Relationship between Board of Directors and Auditor - Visma
Agency Relationship between Shareholders and Auditors. provisions of Section (1)-(6) of the Companies Act. The auditors are supposed to c) Having a voluntary code of ethical practices to guide the branch managers. The activists' technique was to press for changes in corporate governance. But these The Role of Audit in Board-Shareholder Relationship. The auditor participates in Board meetings dealing with the financial statements. Equal treatment of shareholders and transactions with close associates Relationship between Board of Directors and Auditor At the same meetings, the auditor explains his/her view on the company's accounting policies, risk areas .
Boone Pickens took on Big Oil, he not only changed the shape of the industry, but he also allowed people to see that it was possible to question stale business strategies, even at the largest companies. Shareholders need not accept unimaginative or distracted chief executive officers, and they could expect the boards that oversaw them to demand skilled management and good business strategies.
Boards came to understand that if they did not do their jobs well, activists would ensure that others would. This was the era when the political theorist and legal scholar, Ronald Dworkin, wrote on the legitimacy of political power. Shareholder groups, too, began to ask, When is corporate power legitimate? It was the perceived arrogance of management that sustained and enabled the tender offer. But it also motivated boards to open a constructive dialogue with long-term investors.
This was a uniquely American phenomenon. There was no vehicle to merge two companies across borders in Europe. The impediments to tender offers were legion in Europe.
But, during the next decade, both here and in Europe, people began to talk about and institute independent committees and independent boards. These fresh boards competed with activists to mobilize funds and other previously passive institutions.
The Relationship between the Board of Directors and the Management
The American Law Institute ALI played an important role, by developing and advancing new model principles and bylaws, beginning in the s all the way through the mids.
The exchanges modified their listing standards. These were the seeds of developments in corporate governance that are now institutionalized, and that young lawyers may take for granted today.
Such has been the evolution of corporate law, from generation to generation, each starting from a new point and growing the law to address the challenges and demands that arise.
We are now well beyond the original principle motivating corporate governance reforms — that directors should attend the meetings, read the materials and ask questions about how management used the corporation's resources, and be attentive to weaknesses in management's strategies.
Directors can't just ratify unexamined actions. They must have a satisfactory reason for their decisions to maintain shareholder support. They cannot be perceived as simply the enabler of management. Nor can their counsel.
The Gutfreund case In re John Gutfreund,and the Securities and Exchange Commission's rule e process contributed to the evolution of the role of corporation counsel vis-a-vis management. Enron and the Sarbanes-Oxley Act also intervened. The Act took up the legal themes of the ALI project on corporate governance and enshrined them into law. It refined and imposed new obligations for oversight of financial reporting.
There are new expectations that boards consider the implications of social, economic and environmental phenomena that go well beyond those prescribed by the securities laws.
In this, Europe has taken the lead. But through best practices and familiarity, the role of the U. Earlier this week, we learned that the Paris climate agreement will now go into effect.
That will undoubtedly have an impact on corporate responsibility and reporting. The Sustainability Accounting Standards Board is promoting new metrics and voluntary reporting on a wide range of nonfinancial topics found through its process to be important to investors and other stakeholders. Whether or not all of these changes result in better, more efficient, corporations, we've got to face the fact that they didn't happen just because of government policies or the Congress.
Heads of pension funds certainly had a roll; but we, the lawyers, informed and facilitated all these changes, and helped bring them about. The Role of Audit in Board-Shareholder Relationship The audit, too, contributes both to corporate governance and, ultimately, to shareholder value. But, in this case, boards and the bar could have done more to spur reforms to maintain the audit's usefulness to investors.
I believe this is an idea whose time has come. After all the changes in the field of corporate governance, it is anomalous that the audit has changed so little. It's changed little since the s when I started practicing and, up to that point, it had changed little since the Securities Act of made it mandatory. The late Sandy Burton noted just this point in But he lamented that, instead, auditors devoted a "great deal of effort … to limiting responsibility rather than enlarging it.
But, other than Sarbanes-Oxley's Section requirement that companies obtain an audit of internal control, the scope of the auditor's work, and the opinion, have barely changed. New audit procedures have been devised and implemented, either in reaction to risks or developments in technology. But those procedures result in the same opinion that auditors have given since the s, notwithstanding significant changes in corporate reporting, both in and outside of the financial statements; and, as I've described, the significant changes in board relationships and engagement with shareholders.
Its value doesn't come from the compliance aspect alone — filing audited financial statements as is required by law. It comes from the confidence in the information that the audit provides, and the relevance of that information. Auditors dig into corporate records, they go to far-flung subsidiaries, and they review the top-side journal entries at headquarters. They ask for and see anything they think they need in order to assure themselves that there are no material misstatements and, when applicable, that there is effective control over financial reporting.
