Abstract
Corporate governance is the new device of a new corporate culture which has learnt that a company or for that matter an organization can thrive on accountability, trust and transparency. Just like all powers need a corrective force the upcoming corporate world also needed organs within the corporate culture to better help the company to not only be something for some time but be a going concern, Hence came the concept of Corporate Governance which has various organs. Its prime virtues of success are independence and accountability. Audit Committee is one such organ which is a product of Corporate Governance. This research paper attempts to look at various researches and studies done over the effectiveness of Audit Committees in improving the performance of companies and tries to form a synthesis of the information thus acquired.
Keywords:AuditCommittees,Corporate Governance,Effectiveness,Accountabiility,Transparency
Introduction
Companies are in the corporate world complex entities.From being a legal entity to being the engines of the economy, companies play an important role in the ebb and flow of the economy.However there is more to a company than tall glossy skyscrapers or wealthy tycoons running them. A company is what it is, thanks to the various officers who run the company efficiently and act like unsung heroes with no expectation of appreciation or recognition.
Naturally when an entity is so big it needs to be careful with what it does and what it chooses not to ,as it can make or break the economy.A company flourishes upon the support of the society.The support of the society is the sail of the ship with the mast as connection between the ship i.e. company and the sail.The support and trust of the consumers on the company is the golden recipe for success and not reduced cost structure contrary to popular belief.
To keep a company a going concern there is a committee which has a lot on the plate but it has the responsibility of keeping the company in consistency with virtue and profitability. It is the audit committee that has this huge burden .Numbers dont lie and so whether a company is running well or not should not be seen from the glossiness of it’s head office but it’s balance sheet and it’s outstanding debt. The whole lot of which is looked after by the audit committee which has the task of keeping the company accountable and in many cases, a good audit committee can save a company or a bad one can lead it to liquidation.
An Audit Committee has the job of overseeing the financial records of the company[1].Section 177(2) of the Companies Act of 2013 provides that an Audit Committee must have a minimum of three directors,with independent directors constituting a majority and the majority of the directors must be financially literate.[2]It is important for the directors to be financially literate so that they can interpret books of accounts expediently and take necessary steps to suit the need of the hour.
Research Methodology
The works of different researchers and experts were read to form an idea about the gross effect of an Audit Committee on a company. To understand further whether it is applicable to all kinds of economy a study was also done of the effect audit committees had on companies in India and Jordan to verify whether effects can vary depending upon the dynamics specific to each economy. This was a descriptive study to form a general idea about what are the unavoidable or rather definite benefits of having an audit committee regardless of where your company is located or operating.
Literature Review
Let us now look at the opinion of different researchers and the works of different researchers on the topic of the effectiveness of an Audit Committee and how it affects the organisation as a whole and how it’s dynamics affect the companies.
- Salloum, Azzi, and Gebrayel(2014) suggested according to their findings that the financial problems of a bank have a negative equation with the frequency of the meetings of the audit committee which means that the more meetings the audit committees held the lesser the financial distress.
- According to many studies, it is found that the characteristics of an audit committee can have a negative or positive effect depending upon it’s composition.If the audit committee consisted of more financially literate and independent members then it positively affected the management of the company.
- Merawati 2015 found according to his studies that a company can make more profit if there is a sound internal, and external audit, audit committee and financial soundness.
- Salloum, et al 2014 found that the more frequently an audit committee meets the more accurate the financial records and statements are.
- Zahirul-Islam 2010 in his findings saw that audit committees caused a decline in the manipulation of financial statements by management for personal bonuses.
- Goodwin and Seow 2002 found that a strong audit committee helped in the mitigation of financial fraud and the reduction in errors in financial statements.
- Al-Shareif 2008 found a positive relationship between an independent audit committee and an improvement in earnings quality in Jordan.
- Salehi and Mansoury 2009 provided that a large audit firm or for that matter audit firms with better technology and employees provided higher quality and accurate financial statements as compared to other audit firms that are smaller or not well-equipped.[3]
The previous studies does provide insight but it has its own limitations but does provide a topic for future research.
