The Role of Audit Committees in the Corporate Governance Environment - Research Proposal Example

THE ROLE OF AUDIT COMMITTEES IN THE CORPORATE GOVERNANCE ENVIRONMENT AND ITS EFFECT ON THE FINANCIAL REPORTING QUALITY WITHIN THE SAUDI BUSINESS ENVIRONMENT SERAJ HAMED BAHRAWE KINGDOM OF SAUDI ARABIA ADMINISTRATION AND FINANCE COLLEGE ALBAHA UNIVERSITY INTRODUCTION The worldwide current economic crisis has given rise to a number of issues, which have international attention increase. The world has witnessed economic crunch and collapse in the markets and economies of many countries. Further more due to the crisis a number of international companies have collapsed, which influenced the international economy, and ultimately loss of shareholder investments such as reducing extra shares from the organization or poor participation of the company in stock markets. The scandal of the companies was not the last, which followed by series of consequences in the capital markets including managerial, and accounting corruption or weakness of the internal control systems panel on activities of the financial institutions. Based on the above the global economy has witnessed the introduction of new terminology namely Corporate Governance to detect the weakness in the companies’ control. The concept of the Corporate Governance has been developed to direct the management and business inside and outside the company. The Corporate Governance function enables the company to ensure the existence of efficient systems, sets out responsibilities and duties of the board of directors’ members and the executive management of the company, considering that interest of the shareholders irrespective of their shareholding and the interests of the different stakeholders in the company should be protected (Menon and Joanne1997, p 564). The responsibility of the Corporate Governance is maintaining interest such genuine management of resources and engaging in environmental awareness of the shareholders and achieve fairness among them, strengthening the role of disclosure and transparency, and reiterate role of the management. The laws and regulatory policies of the business in the Kingdom of Saudi Arabia have not given considerable attention to the concept of the Corporate Governance, except after the crisis of the Saudi Stock Exchange which took place in the second half of the year 2006 particularly 1/7/2006. In light of the flourished Saudi economy due to oil price soaring and availability of the cash along with the loans borrowing from the banks, individuals began to speculate in shares through availing loans from the banks and not from their own savings. Lack of transparencies in the market, misleading rumors, weakness of control from the Capital Market Authority and management of company’s speculations on the poor companies in terms of the financial position have increased (Ian and William 2005, p 65). As a result, the market rate of the companies programmed in the Saudi Stock Exchange unjustifiably has increased which resulted extreme decrease causing loss of 52% of the market value. Subsequently the Capital Market Authority has issued a series of legislations to implement the governance practices. The Capital Market Authority has issued a resolution on 21/10/1427H corresponding to 12/11/2007 introducing the final copy the bylaws including (24) guidelines to ensure transparency of the financial reporting for the Joint Stock Companies in the Saudi Stock Exchange. 1(A scientific study has shown that most of the companies listed in the Saudi Stock Exchange do not abide by 50% of the Corporate Governance policy developed by the Capital Market Authority, which included the requirements of the transparency. The study covered 20 leading companies with capital exceeding SR 128 Billion (US$ 35 Billion). The study concluded that the application rate of the policy by these companies varies on a yearly basis. LITERATURE REVIEW This section introduces previous researches and studies relating to the research topic, which were conducted by other researchers. The researcher will discuss and analyze the most significant previous studies in the area of Audit Committees and Corporate Governance together with the role of those committees in quality of the financial statements (Vinten and Lee 1993, p 786). The research will highlight briefly the main objective of each study along with the conclusions thereto. The researcher further would like to confirm that discussion of the previous studies aims at analyzing them for the purpose and objective of the research and not for the historical presentation purposes. According to Alsaga (1995), the article discusses the audit committee effectiveness as being one of the problems associated with the formation of the audit committees. The study has also focused on the evaluation for the requirements of control and audit environment in Saudi Arabia. The study further has discussed the development of a conceptual introduction to measure and improve the effectiveness of audit committees in the Saudi Arabian Joint Stock Companies. The study concluded that the control and audit environment in