Boards don't do that, but they and their shareholders sure can benefit from knowing what the auditor has learned, and from the discipline that the audit provides. If used well, the audit is a tool to communicate to shareholders about the reliability of the information that shareholders see as relevant to judge management's results. Reliable reporting can't keep activists from questioning strategies that aren't working; but unreliable results give well-prepared adversaries an opening just when boards most need shareholder trust.
The '33 Act was enacted for just this reason — to bolster investor trust. It promoted capital formation and economic growth principally by coaxing people back into our securities markets. It did this by regulating the offer and sale of securities to ensure that buyers of securities receive complete and accurate financial information from the company, including financial statements audited by an independent accountant.
The audit is the linchpin to give shareholders confidence that they can rely on published financial statements to decide whether and in which companies to invest, and at what price. Auditors were intended to be the eyes through which both directors and investors look for the truth.
Over the years, public opinion has reinforced the continued importance of the auditor's independent view. In corporate governance, most changes were driven by reform inside the board room, through the push and pull of activism and counseling. But, in auditing, changes to shore up public opinion of the audit were almost exclusively imposed from outside the board room, primarily by the Congress and the SEC.
The Relationship between the Board of Directors and the Management
There have been three key moments of reform. In the late s, there was the collapse of Equity Funding Corporation of America and the scandals over foreign payments that, while not necessarily quantitatively material, nevertheless had a dramatic effect on public trust.
The scandals resulted in broad congressional investigations of the accounting establishment, both in the House and Senate. The Moss and Metcalf investigations Rep.
John Moss and Sen. Lee Metcalfhad highly critical findings about the profession's standards and independence from management, and proposed a wide range of reforms, even foreshadowing independent oversight.
Looking back, there was an opportunity for boards to address auditor independence from management at the same time they strengthened their own independence. Instead, boards left that to the government. Thus, Burton and then-SEC Chair Harold Williams personally negotiated changes in the profession's self-regulatory programs that at least made those programs more formal.
They warned that, if self-regulation proved insufficient to sustain public confidence, an independent regulatory structure would follow. In the 80s, in response to the savings and loan crisis, the SEC, members of Congress, and then-Comptroller General Charles Bowsher pressed for improved auditing standards to address the "expectations gap" between what shareholders expected of the audit and what auditors professed to deliver. Most notably, the resulting standards required auditors to enhance their procedures to detect fraud and other illegal acts, and to report when there is uncertainty about a company's ability to continue as a going concern, even if management has not warned investors.
These developments changed corporate governance. They clarified that, while the auditor does not speak for management, the auditor is supposed to speak.
They provided boards and audit committees more information from the audit.
But they came about through government efforts on behalf of investors — not by boards that, in other respects, were at the very same time looking for ways to open dialogue with investors and gain their trust. Finally, 25 years after Burton and Williams gave the profession's self-regulatory institutions one last chance, following the accounting scandals at Enron, WorldCom and so many other companies, Congress stepped in with the Sarbanes-Oxley Act — which garnered overwhelming support in both the House and Senate.
Many of you played important roles in counseling boards of companies in distress in those days. And, I daresay, those boards came to appreciate the importance of a good audit.
But, to this day, we have still not seen boards take a lead in strengthening and modernizing the audit for their own use or as a mechanism for communicating and engaging with their shareholders. In particular, independent oversight of auditors has proven to be a vital resource protecting investors and fostering economic resilience by advancing reliable, informative and independent audits.
The PCAOB promotes audit quality through its inspection and enforcement programs, its standard setting, coordination with other regulators, domestic and foreign, and with the important investment in economic analysis that we have made in recent years. Analysis is conducted by using Probit regression on a sample of companies listed on the Bursa Malaysia for the year The results show that the issuance of audit opinion is influenced by the director-auditor link, whereby it is found that auditors have higher possibility to issue unqualified audit opinion to interlink companies interlocking companies sharing a common auditor.
The findings are consistent with the attachment theory which suggests that attachments create mutual dependence and mutual trusts between the parties involved.
Director-auditor link, Audit opinion, Interlocking directorates, Auditor independence, Audit quality 39 www. Introduction Independent auditing is an essential feature of efficient capital markets and regulators have long been concerned with potential threats to auditor independence DeFond et al.
The issue of auditor independence is not new, as proven by various literatures which can be found related to the issue see for example Ashbaugh et al. The independent status of an auditor gives value and significance to audit reports Lavin, In addition to this, the fact that major audit failures, including Enron and WorldCom in the United States and Harris Scarfe and HIH in Australia, and other related alleged audit failures have been linked to the closeness of auditor-client relationships, this issue has been receiving a considerable amount of attention by academicians and regulatory bodies.
