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Audit Committees in Business Regulation

Info: 10250 words (41 pages) Dissertation
Published: 11th Dec 2019

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Tags: Accounting

Chapter 1: Introduction

The role of audit committees in the regulation of a business has become a great discussion point since a prominent increase in the number of multinational corporation accounting scandals. The scandals have strengthened and increased the number of rules and regulations surrounding corporate governance and have influenced the roles and responsibilities of audit committees. Major scandals which occurred during the early 21st century, involving high-profile companies such as Enron, HealthSouth, Tyco and WorldCom, affected the confidence of investors in corporations (Agrawal and Cooper, 2013). Subsequently, the roles of audit committees have evolved over the years mainly in terms of the committee overviewing corporate governance, financial reporting, internal control and auditing by both internal and external methods.

Corporate scandals highlighted the importance of good corporate governance, and highlighted the need for genuine independence on the part of audit committee (Deakin and Konzelmann, 2004). The increase of new laws and regulations is to prevent any more fraud cases like the Enron accounting scandal from occurring.  Enron was a rich energy company in the 1990’s – its value reached $70 billion over the course of a decade. The major corporate scandal in Enron caused it to crash and burn in a single year of criminal investigation and brutal media scrutiny. The scandal was not discovered mainly due to a lack of independence of the directors and auditors from the senior executives (Deakin and Konzelmann, 2004). Enron’s audit committee was not independent resulting in biased accounting and financial reporting for personal financial gains which gave the investors an untrue image of Enron’s financial position. A similar scenario occurred with a scandal involving WorldCom, an American telecommunications company, who overestimated their own financial position. The audit committee had poorly supervised management which resulted in the scandal to occur as there was no regulation over the unethical financial reporting (Weiss, 2005 cited in Al-Matari, AlSwidi, Fadzil and Al-Matari, 2012 ). These scandals were all a result of a lack of a structured corporate governance system and an accountability structure. A few government authorities made changes in the structure of corporate governance codes and practices in the Western world to prevent future scandals, as it can cause major devastation to the corporate world.

An audit committee plays a vital role in monitoring a corporations’ financial transactions and assuring all codes of corporate governance are adhered to. The historic evolution of audit committee originates from the early 1940’s (Verschoor, 2008). Their assigned responsibilities have grown over the years as a consequence of corporate scandals, affecting the corporate governance structure and altering their role and responsibilities. The audit committee was initially a committee designed to prevent scandals and to further carry out financial monitoring due to their expertise and independence. The term “audit” simply means to evaluate; the phrase “audit committee” however has a greater connotation to it, so we need to first understand it to comprehend the role and responsibilities of an audit committee. The audit committee has been defined as a board of mainly non-executive directors that focus on the internal control of the organisation and audit of its financial reports (Spira, 1998). There are unique styles of audit committees depending on the corporate law of the country and the corporation must adhere to the governance structure set by its government if regulations are enforced.

In this research, I will concentrate on the role of audit committee and the appropriate arrangement for organisations to implement the UK Corporate Governance Code. An audit committee has certain requirements to meet to be suitable to serve an organization and achieve more tasks with the specific knowledge essential to the role. The audit committee is a standing committee; they are required to meet separately from the board to implement an independent review. These members are required to be independent from the board of directors to achieve autonomy in their audit. “Audit committee requires particular arrangements to meet the standards required for its size, independence and number of meetings” (FRC, 2016). In this study, I will investigate the duty of an audit committee by assessing their interaction with other members in the organisations. Another focus in this study is the requirement and arrangements of the audit committee so it is best suited for its role and responsibility e.g. the audit committee requires at least one of its members to have financial experience and skills.

This paper is structured into eight sections to discuss the role of audit committee and its implications on the internal control. In the first section of the paper is the introduction; audit committee is introduced and explained, addressing the main previous problems of the audit committees and internal control. The second section is the literature review which addresses the related literature review on audit committee, providing information on the requirements of audit committee members. In the literature review the audit committee’s structure and roles are discussed with the audit committee’s size and independence, and there is a focus on further analysing the role of audit committee in an organisation, such as dealing with external auditors and shareholders.

The next section is the methodology which looks at the detailed knowledge that is to be investigated regarding the role of the audit committee while further figuring out the gaps in the audit committee’s internal control. Additionally, section four addresses the results of the research that is discussed with the support of the data collected from Bloomberg and the relevant literature identifying the result the research has attained.

Section five is the conclusion that summaries the findings from the research, mentioning the possible factors affecting the audit committees internal control of the organisation.  Then section six outlines the limitation and recommendations for the research, analysing the current research regarding the audit committee and referring to the limitations discovered during the research and the affect it had on the result of the research. Also in this section, the recommendation for avoiding future mistakes in research will be discussed. The final seventh section accounts for the references used to support the research; it addresses the implications of the research and mentions the improvements possible if future research its conducted on this topic.

