Expanding Limits of Internal Audit - IA in Corporate Governance

Corporate Governance means the credibility, accountability of an entity to its stakeholders. An entity is comprised of promoters, board of directors, Audit Committee. The Stakeholders are investors, creditors, customers, employees, government, society and environment. The performance results of an entity impact the lives of all the stakeholders. Essentially corporate governance is to ensure that all is well for the stakeholders. Corporate Governance as defined by CadburyCommittee, UK- The system by which companies are directed and controlled (Cadbury Committee, 1992 ).

Corporate governance is the keyword in any organization as it decides the rise and fall on an entity. As men may come and men may go, but I will go on forever- (The Brooke by Alfred Lord Tennyson), the entity's sustenance and growth is in having good corporate governance.

The recent collapse of Punjab Maharashtra Cooperative Bank and Boeing 737 Max trails it to bad corporate governance. This raises a major issue that improper corporate governance affects not only the entity but the reputation of the governing bodies.

Recently a survey was conducted jointly by IIA and University of Teneseee Neel Corporate governance Centre gave a new index to US public listed companies an overall grade of C+, with 1in 10 companies surveyed earning F grade for corporate governance. The survey was conducted anonymously among the Chief Audit Executives (CAE's). Although responsibility for corporate governance begins in the boardroom, "governance is so much bigger than what's going on at the board level," said Terry Neal, director of the Neel Corporate Governance Center, at the Washington event. This is where internal audit, with its enterprise wide perspective, could help companies improve their grades, he said.

While internal audit could be positioned to help boards look at risks deeper down in companies, assessing corporate governance is still a new area for many audit functions. Less than one-fourth of companies evaluate corporate governance annually, and when they do, it goes through the legal function, said Lauren Cunningham, assistant professor and director of research at the Neel Corporate Governance Center. "If legal does it, it's a check-the-box mentality," she said.

The survey throws light on the potential opportunity for internal auditors and at the same time raises the issues in corporate governance. The low grade on Corporate governance is an alarm for the next big scandal. The Internal Auditor with Board Approval can provide some introspections on corporate governance to curb scandals. It will assist the entity in the maintenance of the highest standards of corporate governance.

As per Robert Half' s latest Salary guide lists internal auditor as one of the most in demand roles in the accounting and finance field today. The increase in risk appetite demands better corporate governance which can be ensured with internal Audit function. TheInstitute of Chartered Accountants of India (ICAI) has introduced some new Standards of Internal Audit and is working towards its implementation. All the SIA will be made mandatory in a phased manner with adequate training and workshops in this line. These steps will further strengthen and nurture the requirements of Internal Audit. The list of SIA issued by ICAI as given below.

Internal Audit which started as a compliance check has today expanded to business advisor, risk assessor, control specialist. As businesses are breaking barriers of conventional thoughts,risk also keeps evolving on daily basis. Risks can be primarily classified into two risks-Internal and External.

Internal Risk can be mitigatedby ensuring the presence of adequate internal controls with timely review of the efficiency of the controls. External risk cannot be controlled but the impact can be minimized by taking proactive steps.

Today, the most important risk is “CHANGE”. How well are we equipped to overcome this challenge? There is a sudden shift in business globally due to changing people' s needs, govtregulations, climatechange, changing political scenarios etc. Changes are happening in the wink of an eye which we need to hold on to.Let us consider Nokia case to understand how it got washed away by a high tide change in handset industry called “ANDROID and iPHONE”.Based on the inputs from the book written by David J.Cord,” the Decline and Fall of Nokia”, the reasons for its collapse are listed below.

1. A pervasive bureaucracy leading to an inability to act,
2. Destructive internal competition
3. The failure to realize the importance of lifestyle products like the iPhone.
4. The company' s weakness in North America
5. The Company' s faulty organizational structure

A study was conducted by Tim O. Vuori, assistant professor in strategic management at Aalto University and Qui Huy, Professor of Strategy at INSEAD Singapore which was published in Distributed Attention and Shared Emotions in the Innovation Process: How Nokia Lost the Smartphone Battle . The study consisted of interviewing 76 Nokia top and middle managers, engineers and external experts and conducting in-depth investigations. Findings are listed below.

• that time Nokia suffered from organisational fear;

• The organisational fear was grounded in a culture of temperamental leaders and frightened middle managers.

• The middle management was scared of telling the truth because they feared being fired.

• Top managers were afraid of the external environment and not meeting their quarterly targets.

• Executives were afraid to publicly acknowledge the inferiority of Symbian, Nokia' s operating system.

• They knew it would take several years to develop a better operating system that could compete with Apple' s iOS.

• Top executives were afraid of losing investors, suppliers and customers if they acknowledged their technological inferiority to Apple.

• Top managers intimidated middle managers by accusing them of not being ambitious enough to meet their goals.

• Top management was lied to by middle management who felt telling the truth was useless.

• Top managers lacked technical competence which influenced how they could assess technological limitations during goal setting; by comparison, the top engineers at Apple were all engineers.

• Instead of allocating resources to the achievement of long-term goals such as developing a new operating system, Nokia management decided to develop new phone devices for short-term market demands.

