Good governance is pivotal for an organization’s smooth running and corporate success. However, for that to be the case, an organization needs to assess its governance frameworks, policies, and operations, necessitating a corporate governance audit.
During a corporate governance audit, the auditing team examines the organization’s governance structure and communicates the findings and suggestions to key stakeholders. Effective governance audits ensure an organization maintains transparency, high-level accountability, and unquestionable ethical conduct.
Companies can conduct internal or external governance audits to assess their operations and internal controls properly. In the long run, the audits measure the organization’s governance status and corporate health and help the board and top management determine the next course of action.
However, choosing or building the right governance audit team for either an external or internal audit exercise is essential. Such a team should demonstrate attributes like independence, integrity, and proactiveness.
But do companies need to audit their corporate governance structures? What do they stand to gain by doing that? More importantly, how is the process? This guide will answer those questions and explore everything about corporate governance audits, especially their scope and benefits. Let’s dive in!
Key Takeaway:
- A corporate governance audit is a professional way of assessing and reviewing an organization’s governance structure, protocols, and operations.
- Corporate governance audits focus on board composition, regulatory compliance, ethical practices, financial reporting, corporate citizenship, risk management, disclosures, shareholders’ rights and responsibilities, and stakeholder relationships.
- Effective corporate governance audits are beneficial as they contribute to transparency, accountability, risk mitigation, operation efficiency, ESG impact, improved compliance, improved decision-making, investor confidence, and better governance.
- Every corporate governance audit involves four key phases: planning & preparation, testing, reporting, and communication.
- While internal and external audits are essential for effective corporate governance, they differ in objective, member constitution, qualification requirement, reporting, and publicity.
- Characteristics of an effective governance audit team include independence, integrity, proactiveness, competence, and collaboration.
What’s a Corporate Governance Audit?
A corporate governance audit is a detailed review and assessment of an organization’s corporate governance frameworks, practices, and day-to-day processes. Its goal is to evaluate the extent to which the organization adheres to its governance principles, rules, and guidelines.
A corporate governance audit usually involves systematically examining fundamental elements like board composition, compliance, risk management, and ethical practices, which we shall discuss next.
Corporate Governance Audit Scope
While a company’s corporate governance audit approach may differ depending on the auditing team, its scope focuses typically on the following:
1. Board Composition
So many things go into constituting an effective board of directors. Boards must reflect diversity and inclusion when deciding who should sit around the boardroom table, which means observing gender balance, diverse backgrounds, and varying experience levels.
Overall, everyone on the board should be there on merit. If that’s not the case, the audit will point it out, and it’s up to the company leadership to take the right course of action, depending on the audit recommendation.
2. Regulatory Compliance
Every organization is obliged to comply with all applicable regulatory standards and policies. Failure to do so could result in hefty fines, expensive court battles, license withdrawals, and sometimes a total shutdown of business operations.
Before a company can do that, a governance audit can help identify the gaps that need bridging. Once the directors or audit committee receive the audit report with suggestions, they should share it with key stakeholders who can facilitate the required action.
3. Ethical Practices
Ethical leadership is a fundamental pillar of good governance. Thus, any corporate governance audit should focus on it alongside other pillars. During the audit, the company’s ethical practices are assessed and weighed against existing standards and codes of conduct to ensure the company is fulfilling its moral responsibility.
4. Financial Reporting
Governance audits examine an organization’s financial reporting culture to ensure transparency and accuracy. The auditing team determines whether there are discrepancies, intentional errors, or inconsistencies in budgeting, asset allocation, or data entry. Ultimately, this helps maintain the company’s integrity in financial reporting.
5. Corporate Citizenship
Corporate citizenship refers to how a corporate entity exercises its rights, responsibilities, and privileges. It also relates to a company’s actions to promote socio-economic and environmental effects in its community.
Corporate citizenship is founded on economic, environmental, and social responsibility pillars, which are measurable during a corporate governance audit. A governance audit can help determine if a company meets its corporate social responsibility (CSR).
6. Risk Management
A governance audit assesses an organization’s risk management structures to identify potential threats and measure the effectiveness of existing risk mitigation strategies. The audits look into the organization’s processes to carefully uncover probable corporate governance threats and devise measures to counter their effects or avoid them entirely.
7. Disclosures
Governance audits also focus on a company’s protocols for revealing relevant information to the public by assessing its existing disclosures. It focuses on the quality and transparency of the company’s financial reporting and decision-making process to ensure that everything is clear to stakeholders and that they get to know what they need to know.