Chapter 2: Literature review

UK corporate governance code demands all public companies to structure an internal control system by establishing an audit committee in their organisation. The committee should consist of three non-executive directors that are independent of the management. Small non-public companies only require two non-executive directors. Furthermore, an audit committee member can be a part of the board of directors but cannot chair the board so that there is independence for the audit committee. “To be independent, an audit Committee member may not accept any consulting, advisory, or compensatory fees from the company” (Lindberg, 2004). The committee should be knowledgeable about the business of the corporation and possess professional skills to comprehend any misconduct within the corporation. Even though the committee members’ knowledge is essential for them to understand the corporations’ business, it is vital that there is no previous involvement of committee members directly with the management of the corporation. “Recommendations have focused on the independence and expertise of committee members” ( Stewart an Munro, 2007). The responsibilities of the audit committee need to be written clearly in a charter which mentions the authorities the audit committee members have been appointed and the duties that have been set. The audit committee need to reduce the agency cost by aligning the interest of both shareholder and management. The objective corporate governance gives to audit committee is to increase the investor confidence by producing transparency of the corporation and credibility of the financial information. “The various forms of intellectual capital disclosure are valuable information for investors as they help reduce uncertainty about future prospects and facilitate a more precise valuation of the company” (Li, Pike and Haniffa, 2008).  The committee manage the supply of information between external auditors, the board of directors and shareholders which allows them to ensure executive bias has no effect on the financial reporting. The audit committee assists the board of directors in managing a fair financial reporting by monitoring for any discrepancies.

The audit committee have a responsibility of holding meetings; it is the audit committee chairman’s duty to organise them. The committee chairman must discuss the regularity of the meetings with the company secretary and they should have enough meetings to fulfil their roles and responsibilities.  These meetings should occur prior to the key audit cycle dates to allow for adequate meetings to address important issues. Price Waterhouse (1993) mentions in his study that a minimum of three meetings is required per year for an audit committee and additional meetings when necessary. Audit committee meetings need to be prior to board meetings so they can report any information required for the board meeting. In an audit committee meeting, there should only be the audit committee Chairman and committee members in attendance. Only for specific agenda meetings can non-members attend, including the external and internal auditors.  It is the committee’s responsibility to meet the external and internal auditors at least once a year without the presence of the board of directors to ensure the quality and independence of the financial reporting. These meetings with auditors should be used to discuss issues that were found in the financial or annual report, and clarify the responsibilities carried out by the auditors. It is expected that the larger the audit committee the more frequent they should meet in order to achieve a greater influence in an intellectual financial disclosure (Li, Pike and Haniffa, 2008). The audit committee duties must be undertaken properly, so sufficient resources should be provided to carry out their meetings and responsibilities. This means the audit committee should have the ability to communicate with appropriate personnel with matters that arise. The point of contact for the committee is the company’s secretary. The committee are required to arrange adequate times for meetings to find a solution for key issues (Olson, 1999) The secretary must guarantee that the audit committee receive the required information at the required time and provide them with considerate time to deal with any matters that arise. The board of directors should support the committee resourcefully and practically by any means necessary such as the provision of information to the committee. It is the board’s responsibility to provide sufficient funds to the committee to permit them to undertake their responsibility and seek further independent advice if required.

2.1 Ownership and control

Klein (2002) informs us that there is a negative correlation between audit committee independence and earnings management. This is a result of accounting scandals that have regularly occurred within corporations due to the unification of ownership and control.  The growth of businesses into multi-corporations affected the methods of ownership due to financing from shareholders. This joined ownership of the public trade corporations required monitoring of their investment by an entity separate from the business partners to achieve stronger control. Cotter and Silvester (2003) state that in an audit committee a good appointment for a member is that of an independent director, as they are in a better position to monitor the board of directors. This independence of auditors is so essential that auditors must declare any relations to the corporations or directors, as this can jeopardise the authenticity of the auditor and may affect investor confidence.  Directors that are not independent would be liable, as the relationship with the corporations that has not been mentioned can have control over the finances. This control permits directors to manipulate stock prices by either increasing the cost of investment capital resulting in a monetary loss from their investment. Lawmakers have focused on enhancing the role and responsibilities of the audit committee to increase emphasis on the audit committee’s independence. (US Congress, 2002; Commonwealth of Australia, 2004 cited in Stewart and Munro, 2007). Independent non-executives need to analyse the financial statements with a sceptical mindset. This impartial view can prevent fraud, resulting in investors and shareholders to have more trust with the corporation. The audit committee plays a significant role by allowing for transparency for the economic loss or gain incurred by the corporation. It also prevents financial fraud from taking place at the hands of the management of the corporation.

The rise of major scandals has increased conflict between management and investors, as interests of all parties are not satisfied resulting in a rise in agency cost. The board of directors aim to increase their wealth while increasing their power and control allowing them to focus on their self-interest. Islam (2010) tells us that people are motivated mainly by self-interest and cannot have the same control of others’ money as their own money. This is a primary reason for the agency problem between agent and principal. Principals do not believe agents have their interest to provide them with relevant and reliable information. Auditor independence is important to shareholders as it provides them with reliable information and aligns the interest of both shareholder and management. Jensen and Meckling  (1976)  describe this as the agency cost. It is the expense arising from the conflict of different interests between management and shareholders, each focusing on their main interest. Audit committee act as agents to principals (the board of directors), but the independence of the auditors affects their integrity and lets them act as an agent for management. This is a conflict of interest for shareholders as it conflicts their primary aim of an impartial control to increase their share value, and this partisan monitoring of the audit system arranged by the management questions their trust and confidence in the corporation. One method to decrease the agency problem is by improving the quality and reliability of the audited financial statements to support the audit committee with protecting and safeguarding the interest of the shareholders and board of directors ((Fama and Jensen, 1983; Fama, 1980; Jensen and Meckling, 1976 cited in Islam, M.Z., Islam, M.N., Bhattacharjee, S., Islam, A.K.M.Z., 2010). Audit committees act impartially to the board of directors and shareholder interest, and need to align management with shareholder interest to increase shareholders trust and portray their loyalty to their shareholders. This trust and understanding built between management and investors would benefit both parties and most likely reduce monitoring costs allowing both parties to beneficial financially. The audit committee aims to reduce agency cost by aligning these differences and preventing economic loss for shareholders and stakeholders. This separation of ownership and control increases shareholder confidence.

