broader,better information on the activities of auditcommittees. Collier and Gregory (1999), forexample, describe how the British marketcomprehensively assesses auditing activityusing both the number of audit committeemeetings and their duration. Such an approachis unfeasible for the Spanish market since thereis neither obligation nor willingness to providesuch information. Studies on auditing pro-cesses in the Spanish market have so farfocused on external auditing. 5 In contrast, thispaper targets internal auditing and studies thefactors that affect the activities of audit com-mittees in Spanish listed companies.The main outcomes of our study are thataudit committee activity of Spanish listed com-panies is affected by ownership structure,leverage and size. However, contrary to therecommendations of the 2003 Aldama Report,the composition and independence of theboard and the audit committee seem to exertno influence on the activity of these commit-tees. The remainder of this paper is structuredas follows: the second section reviews the lit-erature and develops our hypothesis. Thethird section describes the variables andthe methodologies used in the study, and thefourth section analyses the sample and data base used. The fifth section describes resultsobtained and the sixth section draws a numberof conclusions.
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