Question

Making explicit reference to relevant academic literature, discuss the role of corporate disclosure and external audit in corporate governance.

Answer 1

A) Role of corporate disclosure:

1. The board approves corporate strategies that are intended to build sustainable long-term value; selects a chief executive officer (CEO); oversees the CEO and senior management in operating the company’s business, including allocating capital for long-term growth and assessing and managing risks; and sets the “tone at the top” for ethical conduct.
2. Management develops and implements corporate strategy and operates the company’s business under the board’s oversight, with the goal of producing sustainable long-term value creation.
3. Management, under the oversight of the board and its audit committee, produces financial statements that fairly present the company’s financial condition and results of operations and makes the timely disclosures investors need to assess the financial and business soundness and risks of the company.
4. The audit committee of the board retains and manages the relationship with the outside auditor, oversees the company’s annual financial statement audit and internal controls over financial reporting, and oversees the company’s risk management and compliance programs.
5. The nominating/corporate governance committee of the board plays a leadership role in shaping the corporate governance of the company, strives to build an engaged and diverse board whose composition is appropriate in light of the company’s needs and strategy, and actively conducts succession planning for the board.
6. The compensation committee of the board develops an executive compensation philosophy, adopts and oversees the implementation of compensation policies that fit within its philosophy, designs compensation packages for the CEO and senior management to incentivize the creation of long-term value, and develops meaningful goals for performance-based compensation that support the company’s long-term value creation strategy.
7. The board and management should engage with long-term shareholders on issues and concerns that are of widespread interest to them and that affect the company’s long-term value creation. Shareholders that engage with the board and management in a manner that may affect corporate decision making or strategies are encouraged to disclose appropriate identifying information and to assume some accountability for the long-term interests of the company and its shareholders as a whole. As part of this responsibility, shareholders should recognize that the board must continually weigh both short-term and long-term uses of capital when determining how to allocate it in a way that is most beneficial to shareholders and to building long-term value.
8. In making decisions, the board may consider the interests of all of the company’s constituencies, including stakeholders such as employees, customers, suppliers and the community in which the company does business, when doing so contributes in a direct and meaningful way to building long-term value creation.

Some evidence demonstrate that governance codes can be viewed as mechanisms facilitating governance convergence across countries. Such convergence is the result of several external forces among which the most powerful are globalization, market liberalization and influential foreign investors. Namely, globalization, the internalization of markets and deregulation have led to rapid changes in traditionally grounded models of corporate governance . These external forces ‘lead to pressure on national governments, institutions and companies, to conform to internationally accepted best practices of corporate governance at the international level, thereby influencing the attractiveness of countries and companies for foreign investors. Countries that are more exposed to other national economic systems experience greater pressure to change governance practice not only to improve efficiency of domestic companies but also ‘to harmonize the national corporate governance system with international best practices.

Several research findings on corporate governance codes revealed the governance convergence towards the Anglo-Saxon model (i.e. shareholder model). Governance codes, which are more in line with the Anglo-Saxon model, can be found not only in the established European economies but also in emerging economies . The explanation for this convergence may lay in the efforts of transnational organizations (e.g. the World Bank and the OECD) to promote those global standards of corporate governance that are more in line with Anglo-Saxon model . The European Commission (EC) also encourages the convergence of governance practice in European countries by issuing recommendations in the area of corporate governance. According to Cromme, the governance guidelines at the European level are highly aligned with the country codes. This can be due to the fact that certain governance issues (e.g. stakeholders rights and responsibilities) have been taken more seriously in countries of Continental Europe since ‘their former weak capital markets are strengthened and institutional investors become more assertive in promoting more effective governance measures such as higher accountability and better disclosure’  claim that the introduction and the contents of governance codes of the Eastern European countries were the result of external pressure in terms of the EC corporate governance recommendations. The codes in these countries were largely determined by the demands that resulted from the EU accession process; many contents of the codes were also more or less copied from the UK and the USA codes. However, based on the research results on the comparison of the codes contents of the Eastern European countries, which are the EU member states, Hermes claim that domestic forces (e.g. the extent of enterprise restructuring, large-scale privatization and stock market development) in some of the analysed countries played an important role in shaping the codes’ content.

Several scholars raised doubt about ‘one size fits all’ corporate governance regulations. It is highly unlikely that a single set of best practices exist for all companies since corporate governance is a very complex and dynamic system and not all mechanisms may work well in all governance contexts . The corporate governance practices and regulations should reflect particularities of companies’ ownership and control structures that differ across countries and industries and determine the type and severity of agency costs .

B) Role of External audit in corporate governance:

Represent Interest of Shareholders:

One of the primary roles of external auditors in corporate governance is protecting the interests of shareholders. This is possible because external audition reports are conducted independent of the company’s influence. External auditors report the state of a company's finance and attest to the validity of financial reports that may have been released. They ensure that the board receives accurate and reliable information. The board may also question the auditors' views and assessment on the appropriateness of the accounting principles used by a company.

Promote Accountability:

External auditors may introduce measures and policies designed to compel accountability in the workplace. For instance, auditors could recommend penalties for officers who manipulate financial statements by inflating figures or cooking accounting numbers. Penalties for such acts could include stripping the manager of his position or his compensation, such as reducing annual bonuses, and even pensions.

Risk Assessment and Mitigation Planning:

External auditors help promote corporate governance by conducting period risk assessment. Auditors review the security measures that a company has in place against corporate fraud or corruption. In addition to assessing potential risks, auditors also analyze the overall risk tolerance of the company as well as the efforts the company has made toward mitigating risks. For instance, if a company or government agency has an under-performing whistleblower system, efforts may be made to improve this.

Crisis Management:

External auditors can help ensure good corporate governance by developing efficient crisis-management plans to be used in the event of allegations of fraud or corruption. The plan typically involves assigning responsibilities to different administrative officials. This way, if the company becomes involved in a financial crisis, officials have an active plan that they can use in sustaining confidence among investors. Crisis-management plans may also include control measures that are to be used with the media and law-enforcement officials.

Maintain Strong Relationship with Regulators:

The efforts of an external auditor help foster a good relationship with regulators. Most regulators are supportive of companies and agencies that appear to have transparent operations. External auditors evaluate the organization of a company for compliance with regulations. Regulators are also more likely to trust company disclosures after an auditor attests to them.