The review of non-audit fees is more important in the US because of the regulatory requirement under the Sarbanes-Oxley Act. However, there was no mention of the maximum non-audit fees, either as an absolute number or as a percentage of audit fees, allowed under guidance issued by the audit committee of the company.
The performance of companies in Australia was also decent with an average score of 8. The diversion in scores was very low. The relatively lower scores of companies in Australia and the UK and the US were because of the smaller size of audit committees in Australia. Companies in Australia also scored lower in the number of audit committee meetings in a year. The lower score in Australia should not be seen as a reflection of poor corporate governance with respect to the audit committee if smaller size audit committees were equally effective in preventing and detecting financial statement frauds, a parameter beyond the scope of this report.
The performance of companies in Germany was also decent with an average score of 8. There was no data regarding the attendance in the audit committee; a score of 1 was awarded to each of the 5 companies. One interesting aspect of the audit committee in Germany was the relatively large size of audit committees. This implies that more emphasis was given on preventing financial fraud than other aspects of corporate governance.
The scores of companies in the UK and the US were similar, while average score of companies in Australia and Germany were lower. Some of the lower score in Germany is because of less information, which means that disclosure is relatively poor even though actual practice may not be.
Reporting on internal control and risks The data collected regarding with respect to reporting on internal control and risks was converted into a score for each aspect and then added to arrive at a score for each company Refer Appendix III for converting data into scores.
The maximum possible score was 5. All companies in the UK achieved a score of 4, which implies that the average score in the UK was 4 also Figure 9. The requirement to attest is a regulatory requirement in the US under the Sarbanes-Oxley Act of Hence, companies in the UK have not shown an interest in implementing this since it will increase their costs due to payments to the external auditor. One important issue in the quantitative analysis of reporting on internal control and risks is the difficulty in capturing substantial differences in the amount of coverage given to this aspect in annual reports of companies.
All companies state that they have procedures for risk assessment and measuring effectiveness of internal control, but some corporations devote substantial part of their annual report on describing risks and controls. The information in the annual report of BHP on internal control is very helpful for investors and lenders. The difference in the coverage to risks and controls is also because of the variation in size and risks faced by businesses. BHP faces many international risks than, as an example, Tesco.
Therefore, the reporting on internal control and risks should be viewed in light of the risks faced by a business. The score of all 5 companies in the US was 5 Figure Again, same scores reflect the regulatory requirements. Scores were similar and 4 each in the case of 4 companies in Australia; only Sonic Healthcare had a lower score of 3 Figure This was because there was no summary of process used in reviewing effectiveness of internal controls.
The score of each company in Germany was also 4 Figure The reporting on internal control and risk does not show significant differences among companies.
All firms mention about their internal control and risk procedures. However, the amount of description of risk assessment and controls varies in annual reports. Financial reporting quality and effectiveness of controls Financial statements are used by many stakeholders to form an opinion about the financial performance and financial position of the company.
Existing and potential investors, lenders, government agencies, employees and suppliers use information in financial statements to make economic decisions. Shareholders review financial statements to see trends in past performance to form an opinion about the future earnings of the company. Shareholders are interested in capital gains and dividend income, and therefore they are interested in prospective earnings and risks.
Lenders want to know whether the debts given by them to the company are secured with sufficient safety margin. Collateral provides the lender with assets that can be used to raise cash if the borrower defaults on the loan Leitner, Lenders also want to know if the business will generate enough cash in the future to make interest and principal repayments because the collateral has value only to the extent of its market value, and therefore reliance on historic costs may not be the best way to ascertain collateral values Therefore, lenders rely on historic information in financial reports as well as risk analysis of the management to estimate future cash flows.
Between shareholders and lenders, shareholders place more emphasis on the future earnings, and therefore are more interested in risk analysis and internal control. Suppliers are interested in assessing the ability of a company to meet its short-term obligations as they arise.
Government agencies typically use the historic data in financial reports to determine tax obligations of a company, and whether the business is solvent. Current and prospective employees use financial reports to determine whether the business would be a going concern in the short and medium term. They want the company to be profitable to have assurances about their job prospects, but are less concerned than shareholders about the level of profits and returns.