2.2 Internal control

Internal control is a vital role that audit committee must oversee to ensure the corporation achieves the corporate governance required. The internal control of an organisation’s establishment is a required from the management. However, the audit committee is a monitoring entity of the internal control and its primary function is to be an oversight of the internal control (Krishnan, 2005). Internal control of an organisation is a vital area as it provides a reliable financial report process for the corporation and the quality of the internal control needs to be assessed by the committee. This safeguards the effectiveness of the corporation and the efficiency of its process. “Internal controls can take the form of financial, operational, or administrative controls” (Lindberg, 2004). These controls help the audit committee to prevent fraud within an organisation and help prepare the reliable financial information required which increases the shareholder confidence in a corporation. Internal control gives audit committee the authority to manage the needs of the internal control system regarding the financial reporting and financial statement. This internal control system provided by the independent audit committee resolving conflict of interest between shareholder and management, the communication system provided by the committee is a key to this goal.  Internal control is beneficial for all parties as it insures every personnel is reasonably insured and protected, this independence of the committee can reduce agency problem. (deffo change this reference) “We thus expect that firms with high-quality audit committees are less likely to have internal control weaknesses than firms with low-quality audit committees.” (Domnisoru and Vinatoru, 2008). The committee insure the quality of the internal control of the organisation meets the standard required to meet the internal audit level. The audit committee’s role in internal control is to also review the additionally non- financial issues of corporate governance in the organisation such as employee rights. Audit committee ensures no violation are incurred by any parties, they handle complaints regarding internal control matters. The audit committee should review the annual report and recommend to the board of directors the effectiveness of the internal control and reliability of the reporting (FRC, 2016). Nevertheless, the audits committee’s role is to review with the board of directors, external auditors and stakeholders the effectiveness of the organisations internal controls. A communications system between all corporate operating members to safeguard the internal control system has no shortfalls as it can lead to harm the operations of the company or result into a scandal. The audit committee oversees monitoring, communication of information, risk assessment, corporate governance, human resource and control of activities and environment.

2.3 External audit

The audit committee is usually assigned by the management, so they can assist in the preparation of the company’s financial statements. The responsibility of the committee is to prepare a complete financial statement with consistency to the corporate governance rules and legal requirements of the country. This should be presented by the committee in the annual report. This monitoring process of the organisation by the audit committee also includes the management of external committee (Xie 2001). The management of the external auditors means the committee must establish better communications between external auditors and management. The audit committee has responsibilities with relation to external committee’s appointment, replacement and reviewing of their work for the organisation. The audit committee appoints the External auditor from a Certified Public Accountant firm. The committee is responsible for the overview of the external auditor work within the company. This permits the organisation to maintain their independence from the employment of an external audit and increases investor confidence.  External auditors provide assurance, encouraging a strong relationship between board of directors and shareholders through the audit committee. The audit committee can serve as an effective sounding board for the external auditors when resolving financial or control reporting disputes with management. (Cohen, Gaynor, Krishnamoorthy, and Wright, 2008).  Subsequently, the external auditor must report back to the audit committee, discussing the issues of the financial reporting review and whether they are acceptable. The committee must ensure the independence of the external auditor, making close checks before appointing them for the role. The external auditors’ objective for the corporation needs to be assessed by the committee to ensure they have considered the management and stakeholders interest. If there is a dissatisfaction with their monitoring process, the committee can recommend a replacement for the external auditor; if the board does not agree then it should be presented to the shareholders in the annual report. However, the board cannot approve any removal of the internal audit as this show the lack of independence in the internal audit function of the organisations.

