Role of internal audit in improving corporate governance

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Corporate governance is a priority for investors the last decade, as the in-house factors seem to play increasingly important role in defining the competitive position of business in the global economic environment. Corporate governance defines the relationships between the three pillars of modern enterprise, which are the shareholders, the directors and the board. (Milton H.; Raviv A., 1998; Monks A.G.; Minow N., 2007)


Internal control can be defined as the set of processes, rules, methods and verifications to ensure the protection of company assets and the effective implementation of the strategy. This definition of internal control reflects the following fundamental concepts:

Internal control is a process. It is not one event, but a series of ongoing actions and activities that occur throughout each agency's operations and should be an integral part of each agency rather than an add-on system within an agency.

People are what make internal control work. While the responsibility for good internal control ultimately rests with management, all agency personnel play important roles.

No matter how well designed and operated, internal control can provide only reasonable (not absolute) assurance that all agency objectives will be met.

Internal auditing is an independent appraisal activity established within an agency for the review of operations as a service to management. The objective of internal auditing is to assist agency staff in the effective discharge of their responsibilities.

Internal auditors examine and evaluate the planning, organizing, and directing processes to determine whether reasonable assurance exists that the agency will achieve its goals and objectives. Such evaluations, in the aggregate, provide information to appraise the agency’s overall control system and the quality in implementing assigned responsibilities. All systems, processes, operations, functions, and activities within an agency are subject to evaluations by internal auditors.

The internal control system is an element of the agency whose exclusively responsibility lies with the relevant responsible bodies. It is a functional subsystem of the larger system of the body characteristics and autonomy of a system and as such considered and evaluated by the internal auditor. (Papastathis P., 2003; Kazantzis Ch., 2006; KPMG, 2008)


The management of internal control is a well-organized section that provides high quality services to business and the requirements that exist are too many. It is staffed by qualified and highly trained personnel and recommend relative to the upper levels of management to take corrective measures. It is an independent function that directly attached to the administration.

The position that the internal control has in the chart of the business depends on the size of the company. In the case of a great operation, which provided overall directions it is automatically provided establishment of management internal control. The higher in the hierarchy is internal control is so close to the administration, has a higher profile, greater freedom of movement, greater independence, upgraded role and can provide high quality services. The internal audit of a company is formed according to whether the company is listed on Stock Exchange or not. If not listed, then the internal audit is more effective when it belongs directly to the CEO. When a company is listed on Stock Exchange, then the internal control must be monitored by a supervisory body called the Audit Committee. (Hermalin B. ; Michael W., 2001)

The Audit Committee of a company established by the Board of Directors, from where it derives its authority. It is advisory in nature and, as is an extension of the administration, powers, responsibilities and authority are raised. As duties and responsibilities could be mentioned the following:

It is responsible for issues related to the adequate functioning of the agency's organizational structure, evaluation of the procedures and also checks for issues relating to strategy and business policy.

It is responsible for reviewing at regular periods of time, the

existing organization and activities of the company and to verify the adequacy or not of organization, and a possible deviation from the approved by management policy. Shall indicate weaknesses and prescribe the appropriate corrective measures.

Supervises, along with the management or the CEO, the

Internal Audit and is in constant contact with her, so as to ensure suitable conditions for the exercise of Internal Audit.

Works directly with the Internal Audit Department finalizing the annual audit program, and issues of strategic importance, characterized its high business risks.

It has the responsibility of the final findings and reports prepared by the

Internal Audit and deliberately discuss the recommendations of the Directorate with relevant departments of the company.

Finally, ensures the participation of the head of the Internal

Control in discussions with the Administration on issues of vital importance. (AICPA Committee On Auditing Procedures; McMullen D.A.; Raghunandan K. 1996)

The role of external auditors in an economy where the operation of financial markets is of fundamental importance is judged particularly serious. The auditor should be distinguished for objectivity, impartiality, independence and quality of his work. Factors that affect the auditor’s independence, hence decrease the audit quality are: the provision of specialized administrative services, other than auditing, by the external auditor to the company audited, the number of years of collaboration between auditor and company, existence and composition of auditing committees, the previous relation of external auditor with the company-customer, the severity of legal system and the hours of auditing. (Hermalin B. ; Michael W., 2001)


Internal audit plays an important role in implementing the principles of

Corporate Governance. Transparency, consistency and accountability are issues that determine the objectives of internal audit, which evaluates and records the internal procedures in practice, highlights gaps and weaknesses in the system and provides advice and makes adjustments. The purpose of internal control is the

contribution to the development and the consolidation of corporate culture between departments and executives of the company and to adapt the company's existing institutional framework. (Allen S., 2008)

Internal audit is actually a mechanism for monitoring implementation of

principles of corporate governance, contributing a large percentage of the company to protect and safeguard the interests of shareholders. The internal audit management the ensuring that everything works in the manner provided and extends beyond the accounting and financial functions covering the entire width of the company and deals with all activities of the organization. (Baker C.R.; Owsen D.M., 2002)

The importance is given to internal audit and the existence of

audit committee can be seen from the code on Corporate Governance adopted in all countries. Namely the Code of the Cadbury, based on which most corporate governance codes in the World, says that companies should establish Internal Audit Committee composed of a majority of non-executive Directors.

