A Comparison of the Role of External Auditors within Corporate Governance - Essay Example

A COMPARISON OF THE ROLE OF EXTERNAL AUDITORS WITHIN COPORATE GOVERNANCE Introduction External auditing has gained importance in the recent past in view of increased need of openness in corporate governance. Corporate governance is important in ensuring that there is overall openness in the running of the organisation. Increased incidences of conspiracy and corruption in the corporations have prompted the shareholders to rely on the service of external auditors. This paper will look at increasing role that is being played by external auditors in ensuring that there is transparency in cooperate governance of the organization. (Simunic 2000, p. 82) 1.1 What is the research issue The main issue of research is the role that it being played by the external auditors in ensuring that there is transparency in the corporate governance. External auditors have played an important role in organisation. Even in corporation which have been spending a lot of money in their internal auditing system, some have been found to be seeking for the service of external auditors. Therefore there is a question that is being raised on this emerging trend in auditing and the role that is being played by the external auditors in corporate governance. 1.2 Why is it an issue This trend of seeking the service of external auditors has grown to be an issue in corporate governance stemming from the understanding of trust that shareholders have on the board and the auditing system of the organization. In many instances, it is the board which is trusted with the everyday running of the organization and therefore it is expected that this board should be trusted even with the results of the internal auditors. But the recent trend in corporate governance has shown that there is an increased preference of external auditors as the main auditor for corporation and the internal auditors have been reduced to plying the second role in helping the external auditors in their work. It still remains an issue if organizations will be spending a lot of money in maintaining the internal auditing system and still incurs more cost in hiring external auditors. This means that either the corporation can decide to do away with internal auditing systems and continue with external auditing system. But is has also been realized that the use of the two system helps to ensure transparency in the auditing system and probably breaks a corruption chain that could be running in the corporation. 1.3 Why is it an issue now In the recent past, corporate governance has become a yardstick in attracting investors in a corporation. With the increased openness in running of corporations corporate governance is the most important aspect which determines how the shareholders have a say in the running of the organisation. The increasing globalisation is opening investment chances in the whole world and this has prompted increased need for openness in running of the corporations. This may be the main reason why organisation have preferred to use the services of external audits in order to show the degree of openness in the running of the organisation and therefore increase the chance of attracting more investors into the organization. 1.4 What could this research shed light on This research could give important information of the importance of using the service of the external auditors and the internal auditors in order to increase the level of transparency in the running of the organization. The research will shed light on the increased role that is being played by external auditors in corporate governance. Therefore it could explain the reason for increased preference of the service of external auditors in organizations. 2. Background The published financial statements have become an important tool for investors to make decision whether they are going to invest in an organization or not. The published financial statements are not only important to investors but also to creditors and other stakeholders who are interested in a corporation. They are important as they define the bases for capital allocation decision that are made by the board and therefore they can determine the future of the organization. (Groom 2002, p. 9) It has also been realized that there public perception of the credibility of the financial statements from a company have been influenced by the way they perceive the credibility of the auditing system. There have been many cases of Corporation in the world which have portrayed the wrong financial information about the performance of their companies and deceived the shareholders. For example the case of Enron which was seen as one of the most successful companies in the US only to be realized later that the auditing system has been giving the wrong financial performance in order to attract more investors. (Francis 2004, p. 70) Corporate governance is all about accountability and communication in the running of the corporation. In accountability, it means that those who are entrusted with the daily running of the corporate affairs who are the manager should be held accountable to the shareholders and other stakeholders. In communication, cooperate governance shows that there should be constant communication of the accountability to the whole world including the shareholders, the investors, the employees, their regulations and other stakeholders who have interest in the affairs of the organization. (Watts and Zimmerman, 1983, p. 24) There have been other cases where the internal audit system have colluded with the management board in siphoning funds from the corporation and later releasing wrong financial statements. These incidences have in general tainted the image of the internal auditing system and erosion of the shareholders confidence in the running of these corporations. It has been found out that there has been increasing preference to the service of the external auditors in the preparation of the financial statements even when organizations have an internal auditing system. This is a new emerging trend which has left us with many questions on the credibility and the general trust that the shareholders have on the board and the internal auditing system. (Singh 1997, p. 14) In most of the emerging markets and even in the developed market, corporate