Enhancing Corporate Governance Research Articles

Reliance of External Auditors on Internal Audit Work: A Corporate Governance Perspective

The literature suggests an increasing need for interactions among board of directors, management, internal audit and external audit as the four components of corporate governance and presents internal audit as a resource for the other components. External auditing standards that originated in the Western world, which are also being applied in developing countries, recommend external auditor’s reliance on internal audit to achieve audit efficiency. Nevertheless, whether this efficiency motive explains such reliance in corporate governance settings that differ from the West has not been sufficiently explored as yet. This study examines external auditor reliance on internal audit work using questionnaire survey of 119 external auditors in Ethiopia. Mann-Whitney U test results suggest that external auditors’ reliance on internal audit work is not significantly associated with the competitiveness of external audit sub-markets in Ethiopia. Results of multiple discriminant analysis indicate internal audit work performance is the most important factor that determines the extent of external auditors’ reliance on internal audit work. Overall, findings suggest that organizations can enhance corporate governance effectiveness by strengthening internal audit and fostering internal-external auditor coordination.

The Effect of Regulatory Oversight on the Association between Internal Governance Mechanisms and Audit Fees

Recent episodes of corporate scandals have resulted in higher levels of regulatory oversights and calls for enhanced corporate governance (CG) and audit quality. These measures impact audit fees which are intrinsically linked to CG. Whilst prior research examines the relationship between internal governance mechanisms and audit fees, the impact of regulatory oversight has not been examined. Hence, the primary objective of this study is to examine the moderating effect of regulatory oversight on the relationship between audit committee (AC) characteristics, internal audit (IA) function attributes and external audit fees in an emerging market, namely Malaysia. The Bursa Malaysia revised its Listing Requirements (BMLR) in 2008, requiring increased interaction between the AC and IA function. Prior thereto, Bank Negara Malaysia, had exercised oversight functions over financial institutions and insurance companies. They were and continue to be highly regulated. This study focuses on the pre- and post-revised BMLR, and also differentiates between highly regulated and less regulated industries. The contributions from this proposed study are threefold. Firstly, we expect the results to provide empirical evidence of the impact of the revised BMLR on audit to feedback to regulators of the efficacy of their CG policy initiatives. Secondly, this study will evidence the moderating role of such regulatory oversights on CG practices. Thirdly, given that prior studies show mixed results regarding the relationship between IA function and external auditing, whether substitutes or complementary, taking account of the regulatory environment may explain the mixed findings thus far. A methodological triangulation approach, involving qualitative and quantitative methods of data collection, through interviews with selected audit practitioners and data from firms’ annual reports, is used. The theoretical model to test the hypotheses is built upon the Simunic (1980)’s model further modified by Griffin and Lont (2007), incorporating the local nuances in the emerging economy context. Supervisors: Assoc. Prof. Dr. Susela Devi, Dr.Chan Wai Meng, Faculty of Business Administration and Accountancy, University of Malaya, Malaysia.

Ownership and control structure, corporate governance and income smoothing in Brazil

Income smoothing is a longstanding practice under the more general category of earnings management. As the name suggests, it consists of smoothing out the fluctuations of the income series. This article examines the association between the ownership and control structure, level of corporate governance and origin of capital (foreign or domestic) of Brazilian companies on their propensity to smooth income. Using a sample of nonfinancial firms with shares traded on the São Paulo Stock Exchange (Bovespa) at the end of 2007, we performed covariance analysis based on data from the preceding ten years, where the dependent variable was the index proposed by Eckel, an empirical proxy for smoothing. The results indicate that the more concentrated the shareholding and control structures of Brazilian firms are, both according to overall capital and voting capital, the more intensely they tend to smooth earnings to favor the interests of the majority shareholder. The results also show that this effect is less pronounced for firms with enhanced corporate governance levels and those with foreign capital.

