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Home > Corporate Governance Best Practice > Should Internal Auditing Assess Board Performance?

Corporate Governance Best Practice

Should Internal Auditing Assess Board Performance?

by Sridhar Ramamoorti

Executive Summary

  • Internal auditors are increasingly being challenged to look at ways by which they might evaluate and improve the governance process.

  • When properly leveraged, the internal audit function can play a critical role in promoting and supporting effective corporate governance.

  • Internal auditors must understand and recognize that corporate governance is a politically charged area, managed by individuals at the top of the organization, including the board and its key committees.

  • The governance audit encompasses: gaining consensus on a definition of governance, ascertaining whether an assurance and/or consulting engagement is more appropriate, scoping the project along with commensurate resource allocation decisions, and ensuring proper communication flow before, during, and after the engagement is concluded.

  • Examples of assisting the nominating and governance committees, as well as auditing executive compensation and the compensation committee are discussed.

  • The experience of Kaiser Permanente’s efforts to “improve their governance processes” is described.

  • The importance of changing the outlook of the internal audit function, making it more proactive and influential, is highlighted.

Introduction

“Ultimately, the overall responsibility for the organization and its assets, and for its perpetuation into the future, rests squarely with the board.” Dr Thomas R. Horton, Former Chairman, National Association of Corporate Directors.

Internal auditors are increasingly being challenged to look at ways by which they might evaluate and improve the governance process. Given their competencies and expertise in the areas of governance, risk management, controls, and compliance, when properly leveraged the internal audit function can play a critical role in promoting and supporting effective corporate governance (Ramamoorti, 2003). Indeed, internal auditors’ skills in risk management and their broad-based perspective of the organization uniquely position them as a valuable resource for facilitating superior corporate governance outcomes.

Auditing governance can be a daunting challenge simply because it represents uncharted territory, and much of how to go about it in practice is ill-defined, amorphous, and intangible. Typically, the goals of corporate governance reform include, first and foremost, ensuring the organization’s survival (i.e. preempting or mitigating catastrophic risks), and then, when continued existence has been assured, to thrive, to grow, and to remain profitable. In other words, the core strategy for management is to exploit upside risks or opportunities consistent with the business model, while simultaneously managing downside risks or threats to organizational objectives. Internal auditors can provide assurance services to the board on how successfully such strategies are being implemented by management.

“Today internal audit should be as much about performance as it is about conformance,” contends Christopher McRostie, CEO of the Institute of Internal Auditors—Australia. However he concedes that this challenge is formidable, citing Niccolò Machiavelli’s The Prince, written in 1513: “…there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than the creation of a new system. For the initiator has the enmity of all who would profit by the preservation of the old institution and merely lukewarm defenders in those who would gain by the new one.” McRostie adds: “At the end of the day we need conformance and performance—they are not mutually exclusive. Despite the headline-hogging Enron, HIH, WorldCom and like fiascos, more money is lost in corporate disappointment than in corporate collapse.”

The internal audit function can provide the board objective assurance about the organization’s governance, risk management, and control processes (Swanson, 2010). However, internal auditors must recognize that corporate governance is a politically charged area, managed by individuals at the top of the organization, including the board and its key committees (Marks, 2007). Hence, to audit the governance process not only requires internal auditors with the appropriate stature, independence, and objectivity, but also the credibility and the formal organizational mandate to engage in such activity. Clearly, assessing the effectiveness of governance activities requires access to highly confidential and sensitive information, with a corresponding need for discreet and delicate handling by the auditors.

Marks (2007) persuasively argues that “Audits of governance, whether assurance or consulting in nature, may not be easy and often carry political risk. However, they are clearly important and should be given strong consideration in the audit plan—not just because they are required by the Standards, but also because they add value to the organization.”

With this background, there is no argument that internal audit can play an extremely important role in being tasked with assessing board performance. Indeed, such a mandate would be in line with the IIA’s International Professional Practices Framework (2011a) and the Standards (2011b) related to governance.

It is abundantly clear from a quick reading of Standard 2110 that the IIA Standards expect internal auditors to make assessments of and recommendations for enhancing the governance process within their respective organizations.

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Further reading

Books:

  • Institute of Internal Auditors (IIA). International Professional Practices Framework. Altamonte Springs, FL: IIA Research Foundation, 2011a.
  • Swanson, Dan. Swanson on Internal Auditing: Raising the Bar. Ely, UK: IT Governance Publishing, 2010.

Standard:

  • Institute of Internal Auditors (IIA). “International standards for the professional practice of internal auditing (Standards).” Rev. ed. Altamonte Springs, FL: IIA, 2011b. Online at: tinyurl.com/cobatlu

Articles:

  • Marks, Norman. “Internal audits of governance: Assessing organizational governance can be complicated and may involve political risk, but it should still be given strong consideration in the audit plan.” Internal Auditor (December 2007).
  • Overmyer, Cindy, and Neal Purcell. “The quiet revolution: Kaiser’s internal audit expands governance role.” Directorship (October/November 2010). Online at: www.directorship.com/casestudy/
  • Ramamoorti, Sridhar, and Usha R. Balakrishnan. “Carrots and sticks: By auditing executive compensation and benefits, auditors can help their organization move from risk to rewards management.” Internal Auditor (October 2010).

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