ownership has become the most important factor of consideration in investment decision. It has been found out that corporation which have shown a good recorded of corporate governance which is backed by good yearly returns have attracted more investors and therefore expanding their operations than corporation which have portray bad governance system. Cooperate governance has become the single most important tool in the overall management of organizations. However there is increasing conflicts between the controlling owners of these corporations and minority shareholders which is the case in most emerging markets. It has also been found that the conventional corporate control mechanism which have been put in place like board of directors and the increased takeover are ineffective in controlling such an agency problem. Therefore in search of a consistent method that can ensure continued control of the corporation by the owner and a degree of transparency to the minority shareholder have led to employment of different mechanisms including the use of external auditors. Therefore there is a need to look into the role that can be played by external auditors in ensuring that there is transparency in the running of the organization. This could help corporation to come up with a method that will decrease these conflicts. (DeFond, Jere and Wong 2000, p. 93) 3. Relevant Literature Auditing is one of the most important activities that are used to strengthen the process of governance. An effective auditing of a corporation is important in ensuring that there is efficient governance and raising the stakeholders trust in the management of an organization. In many of the emerging markets, it has been shown that the owner of many of the listed companies has remained a conflict between the owners and the minority shareholders. (Claessens et al., 2000, p. 5) Even in the diffusely owned corporations like in the US and UK, the problem of transparency in governance has been closely tied to the openness in the governance system. In most of the corporation which have minority shareholders like in the emerging market of Asian and African country, the problem of governance is usually associated with the concentrated ownership in that this ownership tries to control all the dealings of the organization and often colluded with management at the expense of the external investors. (Jensen and Meckling, 1976, p. 72) Corporate management theories have shown that an effective bonding and monitoring system can go a long way in ensuring that there is cohesion in the running of these corporations and therefore mitigate this problem of the control of the organization. This will in turn reduce the financial costs that the organization may be undergoing to stream line its operation. For example it has been seen that in most case common shares for these corporation are traded at discount in order to compensate for the expropriation risk which is burden on the minority shareholders. (Backman, 1999, p. 6; Eichenseher and Shields 1999, p. 38) One of the most important methods that have been found to effectively enhance bonding in organizations has been the hiring of independent external auditors in order to verify and testify the accuracy and the credibility of the prepared financial statements. Unlike in the established market, it has been argued that emerging markets have a weak corporate control system. They have not effective mechanism that can be used to protect the interest of the external investors apart from the controlling owners of these corporations. Therefore the external auditor can play in important role in corporate governance to act as a boding agency between the owners and the minority shareholders. (Shleifer and Vishny 1997, p. 87) However it has also become evident that external auditors cannot play the overall role of ensuring that there is transparency in the running of these corporations. For example a United Nations report questioned why Big Five auditors which were hired as auditors during the East Asia Crisis gave a clean bill of health for some of the large Asian companies and banks in their corporate governance system and the same companies and banks went under after few months of being audited (Rahman 1999, p. 5). The case of Enron and the way it portrayed that it was a profit making companies only to collapse in few months also questions the credibility of the external auditors to give credible financial statements. (Fan and Wong 2000, p. 85) There has also been a question of the use of internal audit system in the corporation and there relationship with the external auditors. Several studies have shown that internal auditor is reduced to merely plying the second role to the external auditors. The mere fact that their work has to be repeated again by external auditors may give them a feeling that they are not likely to be trusted with the running of the organization and therefore most of them are not likely to take their work seriously. (Craswell, Jere and Taylor 1995, p. 40) Therefore hiring external auditor can act as a bonding mechanism between the owner of the firm and minority shareholders but at the same time it is likely to erode the trust of self confidence of the management and the internal auditors. There is need to carry out a systematic research in order to understand the main role that is played the external auditors in corporate governance to understand if at they can reduce corporate control conflicts and increase transparency. (Joseph 2001, p. 87; Porta, Florencio and Andrei 1999, p. 20) 4. Research question and objectives In order to carry out an effective inquiry into the topic, the research will set certain objectives which will be important in helping the study to collected valid data. The main objective of the study will be to look into the role that is played by the external auditor in enhancing corporate governance in organizations. In this broad objective, the study will also look into the specific ways that external auditors have been acting as bonding agencies for the various conflict groups in corporate governance. Therefore the main objectives that will help the study to attain its overall goal include the following: To investigate the important of corporate governance in organization controlled by owners with a minority shareholders To investigate the role the potential cause