2.4 Communication with shareholders

The audit committee has a key role in the communication of information in amongst the corporation. Their role is to protect the interest of the shareholders by safeguarding the financial reporting standard and the internal control of the corporation. The audit committee should ensure the management of supplied information in financial statements and annual report to the investors, ensuring it is fair and balanced. “The additional communication had an impact on auditors’ evidence evaluation and judgments, as auditors were less supportive of management’s aggressive estimate and documented a greater proportion of evidence items consistent with the audit committee’s expressed expectations for conservative reporting” (Brown and Popova, 2016). The annual report needs to be prepared in a clear method including a section with information on the role and responsibilities carried out by the audit committee. It should summaries the work of the audit committee and should be signed by the committee. This summary needs to mention the committee members’ names and qualifications and address the work carried out by each committee member, the process the committee used to monitor and review the corporation and the meetings conducted to execute these responsibilities. The audit committee summary must include the appointment and replacement of external audit, it must clarify in the summary the present audit firm and the length of their charter.  The audit committee must describe the role and responsibilities the external auditor, and clarify the non-audit services carried out by external auditors ensuring the auditors independent was protected. The comprehensive communication between the auditors and audit committee on the content of financial information the increase in communication of this to shareholders (Cohen, Gaynor, Krishnamoorthy, and Wright; 2008).  The audit committee should verify the reason for the external auditor’s non-audit services and clarify the cause for its outsourcing. The audit committee should assess the work of the internal auditor and comment on the quality of the internal audit itself. The main discussion it should present to management and shareholders is the key issues the committee has uncovered and the consideration and options available for the investors. Audit committees may update the executive and non-executive directors to create a better working environment due to the share of information. (Allegrini and Greco, 2013). The discussion should include issues that rises from the financial statement and annual report and the method used to address these issues and the auditors that communicated these issues as well as stating if there were any interactions with the financial reporting council reporting the discussion they developed. In every annual general meeting, the chairman of the committee should be present to answer any queries raised by management or shareholders on the audit committee section of the annual report.

The audit committee have a responsibility to review the financial statement and annual report presented to shareholders quarterly.  Any discrepancy found by the committee during monitoring of the financial report or annual report should be reported to the board, who then assess the issues found in the development of the financial statement or annual report. “The audit committee report sets out its wider scope and its consideration of significant issues in relation to the financial statements” (James 2014). However, the management are responsible for the preparation of the financial statement and the accurate adherence to the accounting standards and regulations. Furthermore, the audit committee should be made aware of the different approaches of accounting methods implemented on the various unfamiliar financial transactions. The audit committee needs to review the financial statement understanding the external auditors upcoming review for the company, so it should ensure the company has adopted the required accounting standards for all their transactions. If the audit committee is not satisfied with an aspect of the monitored report or financial statement, it should report its views to the board. (FRC, 2016). The content of the financial statement and annual report should be reviewed for the clarity of its disclosure which ensures the shareholders get the aspect and information of the financial statement. Furthermore, the committee should report to the board if the proposed financial or annual report does not meet the UK corporate governance code standard.  The audit committee must further clarify the financial report by assessing the annual report or any related document such as the corporate governance statement. The UK corporate governance code asserts that the audit committee must advise the board if the statements presented by them are fair and understandable and whether it adheres to the corporate governance code. Furthermore, a change to the statements should be presented to the audit committee and they should review if the additional information is acceptable and consistent with the report (FRC, 2016). The supplied information in the financial statement is key as the major financial transactions that return finance from the regulators need board approval. However, these significant financial returns should be presented to the audit committee to review first to avoid inconsistency. This process adheres to the transparency requirements and disclosure rules providing the shareholders with increased confidence and clear supply of information.

The audit committee must develop relationships with different acquaintances in the company from board directors, shareholders and employees. One of the most vital relationships for the committee is that with the board of directors as they should report to them on the roles and responsibilities they have carried out.  The committee should present the key issues it revised in the financial reporting and the implemented change in the statement to deal with the issue.(FRC, 2016). A lack of agreement between audit committee and the board would have to be discussed with the shareholders. Appropriate time should be given in resolving the issue as to allow the committee the time report it to the shareholders in the annual report . In 2003 FRC, also known as the Smith guidance, was introduced to assist company’s’ boards of directors in understanding their relationship with the audit committees and the shareholders. It was the result of the rise in the major scandals that occurred in the United states, such as the one involving Enron. The Smith guidance was further updated in 2008, making change to the sections of the UK corporate governance code relating to the audit committee and focusing on the board of directors assisting the audit committee in carrying out their role. The audit committee have responsibilities that are beyond just the financial reporting and managing of the corporations. Furthermore, the committee should ensure a system is set for the employees of the corporation to raise issues in confidence regarding finance or other matters (FRC, 2016). The committee should ensure a system is set up to follow up any inappropriate actions and matters raised and to arrange an independent investigation of such matters.

2.5 Internal auditor

Internal control is a major function that varies depending on several factors, such as the independence and size of the committees and employees. An audit committee’s role is to ensure a regular review of whether an internal control function is required to be applied to the company. In this review, the committee should consider all the issues that would affect the risk of the company. As an increase in risk would affect the internal control of the company such as financial reporting method and communication of information. The audit committee focus on the internal auditors monitoring of their sustainability of reporting which demonstrates the auditor’s role and their corporate governance requirements. (Trotman and Trotman, 2015). The internal audit function ensures to management and shareholders that the internal control of the organisation is established. However, in a company without an internal audit process, other methods must be implemented to reassure the parties concerned, to sustain an effective monitoring system and to achieve the internal control required. “The audit committee should review the annual internal audit plan and approve if it is effective. They should further monitor the internal audit process to ensure its effectiveness and implement any changes to increase effectiveness.” (Haron and Qun, 2016). The audit committee’s review of the internal audit plan must ensure the plan addresses the key issues in the internal control of the organisation. It should safeguard the financial statements and ensure external and internal audit are all reliable. The committee should focus on the communication of information to protect the reliability and effectiveness of the information. This open and reliable communication between the various functions allow the audit committee to evaluate the amount of risk and further monitor the internal control to ensure it is suitable to the needs of the organisation.

