OVERVIEW
Objective
¾
To explain the objective, relevance and importance of corporate governance.COMBINED CODE (UK) OECD
PRINCIPLES
AUDIT COMMITTEES
¾ Principles ¾ Guidelines
¾ Background ¾ OECD Principles ¾ Combined Code ¾ Expectations
¾ Overview ¾ Directors ¾ Remuneration
¾ Accountability and audit ¾ Relations with shareholders ¾ Institutional shareholders ¾ Meaning
¾ Objective ¾ Relevance
¾ Voluntary or legislation ¾ Risk based approach
1
CORPORATE GOVERNANCE
1.1
Meaning
¾
There is no single, accepted definition of corporate governance. Corporate governance as a specific discipline is relatively new. As beauty “lies in the eyes of the beholder”, so does the answer to the question “what exactly is corporate governance?”¾
There is a wide range of definitions laying along the range from a narrow view that it is restricted to the relationship between a company and its shareholders (agency theory) through to the much wider view that corporate governance is a complex web of direct, indirect and ever changing relationships between the entity and its stakeholders (stakeholder theory).Example 1
Identify the stakeholders of a typical business entity.
Solution
¾
The Organisation for Economic Cooperation and Development (OECD) defines corporate governance as:“The system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation … and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.”
Participants include the board, managers, shareholders and other stakeholders –
hence “society” in the broader definition.
¾
Other explanations include: “The system of checks and balances, both internal and external to companies, which
ensures that companies discharge their accountability to all stakeholders and act in a socially responsible way in all areas of their business activity.”
“The ethical corporate behaviour by directors or others charged with governance in
the creation of wealth for all stakeholders.”
“The way in which the affairs of corporations are handled by the corporate boards
and officers.”
“It is the relationship among various participants in determining the direction and
performance of companies consistent with the public good.”
“The way of promoting corporate fairness, transparency, independence, integrity
and accountability.”
1.2
Objective
¾
The ultimate objective of a business is increasing long-term shareholder value by enhancing economic performance.¾
Research has shown that entities that take account of the interests of all stakeholders are, over the longer term, more successful and more prosperous than entities that do not.¾
This is achieved through: integrity, transparency and accountability in business activity; compliance with law and regulation; and
securing reputation and confidence in attracting inward investment.
¾
It is reflected by how those charged with governance provide stewardship in order to: achieve corporate objectives;
balance corporate objectives with the expectations of society; and provide appropriate accountability to stakeholders.
¾
In general, governance responsibilities involve a number of oversight activities, including matters relating to: entity strategy development and implementation;
economic development, including mergers and acquisitions; appointment of professional operating management executives; compensation of executives;
formation of adequate accounting systems and related internal controls over
financial reporting, operations and compliance with laws and regulations; and
1.3
Relevance
¾
Increases in size, global reach and shareholder base have moved shareholders further away from the management and control of the companies they invest in.¾
Boards of directors provide stewardship over the resources entrusted to them, but corporate governance stewardship responsibilities are increasingly placed on the non-executive members of the board who are, or should be, more independent from the day-to-day operations of the entities and the actions of the professional operating managers.¾
Professional managers running day-to-day operations of large shareholder-owned companies have in some cases caused serious losses to the shareholders through mismanagement or fraudulent financial reporting.¾
Corporate governance provides the means to exercise greater control over professional operating management. The empirical results of studies show that the presence of outside directors helps in preventing or reducing financial statement fraud.¾
If governance responsibilities are taken seriously and performed with intelligence, competence and due regard for the stakeholders, society stands a better chance: of being protected from financial statement fraud, money-laundering, etc; and that public company personnel will have an early focus on going concern issues,
appropriate business strategies, and the implementation of the strategies.
¾
There is a consensus amongst analysts and policymakers that improving corporate governance of companies is critical to generating sustainable growth in the future.1.4
Voluntary or legislated codes
¾
Corporate governance codes are either voluntary codes (eg Russia, Saudi Arabia) comply or explain codes that are often incorporated into stock exchange regulations (e.g. Combined Code in the UK, Sweden) or fully legislated codes (e.g. Sarbanes-Oxley Act in the USA).¾
The prescriptive approach of the US Sarbanes-Oxley Act (SOX) is in stark contrast to the “comply or explain” approach taken by the Combined Code in the UK.¾
Under SOX, the rules have to be followed, or stiff penalties will be raised against the company and its directors. Some of the entities under SOX, consider the rules to be too onerous and not cost effective – thus they are seeking to de-list.¾
Codes that are voluntary or a requirement of a stock exchange can be easily updated to take into account changes in the business environment and stakeholder requirements. Those that are subject to the due process of regulatory law, may not be able to do so so quickly.¾
Codes that are required by law, will be supported by legal penalties and sanctions, e.g. fines and jail terms for directors who breach the rules. The threat of such sanctions may result in the directors of an entity becoming ultra cautious and complying to the letter of the law – this may take resources that could be more effectively used in running the business and lead to a “tick box” mentality.¾
Where the code is voluntary, compliance by specific companies sends a signal toinvestors to help them identify candidates that match their criteria for investment. Such market based reactions are a powerful inducement for other companies to follow.
