Audit Committee Study Reveals Expectation Gap

A study on audit committees found an expectations gap between how the audit committees see their regulatory role and how their role is perceived by the media. This gap exists where the audit committee’s legal duties are at odds with public expectations. For example, some parts of the media and smaller shareholders appear to see the audit committee role as the prevention and detection of fraud.

But this view sits uncomfortably with the views of audit committee members, who see their role as an oversight function. Indeed, the general view discovered by the study is that, in practice, the audit committee is unlikely to be able to detect and prevent fraud since, by its very nature, the committee is at a distance from business operations. The report was prepared for the UK’s Audit Committee Chair Forum by Dr. Ruth Bender of the Cranfield School of Management. This a very interesting report that deals with best practices, such as how many meeting to have, and broader issues, such as shareholder access to audit committees.

The role of the audit committee is set forth in the Combined Code, the UK’s corporate governance code, and expanded on in the Smith Guidance. Under the Combined Code, the audit committee’s role is, among other things, to monitor the integrity of the financial statements, review the company’s internal financial controls, and, recommend appointment of the external auditor and approve its remuneration and terms of engagement.

The Combined Code also states that the audit committee should be composed of independent directors and not include the company chair. However, the study found that audit committee meetings were attended by many parties other than the actual members, including external and internal auditors, and the chair and the finance director.

The Smith Guidance suggests that the number of audit committee meetings in a year should be at least three. Of the companies reviewed in the study, the minimum number of meetings was three, and the maximum number of meetings found during the research was thirteen. The number of meetings will in part be a function of unusual circumstances during the year, such as the. initial application of Sarbanes-Oxley or international financial reporting standards. Audit committee meetings generally last between two and three hours.

The report found that the growing volume of governance regulation, and the related increased legal obligations of independent directors, can lead to inordinate focusing on process, or box checking, and too little time for other activities, such as risk management strategy. The report recommended scheduling time over the year for what it called a “white space” meeting to give the audit committee a chance to consider broader issues.

The role played by the audit committee chair was seen as critical in setting the tone and structure of the work. All of the audit committee chairs participating in the study were involved in determining the agendas for the audit committee meetings, generally in conjunction with the finance director and sometimes with the external auditor, with some having a policy of always meeting with the external auditor before a committee meeting.

There is a growing movement among institutional shareholders to have closer involvement with audit committees. The Combined Code states that audit committee chairs should be available at companies’ annual meetings to answer shareholder questions, but gives investors no further direct access. The report found that no benefit would be gained by allowing increased access. The crucial issue here is whether the audit committee exists for the benefit of the board or for the benefit of the shareholders. Generally, the view was that it is the board, since the audit committee is a sub-committee of the board to which certain responsibilities are delegated, and its role is to report to that board.