Personal ties encourage advice seeking by enhancing mutual trust, where trust has been described as the willingness to take risks or to make oneself vulnerable Westphal, With the increase in concerns regarding directors sitting on the board of other companies, the issue relating to the closeness of directors-auditors has arise where past studies have shown that interlocking directors have the tendency to select the same auditor across the companies on which boards they sit see for example Davison et al.
This is due to the fact that by holding multiple directorships, interlocking directors may have developed a relationship with a particular auditor whom they have experience working with.
Therefore, this typical kind of relationship commonly known as director-auditor relationship has been argued to have an effect on the audit quality see for example Goldman and Barlev, The inter-corporate relationship is personal between directors and it is this and its potential for utilization and exploitation that drives research on interlocking directorates Roy et al. The paper consists of four sections. Section 2 discusses the relevant literature and hypotheses. Section 3 presents the research methodology used in this study and Section 4 presents the results of this study.
Finally, the concluding section summarizes the findings of this study. Literature Review and Hypotheses Development 2. E3 Bazirah et al. However, there has been evidence on the existence of expectation gaps between the subjects see for example Jenkins and Krawezyk, This is because even though survey-based research is suited for examining individual behavior and beliefs Hodge,surveys measure beliefs but not necessarily actions taken by the subjects. Due to this gap, increasing studies have been done by using the second type of approach; theory driven, which permits a more objective investigation.
This approach which is done by using archival data to measure behavioral constructs necessitates the use of proxies to measure the underlying behavioral relationships Seabright et al. Based on the theory that auditor independence is the probability of auditor reporting any discovered breach in the financial accounts, several proxies have been used by previous studies in examining auditor independence such as the use of audit opinions see for example Barkess and Simnet, ; DeFond et al.
Several factors affecting auditor independence have been identified by earlier studies. Among the main factors are audit services fee see for example Antle et al. Past literatures on interlocking directorships focus more on the nature, benefits and reasons behind interlocking directorships.
Among the reasons interlocks occur which was found in previous studies were because of the size of the corporation, the extent of management control, the financial connections of the corporation, the relationship with competitors and the existence of local economic interest Dooley, ; collusion, cooptation, legitimacy, career advancement, social cohesion Mizruchi, and monitoring Mizruchi , Ornstein , Palmer .
Audit reports are submitted by the auditor in the form of written reports, describing the nature and scope of the examination audit made and includes a statement opinion as to whether the financial statements fairly represent the financial position of the audited firm in accordance with generally accepted accounting principles.
From the definition by Arens et al. In issuing an audit opinion, the auditor 41 www. This is due to the fact that the issuance of an audit report is the outcome of an often continuous negotiation among company and auditor Antle and Nalebuff, ; Carcello and Neal, ; Knapp, ; Teoh, and the issuance of unclean audit opinion may result in negative implications to the auditor and the auditee.
This is generally because the public has been consistent in their belief that qualified opinions are considered as warning signals of business failure. Therefore, companies may engage in strategic behavior to avoid the receipt of a qualified opinion in their audit reports Aguilar and Barbadillo, Attachment theory suggests that greater personal and organizational attachments will be associated with shorter conversion time to an unqualified opinion Meyer et al.
A certain type of relationship or a bond between a company and an auditor has long been argued to have an effect on the level of auditor independence. This is argued to exist where the auditor is over influenced by the personality and qualities of directors or where the auditor knows the client too well Hussey, Auditors with strong relationships with their clients may give their clients the benefit of the doubt or may be concerned about the loss of the client, thereby reflecting a degradation of independence and professionalism Meyer et al.
Hence, the issue becomes more complicated in situations where an auditor is employed by a company which has interlocking relationships in terms of sharing a particular director on the board director-auditor link.
The development of mutual trust through director-auditor link may result in the auditor willing to take risk towards the directors by issuing unqualified audit opinion. In addition to this, the presence of director-auditor link can also be considered as an economic incentive for auditors to compromise their independence.
Therefore, it is expected that the director-auditor link causes the auditor to issue unqualified audit opinion. The director-auditor link is significantly and positively related to the issuance of unqualified audit opinion.
In general, the directors are believed to want to protect their own interest, managers executive directors may refrain from actions that may contribute to turnaround but hurt their own self-interest Sudarsanam and Lai, While management would not want the auditor to report any material misstatements, they also would want investors to believe they were receiving the greatest possible assurance that the financial statements conform to accounting standards Miller, This is because executive directors develop their reputations based 42 www.
E3 on company performance and the lack of reported performance credibility due to receiving unclean audit opinion will diminish their reputation. Therefore, the executive directors would want to protect their reputation as a provider of credible financial accounts and thus, may require for a clean audit opinion.