¾
Voluntary codes do make it difficult to compare companies and make investment decisions. However, research shows that investors tend to favour companies that apply corporate governance procedures over those that do not.¾
In all cases, a balance must be struck between developing a Code and the ability of the directors of a business to run that business for the benefit of the stakeholders.1.5
Risk based approach
¾
Interestingly, there is an argument that it is not the introduction of good corporate governance that will deliver improvements to an entity, but the fact that a lack of good governance will result in poor corporate financial performance – a negative impact.¾
It is argued that good corporate governance is naturally progressive and a natural response to the various scandals resulting from poor governance. Good corporate governance practice (that balances the requirements of all stakeholders) is a progressive norm and as such, companies will benefit from the expectations generated bymaintaining the norm.
For example, one investment fund invested in companies that were considered to
have poor corporate governance procedures. Using their shareholder rights, the fund forced the management to implement sound corporate governance policies. The gains made by the fund were substantial as the market price of the shares reflected the “norming” of the business to “best practice”.
¾
Basically, there is a risk that weak corporate governance will lead to financial losses. Strong corporate governance will minimise such risk. This is reflected within the UK Combined Code for management and the corporate governance process to adopt a risk based approach.2
OECD PRINCIPLES
¾
The OECD Principles of Corporate Governance have, since their introduction in 1999, and updating in 2004, become the most widely accepted corporate governance2.1
Principles
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Protection of shareholders’ rights and key ownership functions.¾
Ensuring the equitable treatment of all shareholders, including minority and foreign shareholders.¾
Recognising the rights of stakeholders (including employees) as established by law and encouraging active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises.¾
Ensuring that timely and accurate disclosure (transparency) is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company.¾
Ensuring the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and its shareholders (the responsibilities of the board).2.2
Guidelines
2.2.1
Protection of shareholders’ rights …
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Guidelines include: Secure methods of ownership, registration, and transfer of shares.
Shareholders to receive relevant information on the corporation on a timely and
regular basis including the voting procedures that govern general shareholder meetings.
To participate in, and to be sufficiently informed on, decisions concerning
fundamental corporate changes including effective participation in general shareholder meetings.
2.2.2
Equitable treatment of all shareholders …
¾
Guidelines include: All shareholders have effective redress for violation of their rights. All shareholders of the same series of a class are treated equally.
Minority shareholders are protected from abusive actions of the majority holders. Any changes in voting rights are approved by those classes of shares which are
negatively affected.
Processes and procedures for general shareholder meetings allow for equitable
treatment of all shareholders.
Members of the board and key executives disclose to the board whether they,
directly, indirectly or on behalf of third parties, have a material interest in any transaction or matter directly affecting the corporation.
2.2.3
Recognising the rights of stakeholders …
¾
Guidelines include: Effective redress for violation of their rights.
Access to relevant, sufficient and reliable information on a timely and regular basis. Able to freely communicate their concerns about illegal or unethical practices to the
board and their rights should not be compromised for doing this.
2.2.4
Ensuring timely and accurate disclosure is made on all material matters …
¾
Guidelines include: Financial and operating results of the company, company objectives and major
share ownership and voting rights.
Information about the board members and key executives on their remuneration
policy, qualifications, the selection process, other company directorships and whether they are regarded as independent by the board.
Related party transactions, foreseeable risk factors and issues regarding employees
and other stakeholders.
Governance structures and policies, in particular, the content of any corporate
governance code or policy and the process by which it is implemented.
Annual audit undertaken by an independent, competent and qualified auditor
accountable to the shareholders.