of conflicts in these organization as far as auditing of the corporations is concerned To investigate the role that is played by the external editors on corporate governance and as a bonding mechanism between the conflicting groups To investigate the relationship between the external auditors and the internal auditors in the corporations where the service of the external auditors are used. These objectives will be important in ensuring that the study explores the whole subject of the role that is played by the external auditors in corporate governance. This study begins by understanding the important of corporate governance in such organization and potential cause of conflicts in these organizations. Then it will look at the role that external auditors can play to validate the financial statements and therefore act as a bonding agency between the owners of these corporation and the minority shareholders. Then it will look at the chances of an effective collaboration between eh internal auditors and the external auditors and the effect of the work of the external auditors on internal auditors. These are important research question that are likely to help the research to carry out an effective research in the overall trend in auditing. These objectives are expected to guide the study in the inquisitive process. They will also assist the research to relate the various aspects of the study in order to come up with the final process. The study will therefore aim at answering important research question which will ensure the systematic inquiry into the subject. The following will be the main research questions that the study will aim at answering: 1. What is the importance of corporate governance in a corporation 2. What is the importance of auditing in these corporations 3. How can auditing enhance corporate governance and how can it be a cause of conflict 4. Can external auditors resolve auditing conflict in these corporations 5. Can external auditors play the role of a boding agency in these corporations and therefore minimize conflicts and increase corporate governance 6. How does the hiring of external auditors interfere with the functioning of the internal auditors These research questions will help the research to answer the important questions in the study. They will assist the research objectives to inquire about the subject in a procedural manner as they will build up from one fact to the next and at the end relate them together. They will assist the research to inquire about the subject in a stepwise manner such that by the end of the study the research will have exhausted the important factors that relate to the study. The research question will look into each objective which will later build up to the final aim of the research. 5. Research design and methodology Methodology is an important part of any research process. The methodology is the backbone of any research since it determines the way the whole research is to be formulated an implemented. The mythology determines how the research wills collect and analyse the data and the choice of sample. Research methodology is the overall approach the research and it gives the meaning to the research process. It will help to answer important question like why the data was collected, the method of data collection use, where and how the data was collected and other important details which validate the research process. Therefore it is that systematic data collection approach which helps to obtain important information from the collected data. It is through the methodology that the research builds up on the process that will be followed in the research. The research process cannot be complete neither can't it be carried out effectively in case the research uses the wrong methodology. Therefore the research methodology is the most important factor that determines who the research process will be carried out. The research methodology will also give validity to the data collection process that is used. Right from the beginning of the data collection process, the research should take the correct approach in the methodology used. Therefore it determines the validity of the data collection process and the data collected in general. These researches will employee the following methodology in order to carry out an effective data collection and analysis process; 5.1 Research design The research design is an important part in any research process. A research design encompasses the research strategy, the data collection methods to be used and the data analysis process. The research is therefore important since it forms an important bridge between the research questions and the data that is to be collected. The research design is the overall guide in the data collection process. The research design determines how the research approaches the data collection process. It lays out the data collection procedure in the right manner. The research design can be taken as the engine that drives the whole process. It gives important guidelines that ought to be followed in the data collection and data analyses process. The research design should therefore be chosen according to the kind of research that is being carried. It will also take into consideration the ethical decision that will have to be made in the research process. For example when carrying out research among the human subjects, it is unethical to use the experimental research design. Therefore the research design is one of the most important factors that guide the whole research. This research will be qualitative management social research. It will aim at collecting qualitative data to be analysed for the study. Therefore this research will use the survey type of research design. A survey research design will be most suited for this study since it will give important chance for the research to compared different source of data. A survey which involves data collection from multiple subjects which are not subjected to experimental research w will therefore help the study to collect data from the selected subjects and give it the independence of selecting the participants for the study. This study will select a case study of the emerging markets in the world. It will select the case study of the emerging East Asia market which has been faced by continuous corporate control conflict. The East Asia market