Abstract
Corporate governance is considered the backbone of corporations. Audit committee is one of the factors that plays a pivotal role to guide and monitor business-related matters of firms while following the national and international audit standards. The chapter covers the involvement of the audit committee with respect to corporate governance. It ranges from audit committee formations to its importance, composition, significance, and the role in quality financial reporting according to international standards. The chapter generally focuses on the audit committee and not any particular country or firms. The importance of the audit committee has always been recognized, but due to some examples of bad corporate governance practices, it became an important variable of corporate governance.
TopObjectives
Indeed, agency cost is present in all walks of life. Agency cost suggests that humans are primarily self-centered in any role of life, especially when working on behalf of someone as an agent. Either employed in any job, the agent will consider his interest before considering what ought to be the principal's best interest. Therefore, the corporate and financial evolution in the last two hundred years is incomplete without proper corporate governance mechanisms! To address agency cost issues, one of the mechanisms inside the organization is the introduction of an audit committee by the Code of Corporate Governance. The objective is to bring transparency accountability and give strength to internal mechanisms that can mitigate the issue of agency cost. The audit committee plays a vital role in the company’s internal structure. Stockholders are concerned about the reliability of financial reports presented to them by a company. Of course, external auditors submit their reports, but the code of corporate governance provides another support in the form of an audit committee that oversees the company's financial reporting. Even the audit committee can strengthen external auditors’ position in case any dispute arises between management and external auditors. It consists of members that must have sufficient financial knowledge and can assess risk associated with different projects and financial decisions taken by company managers. Many empirical findings support the audit committee to mitigate the issue of agency cost or entrenchment. The internal audit head of companies has access and reports to the chair of the audit committee. From one-tier Board model to two-tier Board models, from the construction of audit committee to expanding its mandate and improving the compositions of the audit committee, the evolution is continued.
We consider that the audit committee plays an essential role in curbing the impact of agency cost, and it is one of the most effective tools of Corporate Governance; hence the purpose of writing this chapter is to go through the evolution and significance of the audit committee with the help of literature review.
Key Terms in this Chapter
Board of Directors: A group of agents elected by all the shareholders to represent them in a firm. The mandate of Board is to work in the best interest of shareholders.
External Audit: It is a detailed examination of firm’s books of accounts and its financial records to validate that records are following the International Accounting Standards and display the true picture of events in the firm.
Corporate Governance: A structure of firm designed to give strategic direction as well as establishing control mechanism for smooth, effective and efficient running of operations of firm.
Accounting Standards: A collection of well-designed practices and procedures applied on bookkeeping and accounting practices across firms and time.
Financial Reporting Quality: The quality of financial reporting depends on how useful the reporting is for the analysts to conclude the firm’s performance and its future prospects.
Composition of Audit Committee: A committee which consist of at least three members. The majority of members must be independent but one of the members must be an expert in financial matters hence working as financial advisor for the Audit Committee.
Sarbanes-Oxley Act: It is a law passed by US Congress in July 2002 with the intention to protect investors from fraudulent and misleading financial reporting by firms through major reforms in financial reporting criteria.
Code of Corporate Governance: A set of orientations and training program for Board of Governors which are prerequisite to understand and perform duties efficiently and effectively by Board members in the best interest of Shareholders.
Agency Cost: An internal cost to the firm due to actions of an agent working on behalf of principal. It occurs in the shape of inefficiencies due to conflict of interest between agent and principal.
Auditing: A set of activities to examine the quality of accounting practices following International Accounting Standards (IAS), International Financial Reporting Standards (IFRS) as well as confirm that financial reports are true representative of the state of affairs of firm.