2.2.5
Ensuring the strategic guidance of the company …
¾
The concept here is that the board as a whole (including independent non-executive directors) are able to monitor the day-to-day activities of the entity’s executive management and in particular the CEO (chief executive officer).¾
No one individual executive, or group of executives, should dominate the direction and strategy of the company, and, in particular, to the benefit of themselves or others under their influence. A significant factor in nearly all financial scandals has been the overriding
dominance of the CEO, either by themselves or in combination with the Chief Financial Officer (CFO). This is further compounded where the CEO also acts as the Chairman of the Board.
¾
Guidelines consider that the board (as a whole) should: Act on a fully informed basis, in good faith, due diligence, care, and in the best
interests of the company and the shareholders.
Apply high ethical standards and exercise objective independent judgment on
corporate affairs, taking into account the interests of all stakeholders.
Review and guide corporate strategy, major plans of action, risk policy, annual
budgets and business plans; set performance objectives; monitor implementation and corporate performance; oversee major capital expenditures, acquisitions and divestitures.
Ensure the integrity of the corporation’s accounting and financial reporting
systems, e.g. independent audit, control systems, risk management procedures, financial and operational control, compliance with the law and regulations.
Monitor and manage potential conflicts of interest of management, board members
and shareholders, including misuse of corporate assets and abuse in related party transactions.
Assign independent non-executive board members to tasks where there is a
potential for conflict of interest, e.g. ensuring the integrity of financial and non-financial reporting, the review of related party transactions, nomination of board members and key executives, and board remuneration.
Select, compensate, monitor and, when necessary, replace key executives and
oversee succession planning.
Align key executive and board remuneration with the longer term interests of the
company and its shareholders.
Monitor effectiveness of governance practices and make changes as needed.
3
COMBINED CODE (UK) — EXAMPLE OF CORPORATE
GOVERNANCE APPLICATION
3.1
Overview
3.1.1
History
¾
Applies to companies listed on the London Stock Exchange (LSE).¾
The current code was last updated in July 2003 and applied for reporting years commencing on or after 1st November 2003, i.e. year ends of 30th November 2004 andafter. A review of the Code took place during 2005/6 resulting in limited minor amendments being made in June 06.
3.1.2
Basic elements
¾
Comprises two sections (companies and institutional shareholders) and five elements (directors, remuneration, accountability and audit, relations with shareholders and institutional shareholders). See below for details on each element.¾
Contains related guidance and good practice suggestions: Internal control and risk assessment (the Turnbull Guidance – see Sessions 8 & 9) Audit committees (the Smith Guidance)
Chairman and non-executive directors (the Higgs Guidance)
¾
All companies have to report on how they apply the principles of the Code (extensive guidance is included within the Code of what needs to be disclosed within the report) and either confirm that they have complied throughout the financial year with the code provisions or, where they do not, provide an explanation as to why not (comply or explain approach).¾
In addition: the board must confirm that there is an ongoing process for the identification,
evaluation and monitoring of significant risks; and
summarise the process by which they have reviewed the effectiveness of the
internal control system (see Sessions 8 & 9).
3.1.3
London Stock Exchange (LSE) audit requirements
¾
External auditors are not required by the Code to report on management’s application of the Code. They are, however, required by the Listing Rules of the LSE to review and report on whether the corporate governance statement reflects the entity’s compliance with specific elements of the Code as follows: The directors’ responsibility for preparing financial statements explained. Review of the effectiveness internal control carried out and reported to
shareholders.
Audit committee established of at least three independent non-exec directors. One
member must have recent and relevant financial experience.
Role and responsibilities of the audit committee set out in writing and includes
details as required by the Code.
Terms of reference of the audit committee, including its role and the authority
Arrangements are in place by which staff may, in confidence, raise concerns with
the audit committee over possible improprieties of financial reporting or other matters (“whistle blowing”).
Arrangements are in place for the independent investigation of such matters and
for appropriate follow-up action.
The audit committee has monitored and reviewed the effectiveness of the internal
audit activities.
Where there is no internal audit function, the audit committee has considered
whether there is a need and made recommendations to the board.
Reasons for the absence of internal audit have been given in the annual report. The audit committee has primary responsibility for making a recommendation on
the appointment, reappointment and removal of the external auditors.
If the board did not accept the recommendation, a statement from the audit
committee explaining the recommendation and reasons why the board has taken a different position, is included in the annual report and in any papers to the
members recommending appointment or re-appointment.
The annual report explains to shareholders how, if the auditor provides non-audit
services, auditor objectivity and independence is safeguarded.
3.2
Directors
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Deals with the board, the chairman and chief executive, board balance andindependence, appointment and re-election to the board, information and professional development of board members, performance evaluation.