The above analysis shows that various stakeholders use financial reports for economic decision making, but some use it more often than others. Investors and lenders use are interested in all financial reports, whereas government agencies are less likely to review reports unless a company declares or is close to bankruptcy.
This suggests that the need for reliability of financial reports is higher in the case of shareholders and lenders. Audit committees, internal control and assessment of effectiveness of internal control measures improve the reliability of financial reports. They give more assurance to users of reports regarding the authenticity of financial statements. However, it is difficult for an outsider to observe the true effectiveness of these measures. Audit committees and internal control systems are two main components of corporate governance structure to give positive assurance to the users of financial information about financial reporting quality.
The Sarbanes-Oxley Act of expanded the formal responsibilities of audit committees. Krishnan lists three measures to determine audit committee quality: Independence of an audit committee minimises the influence of the management in the preparation of financial statements, and therefore gives higher assurance to external stakeholders. All companies in the UK, the US and Australia have to show whether members of their audit committees are independent or not.
This disclosure increases the reliability of information in financial reports to the users, and suggests that financial statements of the company are useful for decision making. PepsiCo described in its annual report the steps taken by it to ensure the effectiveness of the Audit Committee, including the process to ensure that it consists solely of directors who are not salaried employees and free from any relationship that would interfere with the exercise of independent judgment as a committee member PepsiCo, This increases the assurance to investors and lenders.
The experience and skills of the Board of Directors is also useful in analysing whether audit committee members have right skills in assessing financial reports. Tesco stated that at least two members of its audit committee had skills to fully review financial statements and other members of the audit committee had an appropriate understanding of financial matters Tesco, This is useful in giving assurance to investors since the skills of the audit committee members would be useful in detecting and preventing financial statement frauds.
However, it is difficult to assess the effectiveness of audit committee members as Fiolleau et al. The implication of this statement is that members of audit committees are likely to be less effective than expected by external stakeholders.
This is difficult to test in real cases but field experiments regarding the procedure adopted by companies for selecting auditors have found limited involvement of the audit committee in the auditor selection decision Fiolleau et al. This behaviour of audit committee reduces assurance of investors and lenders regarding financial reports. Internal controls have gained importance after the failure of firms like Enron.
Internal control and risks disclosure increase information of stakeholders regarding earnings in the future. A sound system of internal control in a company depends on a regular evaluation of the business and financial risks Turnbull guidance, Risks are uncertainties which can have a negative impact on profits.
Therefore, risk management can positively influence on profits of the firm. It is argued that the perceived lack in risk management, especially by the financial services firms, resulted in the financial crisis in ASX, This has increased the emphasis on risk management through effective oversight and internal control ASX, The disclosure of risk management processes provide further positive assurance to investors as it shows that the management is taking steps to safeguard their wealth.
A review of the annual reports of companies shows more emphasis on internal control in the recent year. The assessment of internal controls by external auditors is a regulatory requirement in the US. The auditors of PepsiCo defined stated that internal control provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes PepsiCo, This gives higher assurance to external stakeholders.
The objective of the internal control audit by an external auditor is to assess the risk that a material weakness exists within the functions of an organisation, which can have a negative impact on its valuation.
The description appears to be customary, but the company discloses the fee structure and roles of governments in determining revenue of the firm in different countries Sonic Healthcare, This is useful for an investor who wants to analyse the impact of government austerity measures on future revenues of the firm.
However, there are inherent limitations in internal controls which imply that they may not prevent or detect financial misstatements. The reporting of the internal control function to the senior management creates doubt about its effectiveness.
External stakeholders will be sceptical about the ability of the internal control function to report frauds being conducted by the management. Olympus fraud in Japan resulted in heavy losses for investors. The fraud went on for more than a decade before it became public news. This shows that internal control measures were not effective in preventing the management from committing the fraud.
The above analysis shows that audit committee and internal reporting on control and risks increase assurance regarding the quality of financial reports to external stakeholders. The audit committee disclosures are useful in increasing assurance regarding the quality and truthfulness of the historic information.
The disclosure of internal control and risk reporting gives higher assurance regarding the future earnings of the business. However, there are some limitations in both disclosures, but it is better to have these disclosures than not having them. Recommendations This section of the report discusses how current disclosures can be made more informative to assist in assessing the transparency and accountability of corporations.
