As the UK moves towards reform of audit regulation there is now much research focused on the work of company directors overseeing the work of auditors. Not all of it comes with good news.
A fresh examination of audit committees suggests those whose companies have been hit by scandals possess characteristics that some observers might call deficiencies. A team of academics from Strathclyde, Coventry and London looked at a number of companies that underwent “audit enforcement procedures” conducted by the Financial Reporting Council and compared their audit committees, their size, number of meetings, length of tenure and diversity to companies untouched by bad news to investigate whether there are any differences. And differences they found.
Results showed that “scandal firms’ audit committees tend to be smaller, hold more meetings, have less gender diversity and are audited less by Big Four firms”.
The team then found that audit committees embroiled in trouble have fewer qualified accountants, more outside directorships, own greater shareholdings and serve longer tenures in committee roles.
The team conclude that “at longer tenure lengths, audit committee members begin to lose their independence and their value has diminishing returns in the rapidly evolving business landscape”. They also find that “audit committees are more reactive than proactive to issues and may meet more frequently in an attempt to legitimise themselves”.
The findings cause the team to offer a number of recommendations, among them that regulators consider advising that audit committees meet more often so they become less reactive, as well as fresh steps to encourage more diversity.
“These changes are incredibly important as high-profile corporate scandals undermine the integrity, quality, reliability and transparent financial reporting, which brings into question the integrity and objectivity of both the accounting profession and the audit committee.”
Restoring trust in audit
There has been much attention in the UK on audit and auditors in recent months with publication in March of a 230-page white paper—Restoring Trust in Audit and Corporate Governance—proposing significant reforms to firms and the audit market.
But there were also proposals for audit committees including a new set of standards and a duty for regulators to supervise the quality of audit committee work which may, when concluded, come with powers to demand information or place an observer at audit committee meetings. There are also proposals to introduce sanctions for audit committees that fall short.
Observers worry that the changes will inevitably force audit committee work to become more compliance-led and push boards to recruit only directors with accountancy qualifications. This, they believe, may undermined their ability to remain diverse and focus on strategic issues.
Audit committees appear to be a growing area of interest. Research published earlier this year found that when German audit chairs moved on audit fees rose and audit quality fell. The authors speculate that one reason a change in the chair might produce a lower quality audit is that new chairs perhaps lack the “firm-specific” knowledge of predecessors. Audit fees might also rise because a new chair could “compensate” for this lack of insight by ordering auditors to undertake more work. Audit committees have been under close scrutiny in Germany following the Wirecard scandal.
Audit committees have been under-represented in research despite undertaking critical work. Policymakers have seen their importance, and academics are now placing them under the microscope.