The primary objective during this paper is to discuss the role of the audit committee and focus on the connection between audit committee size and auditor’s independence to ensure internal control. This study will firstly focus on the audit committee of the 100 largest traded companies on the London stock exchange. It will investigate if the 100 largest companies in the UK abide to the established requirements of the audit committee size set in the UK corporate governance. It will specify if the listed companies abide by the provided UK corporate governance code set of at least three audit committee members to ensure internal control. Subsequently, the study will investigate the independence of the audit committee, whether the audit committee members designated are independent to ensure internal control and avoid agency problems. There have been previous accounting scandals that arises due to a weak internal control in public listed companies resulting in loss of investor confidence.  In the research, I will examine if the committee members and the chairperson of the audit committee is a nonexecutive member of the company and is totally independent of the company. The enquiry will aid to understand the structure of the audit committee and the safeguards set to ensure independence. The importance of the study is to investigate the internal control system in corporations and to further understand the monitoring and integrity of the financial reporting. This internal control of an audit committee has been a vital part for public corporations in the UK, as the independence ensures that the internal control of the corporation is strengthened and sustained. Another purpose of the study is to investigate the frequency of audit committee meetings, understanding if there is a relation between audit committee size and frequency of audit committee meeting.

 

Chapter 3: Methodology

There are diverse types of research methods applied and used over time to investigate and understand studies. All research methods are classified under two groups; they are either qualitative research or quantitative research. Initially, I will emphasise on the qualitative method of research. It is research focusing on the information that is problematic to summarise or interpreted as numerical information as it is a more complex information that is more descriptive. “Qualitative research, document analysis requires that data be examined and interpreted to elicit meaning, gain understanding, and develop empirical knowledge” (Corbin & Strauss, 2008; Rapley, 2007 cited in Bowen, 2009). This method of research supports researchers in collecting a detailed understanding on the research. The qualitative research method does not examine the what, where and when, but answers the questions of how and why decisions are made. The use of this data type allows a better understanding of an individual’s experience and behaviour to be studied. Furthermore, it permits the researcher to gather data of the persons own experiences in their own method. Another advantage is less limitations and assumption are assumed for the data collected as the data can be studied in more depth. This research is beneficial if a more explanatory research is required and aids with a better theory suggestion. However, this research method also has it disadvantages. The data collected is dialectal and is larger which makes it more difficult to determine whether it is reliable or valid to support theories. Qualitative research, such as interviews, have open-ended questions and can be very time consuming to analyse as it creates a lot of data at times. This researched has some weaknesses, one of them being the gathering of data on a person’s experience which can be very biased in the information they provide due to their emotional effect from the experience.

Alternatively, the other research choice is quantitative research method. This is another commonly used method for researchers. Quantitative research is a method of collecting data through a practical method of investigating a study using a statistical or mathematical system. This research method aims to develop a table or graph of mathematical or statistical models to develop a theory or hypothesis for the research. In general, quantitative research is implemented with the support of scientific systems to develop graphs and tables to numerically analyse the data. This method of research uses instruments to develop modelling and analysis of the data by evaluating the results interpreted. Quantitative research is beneficial as it makes it easier for researchers to collect and analyse data compared to qualitative research. The researcher data is more likely to be impartial compared to the qualitative research as the data is numerical. Using this research method is more reliable as it permits researchers to test previous hypotheses if required. The ability of measuring its researches through table or graph models allows it to verify or neglect previous theories. This research also has disadvantages; one of the main disadvantages is that the background of the research is ignored. Quantitative research does not analyse the different description of the characteristics of the research collected; rather quantitative research generalises the information in a table or a graph. This is a consequence of large data for the study and it requires a lot of time and research to focus on each aspect individually

 

In the research, the quantitative method was used for data to be collected from Bloomberg terminal, information regarding the audit committee of the audit to gather published information on companies’ audit committees. The study focuses on the Financial Times Stock Exchange 100 (FTSE) for companies based in the UK. The data is to investigate the structure of the audit committee for the public listed companies on the London stock market. The FTSE 100 had data for 101 listed companies on the Bloomberg terminal, while only 100 of the companies had data on their audit committees. Schutt (2009) tells us that the aim of an investigation is to learn the information for research questions and understand the behaviour of study. This approach to research is appropriate for handling the investigation for the study, as it allows researched studies to adapt to the changing practices of understanding the research and receiving an efficient result to the study.  All public trade companies must present reported statements on the audit committees on their annual report to the shareholders. In this study the audit committees of the FTSE 100 companies are further examined, the research will determine if these 100 companies adhere to the requirements of the UK corporate governance code.  However, the final sample consists of only 100 companies as the other two companies had insufficient data publicly available on the Bloomberg platform. The sample provided on the Bloomberg platform is the data for the years between 2012 to 2017, nevertheless only 23 companies had the audit committee information available for 2017.  The FTSE 100 companies are in various sectors such as pharmaceuticals, Finance, industry, telecommunication, media, insurance and business services. As the variety of the industry is diverse, comparable stratified sampling was implemented (Moser and Kalton, 1996). This study will investigate the audit committees’ role while studying the structure and function of the audit committee. Data regarding the audit committee size and audit committee independent directors was collected.

