Capacidad de la empresa

Research Question 3a: What is success for an audit committee?

Research Question 3b: What are the characteristics of an audit committee that contribute to its successful performance?

Spira (2002) interviewed audit committee chairs, finance directors and auditors in the United Kingdom between 1994 -1996. Spira proposes that audit

committees were ceremonial by nature, providing comfort regarding financial reporting. Spira (2002) uses Actor Network Theory (ANT) to illustrate the role and activities of the audit committee. Spira explains that Actor Network Theory is a theory which sees the world as a series of networks and this theory

(Spira 2002:56). An audit committee is only a part of many wider networks. Many professional bodies doubt whether audit committees can really ensure the integrity of a firm’s financial statements because, as outsiders, audit committee members do not know enough to dig deeply beneath the numbers. Spira argues that such criticism overlooks the ceremonial function that audit

committees play. The audit committee is an arena where members can form and strengthen shifting and fragmented networks with each other and with the external auditors. Within these networks, both consensus and independence are demonstrated, generating comfort, which legitimises the company and maintains its access to external sources of capital. The context of Spira’s work is Britain’s private sector environment and is a response to the Cadbury

Committee’s recommendations. Spira recognises that the audit committee is a key part of the corporate governance structure within an organisation. This thesis will not pursue this line of thought as it is outside the scope of the thesis. An audit committee acts on behalf of the board to assess information provided by management and both internal and external auditors. An internal audit is appointed to undertake independent assurance assignments on risks and evaluate the internal control features of business systems, which include financial systems (IIA Australia 2003:12, Standing Directions of the Minister for Finance (Victoria) 2008). For Australian corporations and government public sector organisations, external auditors are required by legislation to audit and provide an independent opinion on the truth and fairness of financial reports that management has prepared (Corporations Act 2001:s307, Audit Act 1994

(Victoria):s8, Audit Act 1997 (Federal):s11-13).

There may be other sources of information like “whistle blowers” or the Press that could provide information on unusual organisational activities but these sources are outside the scope of this research.

The Blue Ribbon Committee (BRC 1999) regulating US corporate environment suggested that three important issues should be addressed in order to

successfully improve the performance of a Corporate Audit Committee: (i) effectiveness, (ii) accountability, (iii) independence.

(i) In terms of the issue of effectiveness, DeZoort & Salterio (2001) found that, in the case of auditor-management disputes, the independent members of an audit committee and the level of members’ auditing knowledge were positively associated with support for the auditor, thus assuring that financial disclosure would be in compliance with standards. Effectiveness is also associated with the appointment of audit committee members who are financially literate. Regarding financial expertise, Davidson, Xie & Xu (2004) found that auditing and audit firm experience is more important than corporate financial

management and financial statement experience because auditors are required to verify what management has prepared. Verifying and evaluating presented financial reports against accounting standards by applying procedures specified in auditing standards provides that additional assurance.

(ii) On the issue of accountability, the Blue Ribbon Committee (BRC) refers to the relationship between the audit committee, the external auditors, internal auditors and management. Accountability for the audit committee, the external auditor, the internal auditor, and management means performing the role that each is empowered to contribute, working through people with the right skills, qualifications, who proficiently apply their professional activities, procedures as per professional standards required within the environment (human, mechanical or electronic) that business is conducted. An audit committee’s oversight role involves its review and reporting on management’s production of financial reports and its consideration of the opinion of the external auditor. The audit committee should ensure that management provides the proper quality of information supplied and compliance with accounting principles captured and summarised through reliable systems which have been assessed in accordance with an internal audit review program.

(iii) With regard to the issue of independence, independent members in the audit committee, having an independent external auditor, and having a

professionally recognised internal audit function that can conduct internal audit evaluation of operating systems enables a functional environment to be created.

Abbott, Park and Parker (2000:58-65) found that firms, in which independent directors in audit committees that meet at least twice per year, were less likely to be associated with both fraudulent and misleading reporting. A study by Krishnan (2005:649-76) suggests that an independent audit committee decreases the incidence of internal control problems.

The Blue Ribbon Committee’s (BRC 1999:37-44) guiding principles on

effectiveness relate to the issue of independence, diligence and knowledge of audit committee members. Diligence is defined as the willingness of committee members to work as a team in the context of a “three legged-stool’ relationship between board of directors (including the audit committee), financial

management (including the internal auditors) and the external auditors. Akin to the best practice suggested by the Blue Ribbon Committee, DeZoort et.al. (2002) proposed four determinants of audit committee effectiveness namely authority, composition, resources and diligence. The issues addressed by DeZoort in relation to composition and diligence relates well with the Blue Ribbon Committee’s recommendations that an audit committee should be independent, financially literate, have integrity and have objectivity. On the issue of resources required to perform a successful audit committee, DeZoort et.al. (2002) commented on the importance of the size of the audit committee. They considered that an audit committee of between three and six members is considered suitable.