8. Shareholders’ Rights and Responsibilities
Shareholders have rights that must be respected and obligations or responsibilities to meet. A corporate governance audit can help a company assess whether that’s the case and the extent to which shareholders exercise their rights and responsibilities.
Concerning their rights, an audit checks for equitable treatment among shareholders and their right to vote and decide who should join the board. As for their obligations, the audit can measure their level of contribution and if, indeed, they are contributing anything at all besides finances.
9. Stakeholder Relationship
Corporate governance is only effective when the relationships between various stakeholders are solid and everyone understands their roles and rights. That includes shareholders, consumers, suppliers, employees, trade associations, government agencies, and the community. A governance audit can help assess the strength of these relationships.
Why Do a Corporate Governance Audit?
Corporate governance audits are beneficial regardless of whether internal or external. Here are the general benefits:
a) Transparency
During a governance audit, everyone must provide the needed information and answer the audit team’s questions. The board, in particular, should be willing to share information on the company’s financial health, business operations, and existing risks with the audit team.
An audit exercise ensures that the information provided is accurate and timely. Once the staff, management, or board recognizes this will always be the case during an audit, they’ll strive to be transparent in their duties and mandates.
b) Accountability
An audit doesn’t just help improve transparency but also fosters a culture of accountability. Everyone understands that they are answerable for the decisions they make and the actions they take as part of the company. They can back up their decisions with reasonable explanations and facts.
An audit can help determine who should be accountable if something goes wrong. Accountability requires that the affected individuals admit their mistakes and make amends. There can only be accountability without transparency, as the two are essential building blocks of corporate governance.
c) Risk mitigation
An audit helps identify threats and weaknesses in a company’s governance structure, making it easy to take proactive steps to mitigate risks. Ultimately, this saves the company from substantial financial loss or reputational ruin.
d) Operation efficiency
Governance audits can help identify areas a company needs to address to improve its operational efficiency. An audit pinpoints the processes that need streamlining, including areas that result in resource wastage or those that need optimization of company resources. In the long run, improved operational efficiency translates to cost efficiency and profitability.
e) ESG impact
Good governance audits help measure a company’s ESG (environmental, social, and governance) efforts. They identify areas within the company’s ESG aspects that need improving or are risk-related. Ultimately, governance audits improve a company’s corporate social responsibility.
f) Improved compliance
Regular governance audits help a company meet all its regulatory and legal obligations. Thanks to an audit culture, all financial statements, for instance, are prepared per existing accounting guidelines and tax regulation standards.
g) Improved decision-making
Governance audits help improve decision-making by focusing on transparency, accountability, and effective financial reporting. The board can easily identify areas to work on to make better decisions, and insights into the company’s financials and operations can help develop better action steps.
h) Investor confidence
Improved transparency and accountability boost investor confidence. Investors trust the board and upper management more with their investments. There’s also the aspect of ethical compliance, where investors are assured of healthy ethical practices since audits keep everyone on their toes and answerable for their actions.
i) Better governance
Audits ultimately promote better corporate governance. A company can identify areas in the decision-making and policy-making processes that need fixing or extra effort through audits. Moreover, an audit helps realign a company with its mission statement and values, leading to better corporate governance.
How Does Corporate Governance Audit Work?
The process of carrying out a corporate governance audit may differ, depending on the auditing team and its level of expertise or the size of the client firm. However, all audits go through these four phases:
Phase 1 – Planning & Preparation
During the planning & preparation phase, the auditing team first establishes a complete understanding of the client company’s operations and develops the scope of the governance audit. Moreover, the audit team identifies major risks, determines critical objectives, and formulates an effective audit plan.
Phase 2 –Testing
The auditing team comprehensively tests the organization’s transactions and financial records during the testing phase. The team also tests its internal controls, conducts relevant interviews with employees and other stakeholders, and gathers relevant evidence.
Phase 3 – Reporting
Upon correcting evidence and relevant information from the testing phase, the auditing team has to verify all sources for accuracy and reliability, after which the team documents everything. The reporting phase involves creating detailed audit reports highlighting the key findings and overall assessment of the organization’s performance.
Phase 4 – Communication
This last phase involves communicating their findings to the board of directors, the audit committee, or whoever else the audit team reports to. The goal is to offer suggestions to help fix the need gaps and improve the company’s overall corporate governance structure.