Internal Audit
Institute of Internal Auditors defined internal auditing as an” Independent appraisal activity established within an organization as a service to the organization .It is a control which functions by examining and evaluating the adequacy and effectiveness of other controls.The objective of internal auditing is to assist members of the organization in effective discharge of their responsibilities .To this end,internal auditioning furnishes them with analysis.appraisals, recommendations,counsel and information concerning the activities reviewed”.
Internal audit can be a useful mechanism for assistance to audit committees by proving relevant information and records on demand.
A study has been on the close relation between Internal Audit Functions and Audit Committee and how it affects a company[4].
Observations:
- The relation between the two had a positive impact on internal control, corporate governance and risk management.
- The interaction between the internal audit function and the audit committee resulted in greater compliance with professional standards.
- It promoted overall effectiveness and efficiency by improving adherence to the code of ethics.
- Improves risk management
Roles of Audit Committee
- Corporate Governance – As already discussed Audit Committees are one fo the ways to keep the companies in check and keeping them in the path of accountability and profitability.The audit committee has the great task of overseeing the management of the company and the internal and external auditors. A good corporate governance is nowadays one of the qualifications for a company to be listed in the Stock Exchange and one of the ways of having good corporate governance is by having financially literate members in the Audit Committee.It was noticed that those companies who had good corporate governance had financially literate members .
- Internal Audit – Internal auditors are the officers who are the scrutinizers of books of accounts of a company and have the job of foolproofing the books of accounts made by the accountants in the accounting department.They provide important information to the audit committee for their knowledge and informed decision making.The Audit Committee determines the scope of the job of internal auditors and also attempt to ensure the independence of internal auditors so that the auditors can give unbiased and unadulterated information about the about the finances of the company.
- Internal Control – Internal control as the name suggests is the mechanism through which the working of the inside of an organization is managed with the help of policies, bylaws, procedures and protocols. The Audit Committee also looks over the internal control of the company by taking corrective or assistive decisions to better help the smooth working of the organization and correct any derailing from the path.
- External Audit – Audit Committee plays a direct role in selection of external auditors who are selected also based upon the final decision of the Board of Directors. External auditors are chartered accountants who scrutinize the financial accounts as a disinterested third party.The Audit Committee also overlooks the work of external audit to cater to the needs of the key stakeholders and preserve their interests.[5]
- Accounting and Financial Reporting – Naturally the Audit Committee also overlooks the accounting and financial records to keep them original and authentic .They are constantly active in discussing accounting standards and principles used in the company to decide how to improve them or to discuss a more expedient way of recording accounts. Their interaction with the CFO of the company is regular to discuss the finances of the company.
- Compliance-The Audit committees also are in regular touch with the legal team of the company or counsel for checking whether the company is meeting with the taxation laws or other regulatory requirements to keep the company away from a potential lawsuit.
- Risk management – The Audit committee helps the company in managing risks by discussing important financial manoeuvring to improve profitability.They also keep a close eye on the financial trajectory which the number of the company are showing so as to decide when to advise insolvency resolution process for the company so that a company is not liquidated in the worst case scenario .[6]
- Other responsibilities [7]-i)They also have the job of fulfilling other duties as instructed by the board of directors.ii)Carry out special investigations whenever required,iii)Proposing changes needed,iv)Make an annual confirmation that all the duties and responsibilities mentioned in the charter are carried out.
Effects of an Audit Committee
Here is the concise list of positive effects that an audit committee can bring considering favourable support which will take an organization to the next level in general regardless of other factors.
- A research paper suggested according to its findings that the level of independent directors in an audit committee does have a positive relation but may not be that significant this may be due to the fact that due to their insufficient knowledge about the company the independent directors in audit committees. This research was done on Indian companies.[8]
- There is a positive relation between the presence of internal audit with the mistakes present in the financial records of a company when checked by external auditors.[9]
- The composition of an audit committee may or not be a determinant to better results however they may prove to be effective in the operational efficiency of the audit committee.
- Audit committee reduces fraud in the company which is a major concern in the world economy at large as with the world now being the market a leak of news about the malpractice of a company can cause havoc and damage to the market.
- Audit Committees also help in detecting possible financial losses and also help in advising when to proceed with insolvency to help the company to bounce back.