presents an important case study for this research since they are faced with the problem that the research is going to look at. Also there are few studies which have been carried out in the East Asia markets and therefore this study is expecting to make important contribution to the corporate management process in these countries. A case study has been selected since it is less time consuming and provides a chance to carry out analysis study which can give important issue to be focused on. 5.2 Methods for data collection The data collection method gives out the specific details in which the data collection process will be carried out. Data collection method is therefore the specific way in which the research will go to the filed and collect the raw data from which information for the study will be refined. The data collecting method is important in the research process as it determines the specific way in which the research process will be validated. The data collection method has to be suited to the research design in order to collect valid data. This study will carry out a case study in which data will be collected from a number of corporations in the East Asia market which have been using the services of hired external auditors. Therefore it will look into the various data that have been collected in these corporations and make a comparison. Therefore the data collection method will involve the selection of the specific organization from which the data will be collected. These organizations will be collected at random from the various corporations. A random sample selection procedure will be used in the selection process in order to ensure that there is no bias in the data collection process. The method that twill be mainly involved in the data collection process will be an analysis of all the past materials that will have been gathered for the study. This will be a deep analysis which will also look at linking the various materials as gathered and determining their validity before using them in the study. 5.3 Methods to be used and reasons The research will select 5 corporations from which this research will be carried out. The five corporations have been chosen due to the time frame that is available for the study. The five corporations will also be selected on the base of their transparency and access to their financial information and other corporate governance issue. The study has also narrowed to a small sample size in order to ensure that the research process will be carried out effectively and there will be maximum concentration on the research issues to be addressed. From the five corporations, the research will then access their financial statements and the corporate governance issue that have been witnessed in the organization and therefore make a comparison from this data. The method to be used will be merely an analysis of the information data and comparing it with the corporate governance standards in these organizations. The stud will then look at the progress these corporations have made in their corporate governance endeavours and effect of hiring external auditors. From the performance of these corporations on corporate governance, the study can therefore make important conclusions into the role of the external auditors on corporate governance in these organizations. 5.4 Specific methods of data collection On the specific method that will be used in collecting data for the study, secondary information will be used for the study. Secondary information has been selected as the most appropriate method to use based on the fact that it can give information on what has been happening in the organization for a long time. This study does not look at spontaneous role of the external auditors but it is evaluating the process of use of external auditors and how this has affected the functioning of corporate governance and the work of internal auditor. Therefore it will look at the use of external auditors and the effects this has over the time. The use of secondary information will help the study to track the turn of events in these corporations for the time they have been hiring the services of an external auditor and the specific effects it has had on their management. In this case the study will look at various secondary source of information regarding these organizations. The study will look at the various financial statements for these organizations and track it over time. The study will also use source from the studies that has been carried out previously on the issue and government releases on corporate governance in East Asia market. It will also use other source from international bodies which have relevant information regarding corporate governance in East Asia markets. 6. Time-scale The time scale for the study is very important in any research process as it determines the overall viability of the study. The time scale determines whether the time available will be enough to carry out the study or if the study will need additional time. The time scale is also important in scheduling the exact period that certain even in the research process will be carried out. This schedule is important as it helps the researcher to prepare well for the research activities. It is imperative that that researcher give tentative time period within which the research process will be completed. This study will take four months to carry out. It is expected that within this time frame, the research will have identified the sample that are to be used for the study. It will also have contacted these corporations and enquired to be given permission to access their financial information and any other informant that is needed. Since the study will not use primary data collection method in which there are likely to be delays due to booking of interviews, it is expected that it will finish the scheduled data collection process in time. The following is the time table that will be used for the research process: Activity September October November December Research preparation xxx Selection and enquiring of permission to carry out research in corporations xxx Data collection process xxx xxx Data analysis process xxx Data presentation xxx From the above time table it is evident that the research process is very viable. It is also evident that the data collection and day analyses process will take most time in the study although this is just an estimate. If the research will get an early access to all the data sources needed fro the study, the whole research can be completed in much less time than what has been indicated here. The research will be looking at completing the whole process before the end of December so at to give the research time to go over the study again. This time scale shows that the research can be adequately carried out as had been planned. There is a high probability that the research will even be completed before the scheduled time. Therefore according to his time scale plan the research process will be expected to be completed before the deadline and give the researcher time to go over the whole process again. 