Role of Internal Audit in Corporate Governance
A company may do an internal audit of its corporate governance framework where members of the audit team are company employees and report to the board of directors or the audit committee.
In such a case, the goal of the audit team is to ensure the effectiveness of the company’s internal controls, the smooth running of its systems, and strict adherence to internal protocols and procedures. Moreover, the internal audit checks for fair financial reporting
Overall, an internal audit fosters a solid ethical culture by:
- Uncovering and reporting probable ethical breaches such as accounting fraud, staff misconduct, and conflict of interest
- Boosting the organization’s ethical awareness culture
- Measuring the effectiveness of the company’s ethical compliance protocols, especially those touching on financial reporting and company operations
- Examining, monitoring, and measuring a company’s internal control measures
- Assessing the overall effectiveness of a company’s corporate governance efforts and culture
Role of External Audit in Corporate Governance
While an internal audit team can help measure the effectiveness of a company’s internal controls and adherence to internal processes and standards, companies may need an independent opinion from outside, and that’s where an external audit team comes in.
An external audit team’s opinion is usually unbiased since the team has no affiliation with the company or its management. Moreover, the auditing team reports to key stakeholders whose interests it represents. They don’t directly report to the board or board committee, as with internal auditors.
Overall, external auditors are instrumental in a company’s corporate governance efforts by playing the following roles:
- Issuing independent audit opinions on the company’s financial reporting, business operations, and board performance, among other areas of corporate governance interest
- Evaluating a company’s internal controls – same as internal audits
- Measuring accountability, especially by the board and top-level management
- Representing shareholder interests as they usually report to them
- Assessing a company’s risk mitigation efforts and crisis management effectiveness
- Fostering good relationships with applicable stakeholders
Internal Vs. External Governance Audit: What’s the Difference?
Internal and external governance auditors may be performing the same job of auditing the client company’s corporate governance structures and frameworks, but they differ in a few ways. Here’s a table breakdown of their differences:
| – | Internal Governance Audit | External Governance Audit |
| Objective | An internal audit team’s objective is to add value to the company. It identifies areas in operations and internal controls that need improvement. | An external audit team’s objective is to offer independent views on the company’s financial standing. |
| Member Constitution | Members of an internal audit team usually come from the company. They are company employees. | Unlike an internal audit team, an external audit team is outsourced to offer an independent opinion. |
| Qualification Requirements | No legal requirements exist for qualifying to be part of an internal audit team. | Legal requirements are met for anyone applying to be part of an external governance audit team. |
| Reporting | Internal auditors report to the board (of directors) or the audit committee. | External auditors report directly to the shareholders. |
| Publicity | Audit reports are privately produced and shared. | Audit reports are publicly available. |
Characteristics of an Effective Corporate Governance Audit Team
A corporate governance audit team should demonstrate several qualities to be effective. These qualities include:
- Independence: The governance audit team must be independent, even if it’s an internal group. Management or any other stakeholder shouldn’t influence its assessment and decision-making, and the reporting should be unbiased and objective.
- Integrity: The audit team should demonstrate the highest ethical standards and uphold professional integrity during the audit to ensure honest and accurate reporting.
- Proactiveness: A good governance audit team should be forward-thinking. It should anticipate risks and suggest proactive steps that the company can take to mitigate or avoid them entirely.
- Competence: The governance audit team must possess the skillset, knowledge, and professional experience to conduct the audits successfully. That’ll guarantee effective outcomes as far as the company’s corporate governance is concerned.
- Collaboration: Though the auditing team should remain independent, that doesn’t mean they cannot collaborate with the board, audit committee, or whomever they report to about their progress. Good collaboration makes their job easier, enabling the board or audit committee to know what to expect as the exercise continues.
Wrapping Up!
Regular audit exercises are essential for an organization’s corporate governance efforts. The audit leads to better corporate governance, and all organizations need it. We at the Center for Corporate Governance understand that.
Consequently, we conduct board evaluation exercises and corporate governance audits to help our client companies identify and address gaps in their governance frameworks.
Moreover, we run a five-day monthly training on corporate governance, covering various subjects, including board and board committee responsibilities, ethical leadership, ESG compliance, strategic direction setting, and corporate governance reporting.
We invite everyone from board members and top CEOs to entrepreneurs, compliance officers, and business owners to check out this program on our website.