the Kingdom of Saudi Arabia required audit committees based on three factors (1) to make use of previous experience of other countries (2) Capability of audit committees to encounter the practical problems for the auditor (3) Completion of professional development. The study further provided introductory proposal to measure the audit committee effectiveness in order to link between formation of an audit committee, and necessity of completing the audit process in accordance with audit standards. Another researcher, Alwabil (1996), imply that the practical application of the audit committees in the Saudi Arabian Joint Stock Companies and its effectiveness and the factors thereto. The study covered the related parties, namely members of the audit committees, chartered accountants and internal auditors in the joint stock companies in order to identify the factors boosting the effectiveness of the audit committees within the audit and control environment of the Kingdom of Saudi Arabia. Similarly, the study identified the possible development aspects to increase the effectiveness of the committee’s role. The study has concluded the following: With respect to the first factor (membership and meetings of the audit committees), the formation of the audit committee from the shareholders and non executive board members will provide independence for the audit committees and, therefore, materialize effectiveness of the committee which conforms to the Ministerial Resolution No. (903). A written policy should be prepared set out objective, role, responsibility and powers of the committee. Provision of the sufficient resources and the adequate powers to enable the committee to carry out the responsibility (these two factors have influence on the usefulness of the audit committees). With respect to the second factor (role and responsibility of the audit committees), a number of factors are considered vital to achieve effectiveness of the audit committees including compliance with the Companies Regulations, review of the internal and external audit outcome and follow up of the recommendations. The factors also include the proper liaison between the internal and external auditors. Determining of the audit fees, independence of the auditors and supervising the financial report process. Additionally, the study includes such aspects as supporting the independence of the internal auditors and evaluating audit plan of the external auditor. Approval of any changes in the accounting policy or disclosure or accounting presentation and reporting on the conflict of interest were also reviewed as factors from the study. Lastly, reviewing and assessing the internal audit systems, evaluating performance of the finance management together with the internal and external auditors, and reviewing the plans pertaining to the internal and external audit. With respect to the third factor (qualifications and background of the audit committees) includes understanding of the audit committee chairperson and members for the principles and roles pertinent to the financial report, financial control and information systems, and awareness of the audit procedures. With respect to the fourth factor (due care of the audit committees), a number of factors are considered vital to achieve effectiveness of the audit committees including business relation level, cooperation between the audit committee and the internal audit, evaluation of the external auditor performance. Furthermore, meetings between the audit committee and the external auditors’ should be open. Evaluate follow up of management for the weakness reported in the management letter sent by the external auditor, capability of the audit committee members to present, evaluate and settle the problems support by the assessment committee to the internal audit department. Adequacy of the training provided to the audit committee members with respect to responsibilities assigned to them. Review of the interim and audited financial statements, review of the scope and activities of the external audit together with the analysis thereto. Review of the sufficiency and competence of the ICS of the company together with the analysis thereto. Review of the changes in the bookkeeping policies and adjustments at the year-end together with the analysis thereto. Review of the application for the alternatives of the accepted accounting principles together with the analysis thereto. The study of Almitaz and Higson (2002) has worked out to identify effectiveness of the audit committee in the Saudi Arabian Joint Stock Companies. The study was carried out field studies to compare the actual needs of the joint stock companies with what should be implemented. The study has interviewed the members of the audit committees and internal auditors in the joint stock companies together with the external auditors to fulfill the objective of the study. The study has been divided into six groups, role of the committee in the control of the companies, role of the committee with the external auditor, role of the committee with the internal auditor, powers of the audit committee, knowledge of the audit