The UK government may have placed audit reform on hold while it goes through the torture of a general election, but others continue to debate and call for improvements to audit committees.
Not least among them is a recent academic paper claiming that if reform is to have any lasting effect, audit committees equally need a makeover.
In an article aimed at resolving the long-standing issue of auditor independence, academics Martin Gelter and Aurelio Gurrea-Martínez honed in on the key problems underlying the functioning of audit.
They said audit committees require attention because of the risk they “hire less strict auditors”. And stakeholders need exacting standards in their audits.
“Unfortunately, audit committees often do not seem to be doing their job in an effective manner since empirical evidence suggests that the audit market penalises auditors for providing investors with value-relevant information that is critical of management,” they wrote.
What to do? The authors offer a number of observations. Audit committees should be comprised of a “majority” of members with expertise in “accounting, audit, finance and corporate governance”. Without that they could fail to spot problems in internal controls.
But there’s another critical issue. Members of the audit committee should be prepared to tell it like it is and make decisions in the interests of investors regardless of the effect on “corporate insiders”. And that raises the issue of beefing up the independence of committee members.
“The system can be improved by increasing the voice and power of shareholders, for example by enhancing the system of proxy voting and the role of proxy advisers,” wrote the authors.
Their final point is that audit committees face heavier workloads than other board members. They need the space to do their jobs and added time.
“Thus along with independence and expertise, availability and commitment are another pillar of an effective audit committee.”
If audits are to be more independent, the authors also propose better governance inside audit firms. They propose more transparency of performance-based metrics for partners; disclosure of how profit pools are structured for non-variable partner pay; public lists of engagement partners for audits; disclosure of non-audit fees alongside the audit fee and the names of the related partners.
High-quality audit
In the UK the corporate governance code already lays out conditions for non-executive independence. But, while guidance on audit committees asks that the “committee as whole” should have the right competence, it only demands that one members has “recent and relevant experience”.
The UK audit industry has been under extreme scrutiny in the past two years following a collection of high-profile corporate collapses. Government-ordered reviews have looked at the regulation of auditors and the functioning of the audit market. Another, the Brydon review, is currently investigating the content of audits.
Various recommendations have been made though government, while indicating an enthusiasm for reform, has yet to place anything before Parliament for consideration.
The Financial Reporting Council, the current audit and corporate disclosure regulator, recent reported that auditors were failing to challenge management. The report said: “Given the pivotal role that challenge of management plays in executing a high-quality audit, firms need to increase urgently their efforts to understand why audit partners and their teams continue underperform in this area.”
David Rule, the FRC’s executive director of supervision, said: “While we see many examples of high-quality audit, our inspectors are still identifying too many audits which require significant improvements.
“Inspections show that challenge of management is a particular area of concern on which audit firms need to focus.”
Audit, auditors and audit committees have unresolved issues, that much is agreed. Until government makes its reform proposals clear, there remains room to influence the debate.