A number of recommendations are made to increase transparency and accountability. One of the main observations was the way information was presented in the majority of annual reports. All companies had information as required by their national corporate governance codes.
However, in many cases the information seemed to be included in annual reports to meet the obligations of being seen as a good corporate entity rather than being done for the purpose of enhancing transparency. As an example, all annual reports had information about the Board of Directors in terms of their skills and experience.
However, it was only in the case of BHP Billiton that the management had taken extra effort to present the information in a graphical and user-friendly manner. The annual report of BHP Billiton showed pie charts with age, skill and location distribution of its Board of Directors.
This was much easier to grasp than the descriptions seen in the majority of the cases. Users of annual reports would find it much easier to look at these graphics for analysing the diversity and experience of the Board of Directors, and therefore it is recommended that companies should adopt similar presentation formats. Currently, the management of a company is responsible for its internal control over financial reporting. This has both advantages and disadvantages.
The advantage is that the internal control function can quickly get in touch with the management if any issue needs to be reported. This may allow the risk or fraud to continue for a longer duration. The disadvantage of this reporting structure is that the internal control may find it difficult to highlight an issue if the senior management engages in financial frauds.
It is also expected that employees appointed in the internal control function may have been with the company for some time, and therefore may have developed a personal relationship with the senior management.
This also makes it difficult to report any violation by the senior management. It is recommended that the annual report of a company should disclose all financial frauds over a certain amount or percentage of equity of the company. This would increase the knowledge of investors and lenders regarding the state of corporate governance within the company. It is also recommended that each company should establish a guideline which should state that if a corporate fraud is more than a certain amount or percentage of its equity, then the internal control function would report to the audit committee with regards to investigation of that fraud.
This would increase the independence of the internal control function without overburdening the audit committee with small frauds. This step will increase the faith of investors in the financial reports of the company.
It is also recommended that companies should make effort to ensure that users of annual reports find it easier to obtain information on risks and internal control measures.
Risk is an important topic in the majority of annual reports, but information on risk is not typically available in one place in annual reports. Some firms, such as Siemens, provided clear links but others failed to point properly to look for material on risk management. The content on risk and internal control can be overwhelming for investors, especially individual investors who wish to know about the future prospects of a company but find it too time consuming to go through all content in an annual report.
Since risk has a material impact on the future earnings and cash flows, it is recommended that major risk elements and controls in place to mitigate them should be presented in a bulleted summary somewhere ideally in early chapters in an annual report.
This will help investors in gaining a better understanding of risks of investing in a business. Annual reports of companies list a number of risk factors which may influence the performance and financial position of the business in the short and long-term. Listing of risks is useful for investors and lenders but again the effort seems to be on meeting the obligatory requirements under the national corporate governance codes of countries. The effectiveness of risk disclosure can be improved by including a risk-ranking matrix in annual reports.
This will allow investors to focus quickly on major risks and look for steps being taken to mitigate them. It will also help users of annual reports to see if the management of the firm is prioritising more on areas that need greater attention. Firms should design and put into practice strong whistle-blowing systems to ensure that employees with knowledge of frauds within the company can report them to the Board of Directors without the fear of being prosecuted.
In the case of Olympus, the board of the company fired its CEO for questioning suspicious transactions. If this was the treatment given to the CEO, employees at lower level could not have thought of reporting the fraud without being severely reprimanded. Protection of employees is important because most external whistle-blowers first blow the whistle internally Kaptein, Thus, developing a system that encourages internal whistle blowing could result in early detection of frauds.
In terms of accountability, there should be more emphasis placed on the accountability of independent and non-executive directors. Currently, accountability rests with the executive board. It is recommended that the non-executive directors are also made more accountable because of the impacts of their actions. In the event of failure of the audit committee, the designated independent director should be approached first and his actions should be reviewed.
This will increase accountability of independent directors and they will take their role more seriously. There is a risk that some experienced people may not wish to take non-executive director roles because of the increased accountability. This has to be weighed in, but the loss of wealth of shareholders in a large company due to fraud is more important. Conclusion The purpose of this report was to analyse and compare corporate governance practices in countries and companies in three main areas: Board of Directors, audit committee, and internal control and risks.