committee members and diligence of the audit committee. The outcome of the study shows limited approval to the audit committee role in respect of the six groups based on the point of view of the audit committee members and the internal auditors. The average of the groups ranges between neutrality and absolute acceptance, which reflects the weak support for the committee role as regard to the performance of the assigned responsibilities based on the viewpoint of the audit committee members themselves. With respect to the internal auditors, the average for all the groups have increased compared with the case of the audit committee members, which reflects acceptance of the internal auditors as regard to the performance of the audit committee for the assigned responsibilities and roles. In return, we have noted a decrease of support and acceptance of the external auditors for the role of the audit committee in respect of the six groups compared with the other two samples. The external auditors believe that the achievements of the committee are still immaterial, in addition to the doubts with, relation to the usefulness of the inspection committee. The study conducted by Jenny and Jean (2002) submitted two hypotheses to identify view point of the auditors and directors regarding the effect of the Governance on the quality of reporting and the financial statements though the application of example of Singapore. The conclusion of the study as follows: In the first case the auditors and directors agreed that three factors affecting the quality of reporting and the financial statements (1) effectiveness of the audit committee (2) quality of the internal audit department (3) compliance with application of the profession practice law. In the second case, the auditors and directors agreed that availing the audit partner rotation and outsourcing of internal audit services would affect the quality of reporting and the financial statements. The study by Al Rahili (2005) has shed light on the concept of the Corporate Governance procedures through considering the role of the audit committees as a tool to achieve the concept together with its relation with the internal and external audit by focusing on the example of the Kingdom of Saudi Arabia. To achieve the objective, the researcher has followed the descriptive method through out the study. The study has confirmed that application of the Corporate Governance concept enhance disclosure and transparency which will assist in creating healthy atmosphere to attract the foreign investments, combat the corruption, avoid the financial crisis. The study further explained that formation of the audit committees represents a new experience in the Kingdom of Saudi Arabia. The audit committees formed under Ministerial Resolution No. (903) dated 12/8/1414H. However, the audit committees encountered certain problems and difficulties including non-clarity of the objectives, duties and scope of the committees. Accordingly, teamwork formed for study and evaluation of the problems and difficulties. The team work recommended reconsideration of the organizing regulations for the audit committees work approved vide the Ministerial Resolution No. (903). The study by Keung Wt Al (2007) focuses on explaining the role of the audit committees considering the Corporate Governance effectiveness. The study further demonstrated the significant role of the committees to assist management in sorting out the problems considering, which the audit committee members enjoy considerable level of neutrality and independence to encounter problems. El Al (2007) outlines role of the audit committees in the Corporate Governance and its relation with the Governance other tools including internal audit and relation of the internal auditor with the audit committee, relation of the financial controller with the audit committee and exchange of information among them. The study has confirmed the significance of the audit committee role in the Corporate Governance effectiveness with a focus on the controls for selection of the committee members. Peter and Julie (2009) worked out to find out the relation between the audit committees and improvement in profitability for a sample of Australian organizations before implementation of the mandatory requirements for the audit committees in 2003. The conclusions show that the audit committee limits manipulation in profits. The objective of the article by Lisa Et Al (2009) was to test the relationship between the neutral audit committees in the company and the possibility of the financial statements fraud. The factors affecting the financial statements fraud other than the audit committee independence have been subjected to tests. The study concluded that the existence of independent audit committee would not constrain the financial statements fraud, which can be avoided through the following 1. Independence of the audit committee 2. Times of the audit committee meeting 3. Capital structure Chances of the financial statements fraud are linked with the following: 1. Size of the organization 2. Continuation and growth of the organization Beng (2009) conducted a study testing the relationship between effectiveness of the audit committees and taking the immediate rectification actions in respect of the internal control systems. The study demonstrated that independence of the audit committee and objectivity of the board has significant influence taking the immediate rectification actions in respect of the internal control systems. PROBLEM OF THE RESEARCH AND REASONS FOR THE STUDY The term Corporate Governance has been introduced in management of the companies due to the corruption spread out in the big companies. Reasons for the corruption resulted collapse of large companies including weakness of the governing control mechanism and lack of Corporate Governance concepts application. 