¾
Listed companies should have: an effective board with clear division of duties between Chairman and CEO. They
cannot be the same individual (as this gives too much power to one individual) and the Chairman should be non-exec;
a balance of executive and non-executive directors (so that no one group is
dominant, ie 50/50), each group receiving the same relevant, up to date information (so that the board and non-executive directors can constructively challenge the executive);
a requirement for the board to have formal and rigorous annual evaluations of their
performance covering all committees and individual directors;
no executive director holding more than one non-executive directorship with
another company; and
a formal, transparent and independent appointment process for new directors and
3.3
Remuneration
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Deals with the level and make up of remuneration, service contracts and compensation, procedures for developing remuneration policies.¾
There should be appropriate levels of remuneration with a formal and transparent process for fixing that remuneration (i.e. use of an independent remuneration committee) and full details disclosed in the company’s annual report.3.4
Accountability and audit
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Covers financial reporting, internal control, the audit committee and auditors.¾
The company should present a balanced and understandable assessment of its position, maintain a sound system of internal control and establish formal and transparent arrangements for the review of financial reporting, internal control principles and for maintaining an appropriate relationship with the external auditors.¾
An audit committee of at least three, independent non-executive directors must be established, with at least one member having recent, relevant financial experience.¾
The effectiveness of internal control (including financial, operational, compliance and risk management systems) must be reviewed at least once each year.3.5
Relations with shareholders
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Deals with the dialogue with institutional shareholders and constructive use of the annual general meeting (AGM).¾
Companies need to enter into a dialogue with institutional shareholders and use the annual general meeting to communicate with private investors.3.6
Institutional shareholders
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Covers dialogue from institutional shareholders, their evaluation of governance disclosures and voting.¾
Institutional shareholders should make considered use of their votes, be ready to enter into a dialogue with companies and should give due weight to all factors whenevaluating a company’s governance arrangements.
Since the introduction of corporate governance codes within the UK, institutional
shareholders have become much more active in holding the CEO and board accountable for their actions. No longer can CEOs expect “sleeping” loyalty from institutional shareholders.
4
AUDIT COMMITTEES
¾
The audit committee is now considered to be an essential part of the corporate reporting process with the primary responsibility of overseeing, on behalf of the board, the4.1
Background
¾
Audit committees existed in the 19th century.Illustration 1
“Great Western Railway Report of the Audit Committee
The auditors and Mr. Deloitte attended the Committee and explained the various matters connected with the Finances and other departments of the railway, which explanations were highly satisfactory.
The Committee consider the Auditors have performed their arduous duties with great care and intelligence and therefore confidently recommend that they be continued in office.
Benjamin Lancaster Chairman
Paddington Station 22nd February, 1872”
¾
Mandatory for domestic companies listed on the New York Stock Exchange since 1978. Rules significantly updated by the Sarbanes-Oxley Act of 2002 following the singular spectacular failure and ineffectiveness of the Enron audit committee.¾
Disclosure, by exception, in Annual Reports of UK listed companies a requirement of the London Stock Exchange since 1993. Updated through the Combined Code of 1999 and 2003.¾
Specific guidance issued, within the UK, in 2002 on the establishment, membership, role, responsibilities and relationship with the main board of audit committees – the Smith Report.¾
From just a handful of capital markets requiring audit committees in the 1980s, at least 16 countries now require audit committees by law with a further 14 operating under a “comply or explain” basis. Eight other countries operate alternative structures.4.2
OECD Principles
¾
Reference is made throughout the Principles, to the role of independent, non-executive directors. Specific reference to an Audit Committee is made under the following situations:4.2.1
The annual audit conducted by independent, external auditors
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The Audit Committee is often specified as providing oversight of the internal audit activities and should also be charged with overseeing the overall relationship with the external auditor including the nature of non-audit services provided by the auditor to the company.4.2.2
External auditors accountability
¾
That external auditors are recommended and appointed by an independent audit committee (or appointed by shareholders following the committee’s recommendation) can be regarded as good practice.¾
This practice clarifies that the external auditor should be accountable to the shareholders and not directly to the executive management of an entity.¾
It also underlines that the external auditor owes a duty of due professional care to the company rather than any individual or group of corporate managers that they may interact with for the purpose of their work.4.2.3
Conflicts of interest
¾
It is important for a company’s board to encourage the reporting of unethical/unlawful behaviour without fear of retribution.¾
In a number of companies either the Audit Committee or an ethics committee is specified as the contact point for employees who wish to report concerns about unethical or illegal behaviour that might also compromise the integrity of financial statements.4.2.4
Ensuring the integrity of the corporation’s accounting and financial reporting
systems, including risk management.
