The Fraud-Governance Linkage and Audit - Research Paper Example

The Fraud-Governance Linkage and Audit Introduction The paper explores topics in corporate governance, the fraud-governance linkage, and audit committee effectiveness. Recently, there has been revamped interest in the corporate governance, especially in the arena of accountability owing to the high-profile accounting fraud cases that rocked leading corporations. Public and political interests in corporate governance can be said to thrive in times of corporate scandals. The corporate scandals that rocked Enron Corporation and WorldCom heightened questions on the integrity and reliability of corporate governance. Background Corporate governance refers to set systems, principles, and processes through which companies are directed and controlled. Corporate governance encompasses regulatory and market mechanisms and goals on which a company is governed. Corporate governance also highlights the roles and responsibilities of stakeholders such as an organization’s management, board of directors, shareholders, and other stakeholders. Corporate governance avails guidelines centering on the way in which corporations should be governed in order to attain its goals and objectives, as well risk monitoring and assessment and performance optimization (Carcello, Hermanson and Ye 2). One of the outstanding themes of corporate governance revolves around the nature and extent of accountability required of persons running corporations, and mechanisms fashioned at decreasing principal-agent challenge to minimize managerial opportunism. Achieving Effective Corporate Governance Corporations operate in a legal environment and are subject to laws and regulations of a certain jurisdiction. Organizations also have a constitution that avails individual rules that govern the Corporation and sanction or constrain its operations or decision making. There are codes and guidelines that oversee corporate governance cover a broad array of categories. These include auditing, corporate responsibility and compliance, board and management structure, financial transparency and information disclosure. Corporations pursue and maintain an effective system that facilitates continuous enhancement in relation to strategy, performance, compliance, and accountability (Carcello, Hermanson and Ye 3). Effective corporate governance can be achieved when the board of directors strictly embodies the interests of shareholders. In exercising their duty of trustees, the board of directors should review, challenge, and oversee the corporation’s business strategy and its effectiveness. Stakeholders should be well informed, engaged and willing to challenge each other. Parties involved in Corporate Governance The most prominent parties engaged in corporate governance incorporate government agencies and authorities, management (encompasses board of directors), Chief Executive Officer, shareholders, auditors, and other executives such as line mangers, lenders, suppliers, employees, creditors, clients, and the community. Corporate governance mechanisms encompass systems of controls directed at aligning the interests of the managers with those of shareholders. The directors, employees, and management expect to draw benefits and reputation, as well as remuneration from the corporation, while the investors expect to draw financial returns from the Corporation. Lenders, on the other hand, expect specified interest payments, dividend distributions, or capital gains on their investment. The organization’s clients concern centre on certainty in the provision of desired goods and services, which meet proper quality; the concerns of the suppliers revolve around compensation for their goods or services, and probable continuity in the trading relationship with the Corporation. The board is entrusted with playing a critical role in corporate governance. The board is mandated to endorse the corporation’s strategy as well as shaping a directional policy. Moreover, the board is expected to appoint and supervise senior executives while ensuring accountability of the corporation to investors and government agencies (Abbot, Parker and Peters 70). Principles of Corporate Governance Corporate governance is grounded in principles such as conducting business with integrity and fairness, transparency in regard to transactions, making all the obligatory disclosures and decisions, abide by all the laws of the land, accountability and responsibility towards all the stakeholders, and dedication to conducting business in an open and ethical manner. The chief elements of robust corporate governance include honesty, openness, performance orientation, trust and integrity, responsibility and accountability, mutual respect, and commitment to the organization (Carcello, Hermanson and Ye 2). Rights and Equitable Treatment of Shareholders Corporations should exhibit respect for the rights of shareholders as well as aid the shareholders to exercise the said rights. Corporations should aid the shareholders in exercising their rights via openly and effectively communicating information. Integrity and Ethical Behavior Integrity should be one of the critical requirements when choosing corporate officers and the board members. In addition, corporations should also develop a code of conduct for both the directors and executives so as to ensure that the parties make ethical and responsible decisions. Disclosure and Transparency One of the overriding goals of corporate governance revolve around clarifying and making public the roles and responsibilities of both the management and the board of directors; this avails stakeholders with an acceptable level of accountability. The disclosure of substantial matters regarding the organizations should be timely and balanced in order to ensure that every investor accesses concise and factual information. Mechanisms and Controls Corporate governance mechanisms and controls are devised to minimize the inefficiencies that emanate from moral hazard and adverse decisions. Some of the internal governance controls include monitoring by the board of directors, balance of power, internal control procedures and internal auditors, remuneration, monitoring by large shareholders or creditors. External, corporate governance controls include debt covenants, competition, seeking assessment information centering on performance such as financial statements, government regulations, media pressure, and takeovers (Beasley 316). Companies should show