2(Faiure of accounting and audit to detect scandals of large companies, society has lost trust in the Joint Stock Companies. Accordingly, the investors’ doubts have increased in respect of the efficiency, merit and performance of the board of directors and the internal committees. Furthermore, the questions on the efficiency of the internal control system, adequacy of accounting and audit standards and independence of the chartered accountants.) All the above implications represent a real motive to streamline and implement the Governance. The adoption of Governance policies will result in new visions to strengthen control and develop standards to manage business with adequate transparency and credibility. Accordingly, security to the shareholders and investors along with all categories concerned with the reporting and the financial statements could be fulfilled (UNDP, 1997)3. The study concentrated on the position of the audit committees being one of the Corporate Governance mechanism, and effect of the committees on the relevancy of the information of the financial statements published in the Saudi business environment. Based on the above, we may ask a question what is the role of the audit committees to make the Corporate Governance function more effective together with improving the financial reporting quality in the Saudi business environment. QUESTION OF THE RESEARCH Audit committees will be responsible to check the ICS of the organization including the financial statements. Saudi Arabia is the best destination for conducting the case study since it has large international organizations, where employees might be tempted to fraud assets. It is essential to study this relationship to evaluate the effectiveness and accuracy of the financial statements and the ICS (Ali, 2000, p 5)4. The study works out to answer the following three questions: Question One Is it significant to institute audit committees in Saudi Arabia companies? Question Two What is the role of audit committees on the improvement of the financial reporting quality in the Saudi business environment? Question three Why the organization should test the relationship between audit committees and corporate governance Question four What is the role of the corporate governance and audit committees? Question five How will the relevant information be gathered? Question six Will some organizations serve as control organizations to test the effectiveness of the research? Question seven How will the committees determine the quality of the information collected? OBJECTIVES OF THE RESEARCH An objective of the research aims at studying and analyzing the role and audit committees in view of Corporate Governance effectiveness and its effect on the financial reporting quality within the Saudi business environment (Keung, Ashok, Daniel. 2007, p. 132)5. To achieve the goals the research will include the following: 1. Assess the importance of the audit committee in relation to the corporate governance’s functions in Saudi companies. 2. Demonstrate role of audit committees regarding the effectiveness of the Corporate Governance. 3. Study and analyze the effect of the audit committees on the improvement of the accuracy of financial statements that are published in the Saudi business environment. 4. Determine the role to contribute by the committees to improve the quality of the financial reporting and activities should be engaged by them to improve the reporting. HYPNOSIS OF THE RESEARCH 1. Audit committees are dependent on the corporate governance to enhance the effectiveness and improvement of quality of the financial reporting. 2. Audit committees conduct at least four meetings every week to determine changes in the financial reporting in the Saudi business environment through powers bestowed upon them. 3. Audit committees rely on the internal corporate government as a system to scrutinize the financial statements of the statements in Saudi business environment. 