This incentive would be much greater when the executive directors also hold positions in other corporations since a negative reputation in one interlocking company will affect their reputations in other interlocking companies. Therefore, it is expected that executive interlocking directors have the tendency to use their influence on the interlink auditor to issue a clean opinion. Fall of a firm from a superior performance position to an extremely poor position on any appropriate performance criterion normally points to fundamental problems with its management and strategies Sudarsanam and Lai, Meanwhile, non-executive directors on the other hand, posses a two-factor financial reporting quality demand function; which are the preservation of reputational capital and the avoidance of liability resulting from shareholder lawsuits Abbott et al.
Hence, leads to the following additional hypotheses: The director-auditor links generated by executive interlocking directors is significantly and positively related to the issuance of unqualified audit opinion. The director-auditor links generated by non-executive interlocking directors is significantly and positively related to the issuance of unqualified audit opinion.
The director-auditor links generated by independent non-executive interlocking directors is significantly and positively related to the issuance of unqualified audit opinion. An amount of companies 23 newly-listed companies, 39 financial companies, 8 financial year-end-change companies and 34 incomplete information companies are excluded from the sample, which brings to a total amount of companies, which is the final sample of this study.
The model takes the following form: A categorical measure of audit opinion is used, where if the company issues unqualified audit opinion, it will take the value of 1 and 0, if otherwise.Directors - Company Law by CA Jaishree Soni
This variable represents the director-auditor link created by interlocking directors on the board of directors. This measurement is replicated and extended from the measurement used by Jubb and Houghton In order to examine the director-auditor link effects associated with audit opinion, it was considered necessary to control for those other variables that have been identified in previous research as affecting audit opinion which are: Non-Audit Fee LNAS - Logarithmation is applied to non-audit fees fees paid by the firm to its auditor for services other than audit services.
A dummy variable coded 1, if the auditor is Big Four and affiliates and 0, if the auditor is non-Big Four. Total Asset LASSET - A logarithmatic transformation of total assets is used to control for the non-linear relationship between the size of the client firm with audit opinion. This variable, LEV is used as a proxy of agency cost and business risk. Return on Equity ROE - Return on equity ROE is measured by dividing the profit after tax to the total equity and is included to control for the effects of business risk performance.
It is included in the model to capture the possible business risk and audit risk. It is included in the model to capture the business bankruptcy risk. From Table 1, it shows that unqualified-audit-opinion companies have slightly higher director-auditor links than other-type-audit-opinion companies except for the measurement based on executive interlocking directors EDLINK. On average, issuers of unqualified opinion audited an additional 1. Based on types of directors, the issuers of unqualified opinion audit only 0.
However, the results of the t-test did not reveal any significant differences. Meanwhile, by using dichotomous measurement for director-auditor link, the results shown in Table 2 indicated that a majority of companies receiving other-type-audit-opinions are audited by non-interlink auditors.
On the other hand, a slight majority percent of unqualified audit opinion companies are audited by interlink auditors. In addition to this, based on types of director-auditor link, the percentage of unqualified audit opinion companies audited by interlink auditors from non-executive interlocking directors percent and independent interlocking directors percent is higher than the percentage of other-type-audit-opinion companies percent and percent respectively and the Pearson chi-square test shows significant difference at a five -percent significance level.
However, based on executive interlocking directors, the percentage of unqualified-audit-opinion companies being audited by interlink auditors is found to be low percent as compared to the percentage of other-type-audit-opinion companies percent but the Pearson chi-square test shows insignificant difference.
The table also shows that no significant differences was found between audit services fee paid by both types of companies, with unqualified-audit-opinion companies paying an average of RM, while other-type-audit-opinion companies paid an average of RM, However, unqualified-audit-opinion companies were found to purchase higher non-audit services RM, than other-type-audit-opinion companies RM27, The results of the t-test revealed significant differences for non-audit services between the two groups of companies based only on the actual value at a one -percent significance level.
The results of the t-test show significant differences for all these variables between the two groups of companies. In addition to this, unqualified-audit-opinion companies are also found to have higher changes in sales, ratio of long term debt to equity, proportion of profit to equity and quick ratio, even though it is found to be insignificant in the t-test results.
Unqualified-audit-opinion companies are also found to have lower percentages of Bumiputra directors percent as compared to percent and audit reporting lag 99 days as compared to days and the results of the t-test indicate a significant mean difference for all these variables.
Unqualified-audit-opinion companies are also found to have lower percentages of directors from other ethnicity, number of years listed, number of subsidiaries and proportion of inventory and receivables to total assets, but the results of the t-test show insignificant differences between the two groups of companies on these variables.
For the discrete control variables, Table 2 shows that bigger percentages of unqualified-audit-opinion companies issue long term debt or shares and received unqualified audit opinion in previous year audit than other-type-audit-opinion companies. A percentage of percent of unqualified-audit-opinion companies issue long term debt or additional shares in the current period, while a smaller percentage 8-percent of other-type-audit-opinion companies made similar issuance.