The importance of strengthening the role of the Boards of directors in state-owned enterprises in Serbia

As in many other countries, state-owned companies in Serbia are generally characterized by poor performances, non-transparent operations, corruption scandals and lack of accountability. Since the state sector has a high share in the overall Serbian economy, it seriously undermines the competitiveness of the whole economy. Some research has shown that by enhancing corporate governance of these enterprises comparable results can be achieved as in the case of their privatization. Recently Board of Directors has become the only potentially active mechanism of corporate governance in Serbian state-owned companies, so this study was focused on making recommendations for strengthening the role of the Board of Directors. We gave two sets of recommendations: recommendations for the setting up of effective Boards of Directors and recommendations for improving the efficiency of such boards. Prior to that, we briefly analyzed the current situation of corporate governance legislation and practice in Serbian state-owned enterprises.

CEO Turnover in Private Equity Sponsored Leveraged Buyouts

Manuscript Type: Empirical Research Question/Issue: We examine the governance role of private equity (PE) firms in post-LBO companies in the US. We propose and test whether PE firms remove entrenched CEOs or CEOs who cause agency problems. Research Findings/Insights: Using archival data from a sample of 126 PE sponsored LBOs in the USA between 1990 and 2006, we document a CEO turnover rate of 51 per cent within two years of an LBO announcement. We find that the boards of directors replace CEOs in companies with high agency costs, as measured by low leverage and a high level of undistributed free cash flow. In addition, unlike the boards of directors in public companies, the boards in post-LBO companies tend to replace entrenched CEOs. Finally, the boards are more likely to replace CEOs if pre-LBO return on assets is low. Theoretical/Academic Implications: According to the agency theory, a PE-sponsored LBO is a new organizational form that reduces agency costs by enhancing corporate governance. This study uses CEO turnover as a setting to test that prediction. We find that PE firms replace CEOs who can cause agency problems, thus providing empirical support for the proposition that PE firms improve corporate governance in LBO companies. Practitioner/Policy Implications: This study offers insights to policy makers who are interested in regulating PE firms. Our results suggest that, in the US, PE firms provide effective corporate governance mechanisms by replacing incompetent and entrenched CEOs. In addition, our results provide a set of factors for PE firms to consider when they make CEO retention decisions.

Estrutura de Propriedade e Controle, Governança Corporativa e o Alisamento de Resultados no Brasil <br>DOI:10.5007/2175-8069.2010v7n13p11

This article examines the association between the ownership and control structure, level of corporate go­vernance and origin of capital (foreign or domestic) of Brazilian companies on their propensity to smooth income. Using a sample of non.nancial .rms with shares traded on the Sao Paulo Stock Exchange (Bovespa) at the end of 2007, we performed covariance analysis based on data from the preceding ten years, where the dependent variable was the index proposed by Eckel, an empirical proxy for smoothing. The results indicate that the more concentrated the shareholding and control structures of Brazilian .rms are, both according to overall capital and voting capital, the more intensely they tend to smooth earnings to favor the interests of the majority shareholder. The results also show that this effect is less pronounced for .rms with enhanced corporate governance levels and those with foreign capital.

Enhancing corporate governance in listed companies with concentrated shareholdings

PurposeThe paper aims to focus on diverse ownership structures, especially the controlling shareholder system and their impact on corporate governance.Design/methodology/approachThe paper deliberates the agency problems in concentrated shareholder‐listed companies in general which are related transactions involving controlling shareholders, significant corporate actions, and control transactions. The paper further studies agency issues in Malaysian‐listed companies specifically relating to government‐linked companies and family‐owned companies.FindingsThe paper identifies agency problems in concentrated shareholding‐listed companies which are government linked or family owned and then provide solutions to overcome these problems.Originality/valueSpecific agency problems in Malaysian‐listed companies and solutions to overcome them are presented in this paper.