¾
A company’s board will need to ensure that there is appropriate oversight of these functions by senior management. Often, internal audit reporting directly to the board, is used.¾
In some jurisdictions it is considered good practice for the internal auditors to report to an independent audit committee of the board which is also responsible for managing the relationship with the external auditor, thereby allowing a coordinated response by the board.¾
It should also be regarded as good practice for the Audit Committee to review and report to the board on the most critical accounting policies which are the basis for the financial reports.4.3
The UK Combined Code on Audit Committees
¾
The main role and responsibilities of the committee members must be set out in written terms of reference: to monitor the integrity of the financial statements of the company, and any formal
announcements relating to the company’s financial performance, reviewing significant financial reporting judgements contained in them;
to review the company’s internal financial controls and, unless expressly addressed
by a separate board risk committee composed of independent directors, or by the board itself, to review the company’s internal control and risk management systems;
to monitor and review the effectiveness of the company’s internal audit function,
and if there is no internal audit, consider annually if there is a need for internal audit and make that recommendation to the board;
to make recommendations to the board, for it to put to the shareholders for their
approval in general meeting, in relation to the appointment, re-appointment and removal of the external auditor and to approve the remuneration and terms of engagement of the external auditor;
to review and monitor the external auditor’s independence and objectivity and the
effectiveness of the audit process, taking into consideration relevant UK professional and regulatory requirements;
to develop and implement policy on the engagement of the external auditor to
supply non-audit services, taking into account relevant ethical guidance regarding the provision of non-audit services by the external audit firm;
to report to the board, identifying any matters in respect of which it considers that
action or improvement is needed and making recommendations as to the steps to be taken;
to review arrangements by which staff of the company may, in confidence, raise
concerns about possible improprieties in matters of financial reporting or other matters and to ensure that arrangements are in place for the proportionate and independent investigation of such matters and for appropriate follow-up action.
4.3.1
Internal audit
¾
For internal audit, to specifically: Approve the appointment or termination of the head of internal audit.
Ensure that the internal auditor has direct access to the board chairman and to the
Audit Committee and is accountable to the Audit Committee.
Review and assess the annual internal audit work plan.
Receive a report on the results of the internal auditors’ work on a periodic basis. Review and monitor management’s responsiveness to the internal auditor’s
Meet with the head of internal audit at least once a year without the presence of
management.
Monitor and assess the role and effectiveness of the internal audit function in the
overall context of the company’s risk management system.
4.3.2
External audit
¾
For external audit, to specifically: Approve the terms of engagement and the remuneration to be paid in respect of
audit services provided.
Ensure that the external auditors are independent of the company, eg:
−
discussion with the auditors;−
review of their policies and processes to maintain independence; and−
compliance with appropriate ethical guidelines. Ensure that appropriate plans are in place (at the start of each annual audit cycle)
for the audit, e.g. the overall strategy, risk assessment, materiality, resources and work plans.
Review, with the external auditors, the findings of their work, eg:
−
discussing major issues that arose during the audit (both resolved and unresolved);−
key accounting and audit judgements;−
levels of error identified during the audit; and−
discussing with management and auditors why certain errors remain unchanged. Review the audit representation letters (before signing by management). Review the management letter and monitor management’s actions taken on its
recommendations.
Assess the effectiveness of the audit process, e.g.:
−
was the agreed audit plan met and where changes were made, understand the reasons for such changes, including changes in perceived audit risks and the work undertaken address those risks;−
consider the robustness and perceptiveness of the auditors in their handling of the key accounting and audit judgements identified and in responding to questions from the audit committees, and in their commentary, where appropriate, on the systems of internal control;¾
The audit committee should develop and recommend to the board the company’s policy in relation to the provision of non-audit services by the auditor. The audit committee’s objective should be to ensure that the provision of such services does not impair the external auditor’s independence or objectivity. In this context, the audit committee should consider: whether the skills and experience of the audit firm make it a suitable supplier of the
non audit service;
whether there are safeguards in place to ensure that there is no threat to objectivity
and independence in the conduct of the audit resulting from the provision of such services by the external auditor;
the nature of the non-audit services, the related fee levels and the fee levels
individually and in aggregate relative to the audit fee; and the criteria which govern the compensation of the individuals performing the audit.