An effectively performing audit committee has the authority, competent audit committee members and resources, required to protect stakeholder interests by ensuring reliable financial reporting, internal controls, and risk management through its diligent oversight efforts (DeZoort et.al. 2002:41). There are increased concerns about corporate governance and the quality of financial reporting. Analysing and summarising reviews conducted of audit committees DeZoort et.al. (2002:41) categorised four factors that contribute to effective audit committee performance. Audit Committee effectiveness considered under their four dimensions include:

 Authority – responsibilities, influence;

 Resources – adequate number of members, access to stakeholders;  Composition – expertise, independence, integrity, objectivity;

 Diligence – incentive, motivation, perseverance (DeZoort et.al 2002:42). Agrawal and Knober (1996) examined a range of governance variables within a simultaneous regression framework and found that the proportion of the number of outside directors on company boards is the only governance mechanism which consistently affects corporate value, suggesting the value and

contribution of independent members of a board (ultimately independent audit committee members). Fama and Jensen (1983) argued that effective corporate boards must be composed largely of outside independent directors holding managerial positions in other companies. They argued that effective boards have to separate the problems of decision management and controlling the making of decisions. They further stated that the Chief Executive Officer (CEO) if allowed to dominate the board, thus overcoming separation of these functions and the oversight freedom of the audit committee would have a negative effect, and shareholders would suffer as a result. Outside directors, they contend, are more able to separate these functions and exercise decision controls, since reputational concerns, and perhaps any equity stakes, provide them with sufficient incentive to do so.

In a thesis on the determinants of audit committee effective performance, Wayne (2003) developed a four sector framework that documented an

understanding of audit committee effectiveness. Given that a major role of the audit committee is to ensure the integrity of financial reporting, the four sectors they suggested that identify Committee’s level of effectiveness are:

1. Paralysed - where an audit committee cannot be effective.

2. Institutionalised - where an audit committee must be able to trust and confer legitimacy symbolically.

3. Agency – where an audit committee must have and use technical resources to substantively ensure that trust exists.

4. Professional – where an audit committee must be able to trust, have and use technical resources to perform substantive oversight (e.g. verified

assurance).

Wayne noted the role of the audit committee was to ensure integrity of financial reporting and for each of the four types of audit committees.

The range of indicators (Wayne 2003:83) for identifying audit committee effectiveness included:

1. Paralysed Audit Committee: Symbolic in nature; cannot trust managers, thus must be proven; cannot trust internal and external auditors, thus must be proven; Management is opportunistic; Symbolic oversight is not sufficient; Substantive tasks are performed by others; the audit

committee has no technical resources; symbolic oversight, but evidence is needed, none is available; presumed lack of integrity of financial reporting.

2. Institutional Audit Committee: Symbolic in nature; Implicit trust in

managers; Implicit trust in internal and external auditors; Management is not optimistic; Symbolic oversight is sufficient; Substantive tasks are performed by others; The audit committee has no technical skills; Symbolic oversight, evidence is not needed; Presumed integrity of financial reporting.

3. Agency Audit Committee: Technical in nature; Cannot implicitly trust managers thus must have evidence; Cannot implicitly trust internal and external auditors thus must have evidence; Management is opportunistic; Substantive oversight is not sufficient; Substantive tasks are performed by the audit committee; Audit committee must have technical resources; Substantive gathering of evidence; Presumed lack of integrity of financial reporting.

4. Professional Audit Committee: Technical in nature; Implicit trust in

management; Implicit trust in external and internal auditors; Management is not opportunistic; Substantive oversight of all professionals is the duty

of the audit committee; Substantive tasks are performed by the audit committee; Audit committee must have technical resources; Substantive oversight used to discharge professional duty of audit committee;

Presumed integrity of financial reporting.

Wayne focused heavily on the audit committee with less emphasis on the contribution of others like the Board, Chief Executive Officer, Chief Finance Officer, internal audit and external audit to achieve its oversight responsibility. Focusing solely on the audit committee, Wayne’s model highlights the different levels of contribution of these stakeholder partners.

Turley and Zaman (2004, 2007) addressed the informal processes of group dynamics and on power relationships among governance participants. Turley and Zaman’s research involved investigating by way of a case study the

charter, structure,membersand processes of audit committee operating as an organisational unit. They found that power relationships of audit committee members (e.g. arguing different accounting treatment of transactions on issues of disclosure) and the informal voluntary networks between audit committee members, set the attitude towards governance (e.g. agency theory, differences between principal and agent; plus differences in goals between management and external auditors). They also noted that informal structures and processes have a significant effect on audit committee effectiveness.