Accounting Conservatism and Executive Compensation

Using a firm-year measurement of accounting conservatism developed by Khan and Watts (2009), I find that accounting conservatism is positively related to the pay-for-performance sensitivity of executive compensation, negatively related to the level of executive compensation. These empirical findings are robust after controlling, size, performance, risk, growth opportunities, firm age, capital expenditure institutional ownership and corporate governance. The results suggest that accounting conservatism can facilitate linking shareholders’ wealth to managers’ wealth and are consistent with the view that accounting conservatism reduces information asymmetry and enhance corporate governance. I also find significant differences in firms’ stock returns across the portfolios formed on the level of conservatism and the pay-for performance sensitivity of executive compensation. This finding indicates that accounting conservatism may play a role in stock valuation.

Ownership and Control Structure, Corporate Governance and Income Smoothing in Brazil

Income smoothing is a longstanding practice under the more general category of earnings management. As the name suggests, it consists of smoothing out the fluctuations of the income series. This article examines the association between the ownership and control structure, level of corporate governance and origin of capital (foreign or domestic) of Brazilian companies on their propensity to smooth income. Using a sample of nonfinancial firms with shares traded on the Sao Paulo Stock Exchange (Bovespa) at the end of 2007, we performed covariance analysis based on data from the preceding ten years, where the dependent variable was the index proposed by Eckel, an empirical proxy for smoothing. The results indicate that the more concentrated the shareholding and control structures of Brazilian firms are, both according to overall capital and voting capital, the more intensely they tend to smooth earnings to favor the interests of the majority shareholder. The results also show that this effect is less pronounced for firms with enhanced corporate governance levels and those with foreign capital.

The Rising Tension between Shareholder and Director Power in the Common Law World

ABSTRACTManuscript Type: ConceptualResearch Question/Issue: This article explores the rising tension between shareholder and director power in the common law world. First, the article analyzes key arguments in the shareholder empowerment debate, and current US reform proposals to grant shareholders stronger rights, from a comparative corporate law perspective, examining how traditional US legal rules diverge from other common law jurisdictions. Secondly, the article discusses power shifts in the opposite direction – namely toward the board – in some parts of the common law world. It considers the potential friction between legal rules designed to enhance shareholder power and commercial practices designed to subvert it.Research Findings/Insights: The article shows that US shareholders have traditionally had unusually restricted rights compared to their counterparts in common law jurisdictions, such as the UK and Australia. The article challenges a number of arguments supporting this traditional US approach, by showing that the arguments are often US‐specific, and are less persuasive from a comparative corporate governance perspective. The article also identifies an important tension between legal rules designed to enhance shareholder power and commercial practices designed to subvert it. It shows how the dynamic nature of regulation, and the strategic response of regulated parties, can affect the operation of legal rules.Theoretical/Academic Implications: The article broadens the scope of the US shareholder empowerment debate, by means of a comparative law analysis. It challenges an evolutionary/managerialist theory of US corporate governance, by showing that other jurisdictions have made different choices concerning the allocation of power between shareholders and the board. The article also shows the importance in comparative corporate governance scholarship of focusing not only on the terms of specific laws, but also on the commercial responses of parties subject to those laws.Practitioner/Policy Implications: The article assesses the role of shareholder participation as a regulatory mechanism to enhance corporate governance legitimacy. The global financial crisis has highlighted some of the dangers of untramelled managerial power and under‐regulation. The article provides important regulatory insights to policy makers, concerning the appropriate balance of power between shareholders and the board of directors.

Corporate Governance, Auditing and Earnings Management Through Accounting Choices and Operational Decisions in Brazil

This article examines whether enhanced corporate governance, auditing by one of the Big Four and auditors’ opinions, are associated with the propensity to engage in earnings management through accounting choices or operational decisions in Brazil. Although there are some studies on earnings management by Brazilian companies, very few have examined the presence of operational decisions in this practice and none has addressed how to minimize this. Using our own models to infer earnings manipulation by accounting choices and operational decisions, we investigate if firms that manage earnings through discretionary accruals also make operational decisions for the same purpose. The evidence from a sample of Brazilian firms suggests that listing on the Novo Mercado (New Market) segment of the Sao Paulo Stock Exchange, which requires enhanced corporate governance practices, among other requirements, and auditing by one of the Big Four firms reduce earnings management by accounting choices, and that an auditors’ opinion with reservations is an indicator of earnings management. However, except in special cases, listing in the Novo Mercado segment and auditing by the Big Four do not assure less earnings management by operational decisions.