4.4
Expectations
¾
Gone are the days when the audit committee would meet just before the annual general meeting and rubber stamp what the directors had done – the nature of stakeholders’ expectations of the audit committee are now equivalent to those of the main board members.¾
Such expectations have not only come about because of various financial reporting scandals (both recent and past) but because of the wider requirements fromstakeholders for corporate accountability, social responsibility and the rejection of “short-termism” .
¾
Whilst the executive directors bear overall responsibility for the corporate strategy, overseeing risks faced by the company, the controls related to those risks and the financial information released to stakeholders (e.g. annual financial statements and reports), the audit committee’s role is a non-executive one.¾
The audit committee should not seek to take an executive role but should aim to satisfy itself that management has properly fulfilled its responsibilities. In doing so, the committee members must have a sound understanding of the entity, the way it operates, the environment it operates in and be independent of the company.¾
Whilst the role of the audit committee considers the risks and controls over the financial reporting process, they must also consider the tax, environmental, legal and other regulatory matters that have a material impact on the financial statements.4.4.1
Advantages of audit committees
¾
Play a valuable role through effective and informed oversight in helping to ensure market, public and stakeholder confidence in high quality financial reporting.¾
Enables the board to delegate a thorough and detailed review of audit matters, both¾
Enables non-executive directors to contribute independent judgement on matters of critical importance in running the enterprise (e.g. investment decisions, risk analysis) and play a positive role in areas for which their skills are particularly fitted. It is of particular importance that the chief executive of the enterprise and the chairman of the audit committee are able to develop a respected, transparent, trusted and professional working relationship.¾
Offers the external and internal auditors a direct link with non-executive directors.¾
Effective Audit Committees need to be able to investigate issues on their own initiative,rather than as directed by the CEO. They must be clear about what they need to know and determined to receive the information they require. Corporate governance codes will not change the mindset of a CEO/CFO determined to carry out a fraud. But an effective Audit Committee (together with effective internal and external auditing) should act as a significant deterrent and minimise the opportunities for destructive fraud to be carried out undetected over a period of time.
4.4.2
Disadvantages of audit committees
¾
May be seen as an unnecessary legal or regulatory burden placed upon the board – “we know how to run the company without anybody else trying to tell us what to do”.¾
Places an additional ‘cost burden’ on the entity. The advantages offered by having an audit committee must be effectively utilised to ensure appropriate cost benefit (e.g. enhance public creditability, experienced ‘sounding board’ for the executive directors).¾
Audit committees will only be effective were they are able to operate as intended by the various Codes. Anything less than respect, understanding of the role of the audit committee by the main board and access to all information will diminish that effectiveness.¾
The demands now placed by, for example the Combined Code and the Sarbannes-Oxley Act, on the time and expertise of members of the audit committee are such that suitable candidates (e.g. experience and qualification) may be harder to find.¾
The risks and burden of responsibilities being placed upon members of auditcommittees may result in a feeling that the “reward is not worth the effort” or rather that the risks are too high. This may result in the overall ability of the audit committee being less than what it should be.
¾
In the beginning, the aim of the board (of executive directors) was to oversee the role of the CEO. Then non-executive directors were considered essential to strengthen the oversight function. Then audit committees were established to provide oversight of the board as a whole. Following continued financial scandals, the role of audit committees was strengthened, including making all members independent of the company. Will the investigations following the next series of destructive financial scandals recommend oversight of the audit committees or will the continued evolution of corporategovernance result in such scandals being few and far between?
FOCUS
You should now be able to:
¾
discuss the objective, relevance and importance of corporate governance;¾
discuss the need for auditors to communicate with those charged with governance;¾
discuss the provisions of international codes of corporate governance (such as OECD)that are most relevant to auditors;
¾
describe good corporate governance requirements relating to directors’ responsibilities (e.g. for risk management and internal control) and the reporting responsibilities of auditors;¾
analyse the structure and roles of audit committees and discuss their drawbacks and limitations.EXAMPLE SOLUTION
Solution 1 — Typical stakeholders
¾
Shareholders who make an equity investment in an enterprise and who expect share investment growth and dividend distributions.¾
Banks – who provide loans and who expect to be repaid.¾
Executive management and employees – who provide services to an entity and who expect to be paid for the services and to receive various employee benefits.¾
Suppliers – who provide goods and services and who expect to be paid for them.¾
Other companies – who have crossholding interests, who have a vested interest in theentity and who can significantly influence the corporate behaviour of the entity.