The research method for this study is based on numerical information regarding the audit committee, it concerns the size of the audit committee, number of meetings and independence. The research focuses on some selected publicly listed corporations from the FTSE 100. The corporations’ data was collected from Bloomberg and provides information on the corporate governance practise of the corporations and structure and independent of their board committee. A requirement by the UK corporate governance regulations is for a company to have an audit committee comprising of at least three independents that are experienced. This state of three independent members ensures the independence and the skill of the audit committee, providing consistency to the corporate governance of corporations.

Chapter 4: Results

Table 1

The audit committee contract outlines the committee’s’ role, size, meetings authority and independence. The results summarised on Table 1 demonstrate the collated data and specifies the audit committee size and meeting over a 6-year period. Although the data of Bloomberg varies and focused on the audit committee size, number of meetings and independence.  The first 5 years of data analysis focuses on the 100 companies from FTSE100 starting in 2012 and culminating in 2016. Additionally, data collection has been reviewed for 2017, but only information for 23 companies was available as the year is still in progression. In Table I the data presented separates the 100 companies into 5 different sections giving a percentage for each section per year.

Table 1 provides descriptive analyses of the statistics regarding the size of the audit committee. The data from the table reveals that in 2012 only 1 per cent of the FTSE100 had a committee size of one to two members, this is below the requirement of the UK corporate governance code for audit committee size. One corporation out of hundred did not meet the requirement for the UK corporate governance code, as for 66 per cent of the FTSE100 had three to four members in their audit committee, while another 28 per cent had five to six members in their audit committee. However, three per cent of the corporation’s audit committee size was unaccounted for even though it is a requirement to disclose the information in the audit charter and annual report.

As for the data table 1 provides for 2013, the corporations of the FTSE100 audit committee have varied from 2012. No corporation formed an audit committee with less than three members in its organisation – this is a development from 2012 with one corporation with a two-member audit committee. The majority of corporations had an audit committee size of three to four making up 69 percent. The remaining corporations were split into 25 per cent of the corporations having a five to six-member audit committee and a four per cent having seven plus members in audit committees in 2013 for FTSE100. This was an improvement from 2012 as more committees are obliging to UK corporate governance code, and only two organisations did not disclose information that is improvement from 2012.

Results in Table 1 for 2014 studies of the data show that 2 per cent of the organisation did not adhere to UK corporate governance code of the audit committee size. This is the highest in collected data from Bloomberg in my investigations; 2 companies in the FTSE100 not meeting the requirements of the corporate governance is unacceptable and decrease investor confidence. Corporations having three to four members in an audit committee falls back to 66 per cent, and the five to six members category has been falling repeatedly for two years from 28 to 24 per cent. However, corporations with seven plus members in their audit committee has increased to 9 per cent, this is an increase of 3 corporations into the seven plus segment. In 2014 only two organisations did not specify the size of their audit committee on Bloomberg terminal.

The stability returned to FTSE100 audit committee structure in 2015, as not a single corporation established a committee with less than the required minimum of three by the standards of the UK corporate governance code. The most occurring audit committee size was three to four, it has stay consecutively the same from 2014 at 66 percent, this has been the most frequent by corporations for the majority of the years in the study. Furthermore, audit committees with five to six members has continually remained at 24 per cent of FTSE100 corporations for two years. However, there has been a consistent increase in corporations with more than double the requirement with 9 per cent of FTSE100 corporations adopting that audit committee size in 2015. An improvement can be seen towards the end of 2015 as the corporations that do not specify their committee size decreased to 1 per cent, only one corporation did not abide by the UK corporate governance code, but more is expected from the top 100 companies in the UK.

As for 2016, the audit committee size for FTSE100 studied in table 1 reveals that for another consecutive year all the FTSE100 companies disclosed data on their audit committees meeting the requirements of the UK corporate governance code. Furthermore, around  69 per cent of the corporations of FTSE100 established a committee size of three to four members just meeting the minimum threshold of the standards; a cheaper option for corporations.  Nevertheless, the other majority have five to six members at 24 per cent, this has been consistent over many years for the FTSE100 corporations. However, there was a decrease in corporations with committees with  seven plus members, this being a costly upkeeping in having additional employees. Some corporations that did not specify the size of their audit committee, accounting for 1 per cent of the corporations of FTSE100 in 2016.

In my study, I have also included data for 2017 which currently incomplete for most of the organisations; this is completely understandable as the year is still in progress. Only 23 companies had their information available with all 23 corporations audit committee size disclosed and meeting the requirements of UK corporate governance code. Around 74 per cent of FTSE100 corporations audit committee had two to three members in their audit committee, this committee size was implemented by 17 of 23 corporations. However, the other six corporations had a committee size ranging from five to six members, this made up 26 per cent of the corporations. It is a confidence inducing sign that no corporation so far has withheld their information.

The other factor that I analysed in my study is regarding the number of meetings of audit committees for the FTSE100. The data collected revealed whether corporations abided to the UK corporate governance code requirements. The minimum requirements for public trade corporations is three meetings per year. In year 2012, all the corporations met the required minimum standard of three meetings, no company having just one or two meetings. However, in the data it is evident that 4 per cent of the corporations have not specified their number of meetings even though it is a requirement to disclose the information to be available to investors. Nevertheless, the majority of the corporations of FTSE100 in 2012 have had three to four meeting, this is understandable as it allows corporations to keep costs low. Another common number of meetings is five to six, this is preferable for the organisations that are more determinant on ensuring their investors, however, having more meetings does not guarantee better performance.