4. Audit committee should conduct random checks on the internal and, external control systems of the financial reports to determine where errors and frauds might have taken place. IMPORTANCE OF THE RESEARCH The need for the concept of Governance has been introduced to the international business segments due to distrust of the people in the national and multinational companies. The terminology of the Governance has come to strengthen the general trend for most of the countries in order to privatize its sectors. The challenges surrounding the companies, taking into account the complicated world wide economic and social atmosphere which rapidly pressurize management and decision makers of the companies with respect to the negative impact of the profitability have also paved the way to the concept of Governance The importance of the research is to determine the roles of audit committees in the corporate governance of ICS of companies. Accordingly, the research shall offer a solution to challenges that organizations without audit committees face. IMPORTANCE OF CORPORATE GOVERNANCE STUDY 1. The attention to the Corporate Governance in the Saudi business environment is necessary, which will have a positive role to attract the foreign investments and increase the competitive capabilities of the companies. 2. The attention to the Corporate Governance will provide business environment with the transparency and credibility and contribute to increase efficiency of the control to sustain the economic stability in light of globalization (Grant, 2004, p. 100). 3. The responsibility for the preparation of the financial reporting rests with management of companies. The management of the companies carries out responsibilities while different parties putting pressure in order to obtain improved financial reporting. 4. The study addresses attractive issue since the topic of the Corporate Governance in respect of the audit committees in the Saudi business environment is limited. METHODOLOGY OF THE RESEARCH To achieve objectives of the study, the methodology for the study will rely on the qualitative approach. The research will study and analyze the most vital studies and trends in the areas of the audit committees, its relation with the Corporate Governance and its effect on the improvement of the information provided in the financial statements to identify characteristics and completeness of the studies (Jenny and Jean 2002). LIMITATION OF THE RESEARCH 1. The researcher will not analyze the effect of the audit committees’ formation in the government departments and non-profitable organizations. 2. The study will cover only the audit committees being one of the Governance mechanisms and will discuss other mechanisms, which shall act as control mechanisms, for instance, analyzing corporations that do not conduct corporate governance. 3. Determine the activities that should be undertaken by the audit committees to improve the quality of the financial reporting in the business environment of the Kingdom of Saudi Arabia. References (Arabic) Periodicals : Almaitiri, Abeed Saad. (1423H-A) Will corporate governance return trust in the public companies - Accounting Magazine – Riyadh, SAS, edition 34-, pp.12 – 16. Dr Alsayed , Alsaqa. (1995) Proposed theoretical frame work to measure and develop audit committee effectiveness in Saudi Joint Stock Companies (SJSC) - Trade and Finance Magazine – Tanta University, edition 2-, pp.2 Alwabil, Ali Alwabil. (1995) Limitation of the audit committee effectiveness in SJSC, filed study, faculty of commerce magazine , volume 33 edition 1-, pp.441 – 489. Okaz news paper, Sunday 15/7/1428H corresponding to 29/7/2007, edition 2233. Almitaz,Ihsan Salih & Andew Higson , Ali Alwabil. (2002) effectiveness of the audit committees in the SJSC, field visit, accounting first for the role accounting profession to protect and develop the investments, organized by the Saudi Organization for Chartered Accountants (SOCPA) in cooperation with the international Consultants, 1-3 Shaban corresponding to 7-9 October, Riyadh, kingdom of Saudi Arabia. Alrahili , Awad Salama. (2005) audit committees as one of the tools for the corporate governance, Saudi example, first Arab on internal audit within the frame work of the corporate governance, AOMD, 24-26 September 2005, Cairo, Egypt. Basfir , Afaf Salim. (2007), role of the audit committees in the effectiveness of the corporate governance in SJSC, Jeddah King Abdul Aziz University 2007. Al Angry, Hossam Abdul Mohsin (1424H) , audit of financial statements in KSA, second edition ,Jeddah , Alsarawat press. Foreign References Periodicals : Ali, A. (2000) Audit committees role in improving corporate governance- DAWN – Business, 24 July. WWW- googlecom, pp.3 – 5. Andrew, D. (2004). Non- profit governance reforms: five steps toward improve accountability, Mon day Business Briefing, Vol. 25, May. Arnold, P.C. (1993). Audit committees in major UK companies. Managerial Auditing Journal, Vol. 18, No. 3;. Beng, W. G. (2009) Audit committees, boards of directors, and remediation of material weaknesses in internal control. Contemporary Accounting Research, Toronto: Summer Vo l. 26, Iss. Dorothy, A. M. (1996). audit committee performance: an investigation of consequences associated with audit committee. 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The World Bank (1991), Governance and Development, the World Bank Publication, Washington, D.C. United Nations Development Program (UNDP), (1997), Governance for Sustainable Human Development, A UNDP policy Document, N.Y. Read More