In the case of Cadbury Report (1992) the main recommendations that made were the following:

The non-executive directors should not be dependent of management and also the majority of them must be free from other obligations or business

The contracts must expire after three years

And as we mentioned above an Audit committee must be established and composed from at least three non-executive directors (Cadbury A., 1992; Dahya J.; McConnell J.; Travlos G.,2002)

After Cadbury report (1992) and Greenbury report (1995) a committee established in 1996 in order to revise the recommendations of the upper two reports. The new report called Hampel report and was made in order to give emphasis in principles of good governance. In 2003, Derek Higgs published a report, which examined the role of non-executive directors and specified their obligations as following:

The non-executive directors must make contributions to corporate strategy

They must monitor the performance of executive management

And finally, they must remunerate the executive directors (Hampel R., 1998; Higgs D., 2003)

In 2010, the Financial Reporting Council (FRC) has published a new Combined Code. The new code gave additional responsibility to the role of chairman. The new code refers to risk and includes principles in order to avoid them. A great change is that non-executive directors now can help on the development of proposals that made for strategy issues. Also, all directors of listed companies must be re-elected annually by shareholders. Finally, there is an expanded supporting principle that enforces all the directors to be aware of their main shareholders. (Combined Code, 2010)


Speculative attacks and events of business scandals and failures have been recorded historically in the capital markets worldwide. From the bubble of South Sea Company in 1720 in Britain, the panic of 1873 in New York Stock Exchange and the great crash of 1929 until the collapse of Wall Street in 1987 and recent accounting scandals and bankruptcies of large companies such as Enron, the WorldCom and AIG, the main issue remains the effective protection of shareholders.

ENRON was an American company founded in 1985 as a provider of natural gas. In 1999 acquires its own website on the internet at introducing the global energy trading company and contracts. The company converted from a natural gas company a global leader in oil, gas and electricity. The value of the stock reaches $ 45 per share. In 2000, the value amounted to $ 91 per share. In 2001, the company's president Sherron Watkins wrote an anonymous letter to the chief executive Ken Lay that the company faces serious problems with various collaborations that has made concerning the audit

part of these, the role of Head of Finance and Administration in them and the potential negative impact if they would disclosed information on the various investment markets.

At the same time the company sold shares worth $ 41 million. Other members of the company sold $ 71 million in shares. After the terrorist attack of September 11 the share price falls to $ 28 per share. One month then the company makes reference to about $ 618 million loss in the third trimester, which combined with previous reports, amounted to 1.2 billion dollars. (Gudikunst A., 2002)

The Long Distance Discount Services, Inc (LDDS) began in 1983 in Hattiesburg Mississippi. In 1985 LDDS selected Bernard Ebbers to be CEO. The company went public in 1989 through a merger with Advantage Companies Inc. The company name was changed to LDDS WorldCom in 1995, and later at WorldCom. The development of the company “ WorldCom” was fueled primarily through acquisitions during the 1990's and reached its apex with the acquisition of MCI value of 37 billion U.S. dollars in 1998 making it the largest merger in U.S. history. On October 5, 1999, the Sprint Corporation and MCI WorldCom announced a 129 billion U.S. dollars agreement to merge the two companies. The Bernard Ebbers became very wealthy from the rising price of the shares into common shares of WorldCom. However, shortly after the acquisition of MCI in 1998, the telecommunications industry entered a recession and WorldCom's growth strategy suffered a serious blow when he was forced to abandon its proposed merger with Sprint in late 2000.

Starting in 1999 and continuing until May 2002, the company (under the direction of Ebbers, Scott Sullivan (CFO), David Myers (Controller) and Buford "Buddy" Yates (Director of General Accounting)) used deceptive accounting methods to Hide reducing profits drawing a false picture of economic growth and profitability to support the share price of WorldCom. On July 21, 2002, WorldCom applied for bankruptcy protection. Under the reorganization agreement, the company paid 750 million U.S. dollars to the Securities and Exchange Commission in cash and shares of new MCI. (WorldCom Fraud Information, available at: accessed at: April 14, 2011)