In 2013 some corporations changed their meeting structure to potentially enhance the performance of their corporation and establish integrity. Table 1 shows there is a decrease in three to four meetings in FTSE100 corporations, some of the companies move towards additional audit committee meetings within corporations. Analysing the data shows a 10 per cent increase from 34 per cent in 2012 to 44 per cent in 2013, this shows an inclination towards more meetings by organisations. However, the results also reveal a further change that organisations are  moving away from seven plus meetings; this option is likely a costly selection for organisations and less meetings would both suffice the standards and be economical beneficial. Another development for 2013 is that a larger share of corporations have disclosed their information regarding meetings of their audit committee with only two corporations withholding that information, in 2013 the corporations not adhering to the requirements halved from four in 2012 to two in 2013.

In 2014 Bloomberg data revealed further changes by the FTSE100 corporations regarding audit committee meetings. There is a continual decrease for the preceding two years in organisations with three to four meetings, by way of more corporations moving towards extra meetings for their audit committee. Its conceivably proving successful to organisations that have implemented those changes previously. An increase is seen with organisations  with seven plus meetings from 16 per cent in 2013 to 23 per cent in 2014, this indicates the advantage of having  more audit committee meetings as more organisations are  adopting that choice. However, there has been an insignificant decrease in five to six meetings for FTSE100 corporations in 2014, more organisations are shifting towards a seven plus meeting standpoint to reap more benefits. Most of the FTSE100 organisations adhered to the UK corporate governance code, two organisations did not specify their committee meeting for a second consecutive year.

For the year 2015 FTSE100 corporations audit committees have increased their number of meetings across the board. A slight increase in three to four meetings is revealed by the data for 2015, this is the first increase seen in the three to four meeting s section for the past three years. However, a reduction is shown in the five to six meetings as organisation, 41 per cent organisation had five to six meetings in 2014, it fell to 37 per cent in 2015 facing the greatest and only fall in the past three years. Furthermore, a continuous increase in the seven plus meeting is experienced with the FTSE100 organisations. Moreover, organisations that did not specify their audit committee meeting increased, it increased by a single organisation withholding their information which is a stage backwards in FTSE100 progression with abiding to UK corporate governance code.

Major improvements are revealed in 2016 for the FTSE100 corporations as more organisations are continuing to shift towards having more meetings. There is a continuous reduction in three to four meetings for audit committees; in 2015, 35 per cent of the organisations had three to four while in 2016 it fell to 32 per cent of the organisations. However, the FTSE100 has experienced a growth over four years in its five to six meetings segment for audit committees with most organisations within that category. Furthermore, the audit committees overall have increased year after year in its seven plus meetings segment as organisations are increasing meetings to improve the corporation’s performance. Organisations in the FTSE100 in 2016 had the most organisations disclosing their meeting information and abiding to UK corporate governance rule, only one organisation did not specify its audit committee meeting number.

In 2017 Bloomberg did not complete the data collected for the number of audit committee FTSE100 corporations, it’s understandable as the year still in progress and has not yet finished. The data of only 23 companies have been collected as the other organisations have not disclosed their information yet. Over 50 per cent of the organisations audit committee have around three to four meetings, as for 2016 five to six meeting was the most common. Around 34 per cent of the organisations had five to six meetings for their audit committee, and only 13 per cent of the organisations with seven plus meetings for their audit committee.  Furthermore, all companies abided by the UK corporate governance code by disclosing the information regarding the number of audit committee meetings they hold every year, not all organisations have revealed their information until now as the year is not complete.

Table 2

Listed company name MERL

(Year 2012)

RRS

(Year 2012)

RSA

 (Year 2012)

WTB

(Year 2012)

ITV

(Year 2014)

RTO

(Year 2014)

WPG

(Year 2015)

Size of Audit committee 4 2 4 6 2 2 3
Independent directors of audit committee 3 2 2 5 2 2 2
Independent audit committee chairperson No yes Yes yes Yes Yes Yes

A few other irregularities were differentiated from the results collected from the Bloomberg terminal. One of the organisations from the FTSE100, namely RSA insurance group, their indiscretion was found in the year 2012. The corporation’s audit committee was structured from four audit committee members, but two of the members in the committee were not independent as usually required in an audit committee. In some exceptions having independent members in an audit committee is acceptable to an extent if the independent members are a dominant force to achieve clarity. Half of the audit committee consists of non-independent members, this affects investor confidence as the integrity of independence is affected for the organisation. However, the structure of the RSA insurance group (RSA) does not abide by corporate governance code of the UK. Another organisation that came up with irregularities was Worldpay group (WPG) with indiscretion in its data on the Bloomberg terminal. This organisation data was not available for the years 2012 to 2014, their data was available from 2015 for their committee size being the only corporation missing data on their committee size for more than a year. However, the data on 2015 informs us that the committee size is three members, with only two members independent in the committee. By means of one of the directors is in the audit committee is permissible, although it is not recommended in this case as one-third of the members is not independent. However, in this case of WPG it is permitted so long as he’s not the chairperson of the audit committee. Another example of an acceptable audit committee structure is Whitebread (WPG) who had an audit committee size of six members, all members were independent except for one member. This an acceptable structure as majority of the organisations are independent members and the chairperson of the audit committee is independent.