Enhanced Corporate Governance for Restaurant Companies: The Role of Well Performing Audit Committees

ABSTRACT Corporate governance is a popular topic these days among public companies. An important piece of baggage for this journey is a solid corporate audit committee policy, which fosters a well performing audit committee. This article examines the evolution, composition, and duties of audit committees over the past thirty years. In addition it compares the basic audit committee policies and procedures of the Standard & Poor's 100 Index companies with those of the top fifty-one restaurant companies from Value Line, Inc.

Corporate Governance in a European Perspective

Corporate governance has become an important issue at European level. Indeed, on the basis of the Winter Report, the Commission launched several initiatives aimed at enhancing corporate governance disclosure, the exercise of shareholders’ rights and the independence of the board of directors. The question arises to what extent the European legislator should take action. This question is very intriguing. We argue for a rather limited role, since European corporate governance inevitably has to take the differing ownership structures into account. European corporate governance can formulate general principles, but filling in the details will remain a shared task.

CEO Compensation and Firm Performance

This paper provides empirical validation of the theoretical relationship between firm performance and CEO compensation. The rational behavior hypothesis is that the “CEO that is paid more works harder (and succeeds) to improve the financial performance of the corporation that he/she leads. To test this relationship as our hypothesis, we collected information of firms and CEO compensation from the COMPUSTAT and EXECUCOMP data bases. Of the SP500 firms, we selected 276 firms with complete data in the 10-year period from 1995 to 2004. We estimate three measures/indicators of firm performance: Return On Equity (ROE), Return On Equity Average (ROE_AVG), and Economic Value Added (EVA). CEO compensation is measured by six categories: CEO Salary, Restricted Stock Grants, Options Awarded, Bonus, Long-Term Incentive Payouts (LTIP), and Total CEO Compensation. There are over 40,000 observations of both CEO compensation and corporate profit returns in the important large corporations in a period when media, analysts, and university research community were calling for CEOs to get with it. After controlling for fixed effects (macroeconomic and specific industry conditions) of the six types of CEO compensation, we find that only cash bonus has had a significant positive effect on firm performance. A one million dollar increase in bonus—an increase of 83.68% (based on the sample average of 1.195 million dollars) - was associated with a 1.15% increase in Average ROE in the fixed effects model or 1.03% increase in the random effects model. However, once we control for endogeneity of CEO compensation, i.e. that it was simultaneously determined with performance, none of the six payment types had significant effects on firms’ performance. This finding suggests a rethinking of the role of the CEO compensation as an incentive for improving corporate performance, i.e. can the CEO actually affect the annual profit of firms of this scale. The finding, interpretations and conclusions expressed herein are those of the authors. We greatly appreciate the comments and feedback provided by our colleagues at Yale School of Management (especially Professor Paul MacAvoy and Dean Ira Millstein) and Brown University All remaining errors are our own. Email addresses: dennisWmichaud@gmail.com (Dennis Michaud), ygai@babson.edu (Yunwei Gai). Dedication: This paper is dedicated to Professor Paul W. MacAvoy. Throughout this project his suggestions, comments, advice, and encouragement have been tireless. Paul is the former dean of the Simon and Yale Schools of Management and in our opinion, the dean of corporate governance research. As a teacher, scholar, and corporate director, Paul has been a strong advocate for enhanced corporate governance and shareholder rights. We are all in his debt.