7. Resources The source for the data will entirely be secondary information. Therefore the study will be looking at sourcing for the relevant information about the selected corporations from the financial statements which have been presented in these corporations. The study will concentrate on the financial inform for the corporations in the last ten years in order to trace the changes that have been taking place in corporate governance of these corporations and understand how it has been affected by the use of external auditors. A 10 year period will also be important in tracing the changing corporate governance landscape in view of the conflicts that have erupted and how they have been resolved. The important source for this study will include the companies financial information, government industrial release on corporate governance in the East Asia market, OECD publication on the role of external auditing in the East Asia market corporations, the past studies which have been carried out about the issue of corporate governance in these markets, and other important source which can give relevant information about these corporations. However the company financial statements and government publications will be taken as important primary sources of data for the study. It is expected that there will be less problems encountered in the collection of data from these sources. This is because the study will only select companies which have ample data that can be analysed. The study will also select corporation which have been existing for more than 10 years which means they have been recording all the changes taking place in their managements. This means that the study will be faced with fewer challenges in locating the relevant data fro the study since the selected case studies will have all the necessary data. Therefore the availability of enough secondary information about the corporations will be the main selection criteria that will be applied by the study. However if the study meets such a limitation it will be likely to make a prompt decision to cover for such deficiencies in case it fails to get the needed material, then it will be left with not other option other than selection of another corporation to be used in the research process. 8. Access to study population The study population for the research will the corporations in the East Asian market which have minority shareholders. There are many corporations in the region and that is why the study has tried to narrow them down to only those which can give the most relevant information for the study. Therefore the selection process will ensure that the corporation selection will be there for the study. Since the selection process will be carried out with an outlook of the all the cooperation in the region, it is expected that there will be enough samples for the study. The research will also try to look at the corporations which have a history of corporate governance conflict or which have employed the services of external auditors to verify data which may have caused ownership conflict in the auditing process. Therefore it is expected that the study will have access to the study population. The first selection criteria will be the availability of a historical corporate governance data in these corporations. This will then be used in the inclusion and exclusion criteria. In order to get to the data from the selected organization, the study is expecting that it will enquire for particular information from the selected organization. But there is also enough information on the website about these corporations and also from other sources. Therefore the study is expected to compare the different sources of information collected in order to validate it. However it is expected that the study may find some difficulties in reaching this information. It is possible that most organization may not release all their corporate information in their websites. There is that particular information especially which may portray the negative aspect of these corporations which may not be released. Therefore the study will be aiming at collecting all the necessary information from these organizations. The information that cannot be obtained from these organisation will probably be obtained from other sources like the government print outs. However in order to do avoid the restriction to access the information from these sources, the study will ask for permission to carry out the study from the organization which means that if the corporations accept, then they will be willing to release all the necessary information needed for the study. This means that there will be less chances of the study lacking the important information that will be needed for the study. Right from the start the study will ensure that it will be easy to access all the needed information about the cooperation which will be selected for the study. Reference Backman, M. 1999, Exposing the Dark Side of Business in Asia, John Wiley & Sons Claessens, S, Simeon, D. Josephy, F. & Larry, H 2000, Financial Crisis, Geneva, Switzerland Craswell, A., Jere, F., & Taylor, S 1995, Auditor reputations in the industry, Journal of Accounting and Economics, Vol. 20 DeFond, M., Jere, F., & Wong, T. 2000, Auditing evidence from Hong Kong, Auditing Journal of Practice and Theory, Vol. 5 Eichenseher, J. & Shields, D 1999, Corporate Capital Structure and Auditing, Advances in Accounting, Vol. 2. Fan, J., & Wong, T 2000, Corporate Ownership Structure and conflicts in East Asia, Hong Kong University of Science & Technology. 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