Another corporation of the FTSE100, Randgold Resources (RRS) did not adhere to UK corporate governance code required by publicly listed companies to preserve investor confidence and avoid accounting scandals. Randgold Resources have an independent chairperson on their committee, implementing one of the many requirements of audit committee. Yet, their organization is structured from an audit committee size of two members, the minimum requirement for a public corporation is to consist of three members in its audit committee. Nevertheless, Randgold resources managed to structure their company on the following years with three members on their audit committee, further achieved to increase the minimum requirements for their audit committee to four in the year 2014 to 2016.  There were two other corporations that have not abided to the same rule of minimum required members in a committee in the FTSE100 in for the period I collected the data. Furthermore, the organizations were abiding by the corporate governance code after then diverging from the requirements. The two corporations are ITV and Rentokil Initial (RTO) as their audit committee also did not meet standards required for a minimum of three members in the audit committee. For both corporations on the year 2014 their audit committee was structured of two members respectively. Although ITV previous year 20113 had a committee size of four members, the committee was halved resulting in corporate governance code not withheld. As for the Rentokil Initial their audit committee was previously three members, removing the one member resulted in their commitment to the UK corporate governance code required from the corporation disregarded.

All public listed companies are required to abide to the UK corporate governance code, as previously stated. With regards to the data collected from Bloomberg, multiple irregularities were discovered with organizations not abiding to corporate governance code. In the UK audit committees are required to be independent, but there are a few exceptions for a non-independent member to be a part of the audit committee. If only one member is a non-independent member of the committee, and his role is suitably justified.

The data collected in Table 1 was analytically studied and seven corporations were separated mainly for not meeting the required standards of the UK corporate governance code. The three variables we collected were the size of the audit committee, independence of directors in the audit committee and independence of the chairperson of the audit committee.

One of the FTSE100 companies is Merlin Entertainments (MERL), who did not meet the requirements of the UK corporate governance code in the year 2012.  MERL corporations has a audit committee size of four members, but only three of the members in the audit committee are independent directors. However, there are certain exemptions with one non-independent director, but the non-independent director is the chairperson of the audit committee. UK Corporate governance code has not been adhered to by MERL corporation as the chairperson of the audit committee must be independent, yet the chairperson is not independent as revealed by the results from Bloomberg regarding the corporation MERL. Nevertheless, Merlin entertainment has restructured its company to implement an independent chairperson ensuring the organisation to recognize by the governance rules established.

 

 

 

 

Chapter 5: Conclusion

In this study, there is reference to past literature on the change of the audit committee requirements and financial reporting. This increased authority and independence in the decision-making for the audit committee. In conclusion, one of the most important requirements is for an audit committee to be independent. In this study, I have investigated the role of audit committees and the connection between an audit committees’ size and independence.  After analyzing the FTSE100 data collected from Bloomberg, findings have been made regarding the independence, size and meetings of audit committees. The findings in this study revealed that not all corporations abide by the requirements of the UK corporate governance code. Corporations do not suffer any repercussions from not abiding to the corporate governance laws set in the UK. There is a requirement for shareholders and board directors to monitor more of the audit committee independence, shareholders find out at the AGM. A system needs to be adapted to ensure that corporation’s audit committees re structured in a legal and UK corporate governance abiding manner. An internal corporate governance control system should be arranged to allow board directors and shareholders to ensure the independence of the audit committee members. The research made clear that various companies do not implement the requirements of the UK corporate governance on the independence of the audit committee. However, it was a rare occasion to have audit committees with non-independent members, but this was from a sample of the 100 majorly traded companies making up a fraction of the London stock market. Theoretically there are approximately 20 times the companies I analyzed and that would result in more companies not abiding to the UK corporate governance, so this is a major concern. Another factor is that the financial expertise of the members is not disclosed as it is a required for some members to be experienced.

Another concept researched in this study is the number of meetings of audit committee. UK corporate governance code has emphasized on the three minimum meeting requirement for corporation in the UK, after studying the FTSE100 majority of the organizations abide by the requirement. Corporations are moving towards more frequent meetings over the year. In previous studies, they found a positive correlation between the frequency of meetings and the amount of information disclosed. (Allegrini and Greco, 2013).  In the research, I also found that organizations were more likely to disclose information as the number of meetings increased. This shows there is a definite correlation between frequency of meeting and information disclosure. This must mean that the exchange of data is improved a and the monitoring of the information.  However, Allegrini (2013) informs us that there is no assurance that the audit committee members deliver effective supervision or exchange of data if the frequency of meetings increase. More meetings might result in the committee spending more time to communicate in-between the board of directors and shareholders.

Alternatively, in this research I studied the audit committee size requirements of UK corporate governance code. The minimum requirements of audit committee size are three member that are independent directors. For my research, I found that not all corporations abide by this governance code at certain years as it can be costly to hire and pay salary for three members.

“The audit committee meeting frequency also show a positive impact on the amount of information voluntarily disclosed”

 

 

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