It is important to understand all these effects will obviously not be seen together in one company or may be seen, the logic of what you sow, you reap comes into the picture where if the audit committee is given a place to operate it definitely can positively affect any organization it is put into. How an audit committee affects also depends upon the geographical location of an organization as an audit committee is within a company which has to deal with various economical problems, market pattern and demographics. The above mentioned list provides the benefits an audit committee will provide according to me if the company facilitates the operation of audit committee. There may be other benefits but they are highly dependent upon the overall corporate culture, financial education and work ethic of the companies in that region. Many studies suggest many benefits but they are not observed likely in other countries which goes on to prove my point.
Practical implication of an Audit Committee
Research done by Bansal and Sharma[10]has given a deeper insight into Audit Committees and how they affect the company? How their features affect the company? This study tried to examine the equation between the independence of audit committee and profit of the company or performance considering also the frequency of the meetings. They also look into whether the size or board diversity affects, the shareholdings of the promoters and a number of independent directors and their effect too is also studied by this study.
Conclusions of the study:
- Board size does positively affect the performance of the company as long as market capitalization and ratio of market value of firm to total assets are taken into account.
- Higher number of board of directors resulted in rise in stock price and confidence of investors in the company.
- Introduction of a higher number of independent directors resulted in lower return on equity and this can be understood to be triggered by lack of knowledge of the company by them.
- Independent directors are not necessarily able to increase profits with their knowledge.
- The Companies Act 2013 makes it compulsory to have atleast 4 meetings a year for the audit committee but there was no positive relation found between frequency of meetings and company performance,Infact it had negative influence on return on equity and insignificant effect on returns on assets.
- The independence of audit committee did have a positive influence on return on equity but this cannot be said conclusively as other measures of firm performance must also be taken into account.
Another study based on the companies in Jordan provides insights into the effects of audit committees: [11]
- This study found that banks have less financial distress with more meetings held per year.
- Size of the audit committee or audit firm may or may not affect the performance of company depending upon the overall accounting talent present in the country.
From this study we can conclude that although the focus was more on the companies who used audit firms for auditing found better performance but what should be looked at is that if a disinterested,independent,financially literate body keeps a check on the accounts of the company then the company definitely provides profit,excudes trsut and confidence and also has a better name in the market as well.
Suggestions
In order for an Audit Committee to function properly some things can be kept in to better help them serve the company effectively:
- Transparency – The Audit Committee must get all the information it needs.The Audit Committee can help the organization only if it is provided with relevant information without any limitation which can lead to better mitigation of risk and also lead to exposure of frauds or money laundering which are capable of spoiling the image of a company.
- Communication-The Audit Committee must be kept involved in all the important financial decisions and meetings which can have a long term effect on the company.Since the Audit Committees are financially literate and to an extent independent they can provide deeper insight about whether a decision is financially feasible or not .
- Composition– The composition of a company or rather diversity may or may not matter but one thing should always be kept in mind that the committee must consist of financially literate members otherwise there is no reason why an audit committee must exist if it cannot help the company in making financial decisions using it’s financial knowledge and experience.In order for a company t function better the committee must have good auditors who are far-sighted and are sensitive to the needs and aspirations of the company to strike a balance.
- Technology -Audit committee consists of humans so naturally a company in order to reap benefit must first sow seed of support towards the audit committee by giving them updated technology,assistance and good working environment which is a pre-requisite for good functioning of not only the audit committee but any department in the company for that matter.
- Independence-Independence in an aduit cimittiee must not only be allowed but also must be respected and perceived.An audit committee can thrive if right amount of indpeendece is given so that in turn they can supervise the company and keep the processes of company in check[12].
Conclusion
Transparency, trust and accuracy are one of the most important virtues that an audit committee’s presence can easily like a badge of honour add to a company.Audit committees just like there are children of development in every sector an audit committee to is a child of development in business ethics.No business can ever run without ethics.As the Tata family always believed companies are not only fro making profits or for filling your own pockets but are there for smooth sailing of the economy and service to the society. An Audit Committee can easily help the company in achieving the best of its performance by constantly supervising the finances of the company which do not lie about the health of a company.