Corporate governance is a useful tool to increase faith in capital markets, especially in the case of firms where owners are different from managers. The corporate governance systems across the world have shown convergence, but there are some differences. The corporate governance developments in four countries were briefly reviewed.
The Cadbury Committee played an important role in the development of corporate governance code in the UK. The US code is stricter after the Enron scandal. The main difference with the German code on corporate governance is that companies in Germany have two-tier boards. Independence of directors is important in all countries and was reflected in individual company analysis also.
Size of Board of Directors and diversity skills are also important. Actual independence depends upon actions taken by the Board of Directors and is not possible to analyse with the data in annual reports.
Shareholders use historic data to predict future earnings, so they are interested in risks which may reduce earnings and cash flows in the future. Therefore, they rely on audit committees and internal reporting to assure themselves about the quality of financial reporting.
All companies had some members on their audit committees who had financial experience. Some companies disclosed the lead person in audit committees with financial expertise. It was difficult to observe skills in the case of German companies, as they did not disclose individual audit committee members in their annual reports. Emphasis on internal control has increased and companies disclosed summary of policies for the management of business risks.
Management also reported the effectiveness of their management of material business risks. This gives users of annual reports more comfort about the quality of internal controls present in a firm to mitigate risks. However, it is difficult for users to comprehend the actual steps being taken.
Recent examples of massive bankruptcies resulting from weak systems of corporate governance have emphasized the need to improve and reform of corporate governance at the international level. Corporate Governance and Accountability by Solomon, J. UK , , page 1. In current era, due to the recent big corporate scandals, the concept of corporate governance thrive the attention of corporate world as well interest of general public. It is necessary for the organizations to deal with internal and external matters, it also apparently important for the health of economic and social society and part of the world in general.
However concept and definition of corporate governance is defined in poor manners because it creates the critical phenomena for the major portion of the economic world, and considered as challenge or somehow destructive for the organizational existence Berglof and Pajuste, System of corporate governance has evolved over the centuries, often in response to corporate failures or systemic crises. The first well-documented failure of governance was the South Sea bubble in the s, which revolutionized the laws and business practices in England.
The developing world has also faced its own challenges for corporate governance. By Iskander, Magdi R. A frame work for implementation, page 1. Corporate governance however is the best tool to handle the business organizations, but the question is that how effective it is for the organization, at what extent the rules and regulations of the corporate governance affecting the organization.
Research design is mainly related to data collection and data analysis. The data will be collected from both direct and indirect sources and will be analyzed according using appropriate statistical tool. The target population in this research work will be the banking sector of Pakistan. Number of banks from banking industry of Pakistan will be considered as sample, sample size to study the impact of corporate governance practices on the performance of banking sector is 12 commercial banks.
In such kind of study, both type of research can be possible, but the combination of both qualitative and quantitative will enhance the validity of data and finding with the due support of literature review. This kind of research study will consider the concepts of agency theory, managerial hegemony theory, Stewardship theory, external pressures, Stakeholder theory and other theories of convergence and post Enron theories has been studied in concern of this study.
Data will be collected from the following sources: Questionnaire; questionnaire will be used as tool of data collection from the selected sample from banking industry of Pakistan, results will be interpreted and compare with the literature to ensure the validation of results. For gathering the data regarding the financial sector performance and corporate governance issues, the researcher may consult the various articles, journals, books, speeches, etc.
Various empirical studies by many authors and researchers will be used for further insight into the research topic. The data collected from primary and secondary sources will be analyzed by using appropriate statistical tools to approve or disapprove the hypothesis.
Likewise all over the world, in Pakistan too, the corporate governance has significantly improved over the past few years but much remains to be done which includes the removal of the obstacles to good corporate governance. The aim of the research thesis is to find out whether the Corporate governance is contributing towards the improved performance of Banking sector of Pakistan or not?
Research plan is tool which will be used to complete the research work in sequence and in step by step to achieve the objectives of study. Time Period required for completion of research work has been mentioned in weeks in X-axis and activities against the time line are given in Y-axis. Project plan is mainly segregated into two major parts 1.
Data research, complete qualitative sort of data will be collected and arranged and literature review would be complete and the, 2.
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