Navigating knowledge and ignorance in the boardroom

Shareholders elect directors to protect their interests within a company. They count on directors to ensure that the company is well run, that it follows applicable rules, and that management acts in the interest of the company’s owners.

For money matters, shareholders rely on a special group of directors called the Audit Committee (AC). Audit Committee Members (ACMs) are mainly responsible for overseeing the company’s financial reports and control systems. The work they do is considered to be critical to maintain investors’ trust in the company and its financial reporting.

In Canada, the NI 52-110 (National Instrument 52-110) sets out the rules for ACs and ACMs. For example, it requires that ACMs be financially literate enough to understand financial statements. Even though the NI 52-110 lists ACMs’ oversight responsibilities, however, it doesn’t explain how they should exercise that oversight on a day-to-day basis.

Given this lack of clear guidelines and the financial and governance scandals that regularly make the headlines, one can wonder if current regulation is enough to prevent big corporate failures.

“Considering the critical role of ACs in ensuring sound and effective financial reporting processes for investors, we need more research on what ACMs actually do to oversee financial reporting processes,” says Oriane Couchoux, Assistant Professor of Accounting at Carleton’s Sprott School of Business. “How do ACMs understand and perform their role on ACs?”

To answer this question, Oriane interviewed 21 ACMs between May 2018 and June 2019. Fourteen of the participants were CPAs. She asked about their professional background, their work as an ACM, and their knowledge of the rules pertaining to ACs. She also asked how they work with others in the financial reporting world and how they handle their duties before, during, and after AC meetings.

Interview responses show that ACMs develop and adopt different oversight styles: (1) “observing” ACMs have a hands-off approach to accounting issues and focus more on future plans or resource allocation; (2) “inspecting” ACMs spend a lot of time scrutinizing financial disclosures for compliance and accuracy; and (3) “storytelling” ACMs focus on making sure that shareholders will find the financial reports clear, easy to read, and easy to understand. While hybrid approaches are possible, ACMs tend to use the style that best matches their expertise and professional experience prior to joining the AC.

These various styles may explain why there is conflicting evidence about whether ACs make a real difference in corporate governance as some styles may contribute more effectively than others to governance processes. They also raise the question of whether diverse styles among ACMs prompt ACs to address various priorities and work better or create covert conflicts that limit their overall impact.

Oriane’s research was published in Contemporary Accounting Research and funded by the Social Sciences and Humanities Research Council of Canada (SSHRC), Canadian Foundation for Governance Research, and CPA Ontario Centre for Corporate Governance & Accountability.