commitment to ethical behavior in business strategy, operations, and culture. In today’s globalized and interconnected world, investors, creditors, and other stakeholders should exhibit environmental, social, and governance sensitivities, as it is integral to the company’s performance and long-term sustainability. Some of the characteristics of effective corporate governance encompass transparency, responsibility, fairness, independence, social responsibility, and accountability (Beasley 442). Fraud-Governance Linkage Corporate governance has a phenomenal impact on how organizations are run. Corporate governance can be employed to deter fraudulent activities and promote transparency policy. In most cases, firms that manifest instances of restating their financial reports have a low likelihood to have an effective corporate governance structure. For instance, research done in this area indicates a negative correlation between financial restatement and audit committee independence and committee diligence. There is a linkage between corporate governance strength and fraudulent financial reporting whereby strong corporate governance enhances the integrity of financial reporting, lowering incidences of fraud (Beasley 444). The Link between Sound Corporate Governance and fraud Risk Most of the corporate scandals involving accounting fraud indicate a collective failure of corporate governance mechanisms in detecting financial misreporting, accounting fraud, and manipulated earnings. The presence of valuable corporate governance mechanism such as audit committee and internal control structure aids to put off managers from committing fraud owing to an enhanced probability of detection, as well as facilitating monitoring process (Beasley 446). Strong corporate governance enhances the ability of a company in using its resources, strategies, and directions in the best manner possible, and lowers the probability of corporate reporting failure. The genesis and development of accounting fraud is heavily influenced by the company’s regulatory and control systems, especially independence of the auditor from management. Corporate fraud can be deterred by sound corporate governance. Poor corporate governance contributes to the emergence and proliferation of accounting fraud and may neutralize the ability of auditors to prevent or expose fraud. Thus, weak corporate governance has an inclination towards heightening fraud risk. Studies probing the relationship between corporate governance and fraud risk indicate that strong corporate governance structure is inversely related to the occurrence of fraudulent reporting. Audit Committee Effectiveness The audit committee has an essential oversight over financial reporting risks and internal financial controls. Enhancing audit committee effectiveness in overseeing Corporation fraud-related risks requires the creation and maintenance of a culture of honesty, and enviable ethical standards, and implementation of suitable controls directed at preventing, deterring, and detecting fraud (Gendron, Be’dard and Gosselin 152). Effective Audit Committee efficiency translates to fulfillment of the committee oversight responsibilities. Studies indicate that there is a casual relationship between Audit Committee attributes and effectiveness (Archambeault, DeZoort and Hermanson 966). An effective Audit Committee exhibits the characteristics of accountability, effectiveness, and objectivity. The committee should comprise of qualified members with the authority and resources necessary to protect shareholder’s interest by ensuring reliable financial reporting, internal controls, and risk management (Abbot, Parker and Peters 69). An effective Audit Committee should have a strong likelihood to detection of fraud within the company. Audit Committee related disclosure and reporting is a critical module for evaluating the effectiveness of the audit committee function. Significance of an Effective Audit Committee A sound Audit Committee has a positive effect on the quality of financial disclosure. Empirical researches indicate a positive correlation between Audit Committee and the quality of financial information. A functioning Audit Committee heralds improvement of corporate, financial reporting and a reduction of earnings management or financial frauds, as well as a boost in unqualified auditor reports. Existence of Audit Committee leads to reduction of errors and irregularities in financial statements, which enhances the credibility of financial reporting (Gendron, Be’dard and Gosselin 153). Conclusion The global financial crisis has heightened the significance of corporate governance, especially in availing well-versed strategic direction and engaging oversight that goes beyond mere short-term financial performance. The economic health of an organization depends heavily on how sound and ethical the businesses are run. Sound corporate governance enables a company to gain competitive advantage, as it enhances the ability of companies to address fraud risks comprehensively. Corporate governance enhances the capability to enhance operational and market results, which is reflected by enhanced profitability, relative stock prices and liquidity, and minimized cost of capital. It is essential that companies promote enhanced transparency and disclosure within the corporate sector in order to minimize incidences of accounting fraud and disputes within the Corporation. Works Cited Abbot, Lawrence, Parker Susan, and Peters, Gary. “Audit Committee Characteristics and Restatements.” Auditing: A Journal of Practice & Theory 23.1 (2004): 69-87. Print. Archambeault, Deborah, DeZoort, Todd, and Hermanson, Dana “Audit Committee Incentive Compensation and Accounting Restatements.” Audit Committee Incentive Compensation and Accounting Restatements.” Contemporary Accounting Research 25.4 (2008): 965-992. Print. Beasley, Mark. “An Empirical Analysis of the Relation Between the Board of Director Composition and Financial Statement Fraud.” The Accounting Review 71.4 (1996): 443-465. Print. Carcello, Joseph, Hermanson, Dana, and Ye Zhongxia. “Corporate Governance Research in Accounting and Auditing: Insights, Practice Implications, and Future Research Directions.” Auditing: A Journal of Practice & Theory 30.3 (2011): 1-31. Print. Gendron, Yves, Be’dard, Jean, and Gosselin Maurice. “Getting Inside the Black Box: A Field Study of Practices in “Effective” Audit Committees.” Auditing: A Journal of Practice & Theory 23.1 (2004): 153-171. Print. Read More