We can conclude by saying Audit Committee as an organ of corporate governance should not only be an inclusion in all companies but also be supported in its endeavour for the benefit of a company.It is something to observe that an Audit Committee although beneficial will not give positive outcomes unless it is properly supported by the company.In the above-mentioned studies it can be found that on paper Audit Committee is found to have a lot of benefits which are possible.For example, transparency, risk mitigation etc. However, a lot of these benefits are servant to the economy of the country in which the company is situated in for example in the studies done on Indian Companies it found that the frequency of meetings and presence of an independent audit committee did not give that much benefit other than some better returns on equity[13] and on the other hand research in Jordan showed that more meetings resulted in having less financial distress in banks in Jordan.
Keeping all these things in mind one must not see Audit Committee as a profit and loss statement in the short run as an Audit Committee in the long run will always bring more than it takes for the company provided it consists of able-minded and financially literate men who are also knowledgable of the economy of the country to manoeuvre their way around and not stick to a static plan for the company.The Audit Committee in general has pivotal benefits which definitely will help the company but one must not look towards them as the ultimate cure as based on above mentioned studies each and every company has gotten benefits from audit committees in different ways as a result of effect of other factors in the business environment.As a result one must tweak the operations of an audit committee to suit their needs and demands and adapt to the feedbacks from their business environment.Presence of an audit committee does not ensure a successful company but is a means to one.
Name-Ronald Jigar Osta ,St.Xavier’s University,Kolkata
[1] Alicia Tuovila,Audit Committee:Definition,How They’re Used and Purpose,October 28 2020,https://www.investopedia.com/terms/a/audit-committee.asp
[2] The Companies Act 2013,Section 177 and Sneha Mahawar,Section 177 of the Companies Act,2013,March 3 2023,https://blog.ipleaders.in/section-177-of-the-companies-act-2013/#:~:text=Section%20177(2)%20of%20the,reading%20and%20understanding%20financial%20statements.
[3] Laith A.Aryan,”The Realtionship between Audit Committee Characteristics,Audit Firm Quality and Companies’ Profitability”, Asian Journal of Finance & Accounting Vol.7,No.2,2015
[4] Marc Eulerich,Patrick Velte & Jochen Theis, “Internal Auditor’s Contribution to good Corporate Givernance an empirical analysis for the one-tier governance system with a focus on the relationship between internal audit function and audit committee”,Corporate Ownership & Control/Vol13.Issue1,2015
[5] Ahmed Mohsen Al-Baidhani,”The Role of Audit Committee in Corporate Governance”,University Putra Malaysia
[6] Ahmed Mohsen Al-Baidhani,”The Role of Audit Committee in Corporate Governance”,University Putra Malaysia
[7] Idris Adamu Alhaji and Dr.Was Fauziah bt Wan Yusoff, “An Empirical study of the Role of audit committee in promoting good corporate governance”,3rd ICBER 2012
[8] Nidhi Bansal & Anil K.Sharma, “Audit Committee,Corporate Governance and Firm Perfromance:Empirical Evidence from India”,Internantional Journal of Economics and Finance;Vol.8,No.3;2016
[9] Idris Adamu Alhaji and Dr.Was Fauziah bt Wan Yusoff, “An Empirical study of the Role of audit committee in promoting good corporate governance”,3rd ICBER 2012
[10] Nidhi Bansal & Anil K.Sharma, “Audit Committee,Corporate Governance and Firm Perfromance:Empirical Evidence from India”,Internantional Journal of Economics and Finance;Vol.8,No.3;2016
[11] Laith A.Aryan,”The Realtionship between Audit Committee Characteristics,Audit Firm Quality and Companies’ Profitability”, Asian Journal of Finance & Accounting Vol.7,No.2,2015
[12] Laurie Tugman & Laura Leka, “5 key factors to enhance audit committee effectiveness”,September 20,2019(https://www.ifac.org/knowledge-gateway/supporting-international-standards/discussion/5-key-factors-enhance-audit-committee-effectiveness)
[13] Nidhi Bansal & Anil K.Sharma, “Audit Committee,Corporate Governance and Firm Perfromance:Empirical Evidence from India”,Internantional Journal of Economics and Finance;Vol.8,No.3;2016