Corporate Governance of Banks after the Financial Crisis - Theory, Evidence, Reforms

Poor corporate governance of banks has increasingly been acknowledged as an important cause of the recent financial crisis. Given the developments since the Asian financial crisis in 1997, this fact is not readily to be explained. Listed banks and even non-listed firms worldwide have publicly emphasized that good corporate governance is of vital concern for the company, and have adopted firm-specific corporate governance codices. Moreover, banking supervisors have taken up the issue. In particular, the Basel Committee on Banking Supervision has already published two editions of a guideline entitled “Enhancing corporate governance for banking organisations” which perfectly reflects the supervisors’ perception of and approach to the issue Still, only during the second year of the financial crisis, the issue of banks’ good corporate governance has again started to attract pronounced interest. Given the numerous reforms to improve banks’ corporate governance that have either been proposed or already implemented at the international level, national, and supranational, e.g. E.U., levels, the article takes stock of relevant theory and examines recent reforms in light of the empirical evidence. Taking the well-known question “What makes banks different?” (Fama) as a starting point, the theoretical part first analyses the particularities of banks’ corporate governance with respect to a bank’s financiers (shareholders, depositors, and bondholders) in a principal-agent framework and finds that banks’ corporate governance mostly differs from that of a generic firm because of deposit insurance and prudential regulation. While aimed at compensating for deficits in the monitoring and control of banks, both institutions serve to exacerbate the particular problems that are inherent in banks’ corporate governance. The theoretical part, then, presents the supervisors’ financial stability perspective as illustrated by the Basel Committee’s guidance, and concludes with a discussion of the functional relationship between corporate governance and banking regulation/supervision: Whereas banking regulation/supervision acts as a functional substitute for debt governance, equity governance benefits less from such regulation/intervention. Put succinctly, shareholder interests and supervisors’ interests do not run exactly parallel, not even from a long-term perspective. The following part provides an overview of the numerous reform initiatives in light of emerging empirical research on the corporate governance-failure hypothesis, and presents some more ideas for reforms. Of particular interest to this discussion are risk management, board composition, and executive remuneration. The article concludes with some tentative reflections on the lessons from banks’ corporate governance for corporate governance of generic firms, i.e., firms not subject to prudential regulation/supervision. Because of the particularities due to the existence of deposit insurance and prudential regulation/supervision, one may doubt whether banks’ corporate governance should map the way forward for corporate governance.

Corporate Governance of Banks

Good corporate governance of banks is of a vital concern to banks themselves as well as to the banking supervisors. During the past decade, listed banks and even non-listed institutions worldwide started to publicly emphasise that good corporate governance is of vital concern for the company, and even to adopt individualised corporate governance codices. In turn, the Basel Committee on Banking Supervision already published two editions of a guideline entitled ‘Enhancing corporate governance for banking organisations’ which reflects the supervisors’ taking on the issue to perfection. Last but not least, two years into the financial crisis, the issue of banks’ good corporate governance has started to attract pronounced interest, with the OECD taking a leading role. Against this backdrop, the article, on the one hand, discusses the particularities of banks’ corporate governance — due in large part to banking regulation and to deposit insurance — in a principal-agent framework, and, on the other hand, presents the supervisors’ financial stability perspective taking the Basel Committee’s guidance as a starting point. The article concludes with reflections on some tentative lessons from the current crisis for (banks’) good corporate governance: banks’ corporate governance differs from that of a generic firm. Deposit insurance and prudential regulation, while aimed at compensating for deficits in the monitoring and control of banks, both act to exacerbate the particular problems that are inherent in banks’ corporate governance. From this perspective, banking regulation and banks’ corporate governance interact as the driving forces of a vicious circle that produces ever more regulation. Hence, one may doubt whether banks’ corporate governance should map the way forward for corporate governance in general. In particular, this holds true for the way forward to regulating bankers’ pay.

