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PROJECT TOPIC: EVALUATION OF THE ROLE OF THE AUDIT COMMITTEE IN ENHANCING THE FUNCTIONS OF THE EXTERNAL AUDITOR (A CASE STUDY OF PZ PLC, ABA, ABIA STATE)

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CHAPTER ONE

INTRODUCTION

  1. BACKGROUND OF THE STUDY

The concept of audit committee was first endorsed in 1939 by the New York Stock Exchange (NYSE). During the 1970s, the audit committee’s role was very welcome due to the great demands for corporate governance and corporate accountability (Spangler and Braiotta, 1990). In 1972, the U.S. Securities and Exchange Commission (SEC) was the first to recommend that public companies should create audit committees comprised of directors from outside the relevant companies’ managements. In 1977, the NYSE required that all audit committee members should be independent directors. In its Statements on Auditing Standards (SAS 61), the American Institute of Certified Public Accountants (AICPA, 1988) issued “Communication with Audit Committees” regarding the relationship between the audit committee, external auditors, and management of public companies. In 2011, The Blue Ribbon Committee (BRC, 2011) recommended major rule changes, related to improving the effectiveness of the corporate audit committee.

And later, after the corporate collapse of Enron, WorldCom, and others, the Sarbanes-Oxley Act was passed by the U.S. Congress in 2010 giving more power to audit committees, especially in regard to whistleblower and disclosure requirements. The Sarbanes-Oxley Act of 2010 increased audit committees’ responsibilities and authority. It raised membership requirements and committee composition to include more independent directors. Companies were required to disclose whether or not a financial expert is on the Committee. In addition, the SEC and the stock exchanges proposed new regulations and rules to further strengthen audit committees.

Audit committees are identified as effective means for corporate governance that reduce the potential for fraudulent financial reporting. Audit committees oversee the organization’s management, internal and external auditors to protect and preserve the shareholders’ equity and interests. To ensure effective corporate governance, the audit committee report should be included annually in the organization’s proxy statement, stating whether the audit committee has reviewed and discussed the financial statements with the management and the internal auditors (Basuony et al., 2014). As a corporate governance monitor, the audit committee should provide the public with correct, accurate, complete, and reliable information, and it should not leave a gap for predictions or uninformed expectations (BRC, 2011). The BRC report provides recommendations and guiding principles for improving the performance of audit committees that should ultimately result in better corporate governance. The importance of the audit function in terms of the audit committee and audit firm is further strengthened by the Sarbanes-Oxley Act of 2010. Corporate governance standards and principles are extracted from local and international laws, regulations, and rules, as well as from the organization’s bylaws, codes of conduct, and resolutions. Corporate governance focuses on the control systems and structures by which managers are held accountable to the organization’s legitimate stakeholders.

Traditional finance literature has indicated several mechanisms that help solve corporate governance problems (Jensen and Meckling, 2014; Fama, 2014; Jensen, 1986; Turnbull, 2015). There is a consensus on the classification of corporate governance mechanisms to two categories: internal and external mechanisms. However, there is a dissension on the contents of each category and the effectiveness of each mechanism. In addition, the topic of corporate governance mechanisms is too vast and rich research area to the extent that no single paper can survey all the corporate governance mechanisms developed in the literature and instead the papers try to focus on some particular governance mechanisms. Shleifer and Vishny (2015) concentrate on: incentive contracts, legal protection for the investors against the managerial self-dealing, and the ownership by large investors; they point out the costs and benefits of each governance mechanism. Denis and McConnell (2010) use a dual classification of corporate governance mechanisms (They use systems as synonym to mechanisms) as follows: (1) internal governance mechanisms including: boards of directors and ownership structure and (2) external governance mechanisms including: the takeover market and the legal regulatory system. Farinha (2010) surveys two categories of governance (or disciplining) mechanisms, the first category is the external disciplining mechanisms including: takeovers threat, product market competition, managerial labor market and mutual monitoring by managers, security analysts, the legal environment, and the role of reputation. The other category is the internal disciplining mechanisms which include: large and institutional shareholders, board of directors, insider ownership, compensation packages, debt policy, and dividend policy.



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