A closer look on the findings of paper and the book insights, both point to poor corporate governance. This highlights the importance the role of corporate governance in the rise and fall of any organization. Similar was the case with Toshiba, a 144-year-old company which also collapsed due to its corporate culture of obedience to senior employees. Excessive pressure from Top Management to meet unrealistic targets which employees had no choice (corporate culture) but to blindly abide by, got engulfed into a scandal.

1. Carillion - collapse exposes deep corporate governance failings
2. Kobe Steel - inadequate corporate governance
3. Raiffeisen bank - major governance failings
4. Patisserie Valerie - complete lack of control and understanding of the financial accounting

The IIA (Institute of Internal Auditors) Position paper on INTERNAL AUDITING' S ROLE IN CORPORATE GOVERNANCE emphasize the importance of internal auditor in corporate governance . The IIA believes internal audit' s role in governance is vital. Internal audit provides objective assurance and insight on the effectiveness and efficiency of risk management, internal control, and governance processes.

Key Aspects are listed below.

• Internal audit' s role in governance is vital. Internal audit provides objective assurance and insight on the effectiveness and efficiency of risk management, internal control, and governance processes.

• Internal audit insights on governance, risk, and control provoke positive change and innovation within the organization.

• Strong management and board support of internal audit is nurtured by relationships built on mutual trust and frequent and meaningful interactions with the chief audit executive.

• A vibrant and agile internal audit function can be an indispensable resource supporting sound corporate governance

(Position paper means the papers that assist a wide range of interested parties, but are primarily designed to inform and educate internal audit stakeholders on issues of importance to The IIA and the profession. Their focus is generally related to significant governance, risk, or control issues, and delineating the associated roles and responsibilities of internal auditing.)

IIA believes that as risks grow and become more complex, internal audit' s role is likely to expand in areas such as risk governance, culture and behavior, sustainability, and other nonfinancial measures.

There are various standards set for Corporate governance which serves as a guide for ensuring good practices of governance are followed. Few are listed below.

• OECD Principles of Corporate Governance - November 2015

• Charity Governance Code - 2017

• European Banking Authority (EBA) Guidelines on Internal Governance under Directive 2013/36/EU

• Corporate Governance in Central Government Departments – April 2017

• Quoted Company Alliance Corporate Governance Code (QCA Code) – 2018

• The Wates Corporate Governance Principles for Large Private Companies - 2018

The Primary among them is Financial Reporting Council' s 2018 UK corporate governance code and 2018 FRC guidance on Board Effectiveness. Financial Reporting Council' s 2018 Guidance on Board Effectiveness says that the chair should consider ways in which to obtain feedback from the workforce and other stakeholders – for example, the auditors – on the performance of the board and other individual directors.

In India, SEBI adopted the Kumar Mangalam Birla Committee report on Corporate governance by modifying and incorporating a new clause (Clause 49 ) of the listing agreement.

The Uday Kotak led SEBI Committee on corporate governance had submitted report on October 5, 2017.One of the critical and valuable recommendation was separation of roles of Non-Executive Chairperson and Managing Director/CEO.This ensures greater Transparency, Independence and brings more clarity and segregation of dutiesin theirroles. SEBI had recently extended this deadline to 30th April 2022 as majority of the companies are yet to comply on the requirement.

We are evidencing a slow shift in the regulator' s importance on corporate governance running parallel with digitization of financial payments. The addition of Sec 269SU in the Income Tax Act effective from 1st Feb 2020,for having all facilities for making online payments (Debit Card powered by Rupay,UPI,Unified Payments Interface Quick Response Code) for companies having turnover over Rs50 crore is an evidence to streamline the payments process towards digitization.

Good Corporate governance can be ensured if we have right mix of knowledge, experience,technology,risk exposure and Ethics and be proactive to changes in the environment. Ethics in business also pays a crucial role in ensuring the continuity and longevity of business. Ethics and good corporate governance are interlinked. Business Ethics are reflected in a company' s mission /goal statement and thepath of achieving the company' s mission is displayed in its corporate governance practices.

Professionals are bound by Code of Ethics but people running the business are bound on a larger scale by codes of trust, credibility and to give something back to society.

Executive Summary

Internal Audit which started as a compliance check has today expanded to business advisor, risk assessor, control specialist. As businesses are breaking barriers of conventional thoughts, risk also keeps evolving on daily basis.The IIA believes internal audit' s role in governance is vital. Internal audit provides objective assurance and insight on the effectiveness and efficiency of risk management, internal control, and governance processes.In India, SEBI adopted the Kumar Mangalam Birla Committee report on Corporate governance by modifying and incorporating a new clause (Clause 49 ) of the listing agreement.

The Uday Kotak led SEBI Committee on corporate governance had submitted report on October 5, 2017.One of the critical and valuable recommendation was separation of roles of Non-Executive Chairperson and Managing Director/CEO. This ensures greater Transparency, Independence and brings more clarity and segregation of duties in their roles. Ethics in business also pays a crucial role in ensuring the continuity and longevity of business. Ethics and good corporate governance are interlinked. Business Ethics are reflected in a company' s mission /goal statement and the path of achieving the company' s mission is displayed in its corporate governance practices.

References

1. Research study paper of IIA
2. Decline and Fall of Nokia-book written by David J Cord
3. Position Paper of IIA
4. Reference to Articles by IIA on Corporate Governance
5. The Corporate Governance adoption in India
6. Uday Kotak Committee on Corporate Governance