Does accounting regulation enhance corporate governance? Evidence from the disclosure of share-based remuneration

Accounting for stock options and share-based remuneration is a controversial issue. The purpose of this study is to explore the impact of the mandatory adoption of IFRS 2 on accounting for share-based remuneration by Italian listed companies. The requirements under this standard could have relevant implications for corporate governance as IFRS 2 is expected to reduce the information asymmetry that may exist between corporate insiders and outsiders regarding such remuneration. Empirical evidence confirms that overall disclosure in annual reports concerning the costs of remuneration plans has increased following the adoption of IFRS 2, although some cases of lack of disclosure have also been found. We find that this change in accounting regulation has contributed towards revealing the ‘true’ cost of share-based remuneration to minority shareholders and other investors, together with some evidence of creative accounting surrounding the substance over form principle.

The pervasive nature of IT controls

PurposeThe complexity of computerized information systems increases the complexity of the external auditor's assessment of the reliability of a client's internal control systems. The purpose of this paper is to investigate the impact of weaknesses in IT related internal controls on the cost of a SOX 404 audit of internal controls over financial reporting.Design/methodology/approachThe paper considers the impact on audit fees through three dimensions: percentage increase in audit fees; amount of change in audit fees per outstanding common share; and actual dollar amount of audit fees. Examination of first year reports by accelerated filers yields 131 companies with material IT‐control weaknesses. These 131 companies are matched with a similar set of companies with no reported material weaknesses, and for a subset of 54 from the 131 companies in which a good match could be identified, a set of companies having only material non‐IT‐based control weaknesses are compared.FindingsAs expected, substantial fee differentials were identified for companies reporting material IT‐based control weaknesses as compared to both companies without any material weaknesses and those companies with only non‐IT related material weaknesses.Originality/valuePreliminary evidence in regard to the costs of SOX 404 compliance for stockholders is provided. The cost of SOX 404 compliance has often been cited in criticisms of SOX, yet the focus of SOX is not on corporate wealth, but rather on enhancing corporate governance to protect the interest of stockholders. The cost of SOX compliance across the number of reported outstanding common shares for the companies studied is factored. It is found that the increased cost of audit fees on a per share basis is higher for companies reporting IT material weaknesses.

Cross-border acquisitions and firm value: An analysis of emerging-market multinationals

The primary objective of this study is to examine the value implications of cross-border acquisitions of emerging-market multinationals (EMMs). We examine 433 mergers and acquisitions announcements associated with 58 EMMs during the sample period 1991–2004. The mergers and acquisitions announcements data come from the Thomson SDC Platinum database. We employ event study methodology to explore the impact of the announcements on the value of acquiring firms. The results show that, on average, cross-border expansions of EMMs through acquisitions do not create value, but point to value destruction for more than half of the transactions analyzed. To explore the factors influencing the direction and magnitude of market reaction, we analyze a cross-sectional sample of firms. While we find that target size, ownership structure of the target (private vs public), and structure of the bidder (diversified vs non-diversified) positively affect the bidder value, high-tech nature of the bidder and pursuit of targets in related industries negatively affect the bidder value. Our empirical findings provide some support for the positive impact of the stake pursued in the target firm and cultural distance, but not for the international experience and enhanced corporate governance.

Corporate Governance in Emerging Economies - Case Study of Uganda

Corporate governance is becoming an important issue in all emerging and advanced economies. Considering the factors that shape Britain's system of corporate governance helps one to understand the trends which have emerged. In Uganda, various efforts to enhance corporate governance have been made by many organizations including Bank of Uganda, The Institute of Corporate Governance of Uganda, and the Capital Markets Authority (CMA). The CMA developed guidelines in February of 2003 as a minimum standard for good corporate governance practices by public companies and issuers of corporate debt in Uganda. This development in the regulatory framework of the CMA was prompted by the growing importance of governance issues both in emerging and developing economies and for promoting domestic and regional capital markets growth. The objective of these guidelines is to strengthen corporate governance practices by listed companies in Uganda and promote the standards of self regulation so as to bring the level of governance in line with international trends.