Assistant Professor, Management Sciences Department Bahria University
Islamabad. E-mail: ajabburki07@gmail.com
Abstract. The internal audit is a primitive
element for good corporate governance. This need has been largely felt in the
developing countries to enhance and promote the corporate governance mechanism.
This research evaluates the implication of internal audit of Multinational
Corporations (MNCs) of Pakistan on corporate governance’s quality. The outcomes
of this research reveal significance of internal audit role in corporate
governance of MNCs. The significance of audit committee and management in this
aspect is predominant. Similarly the results also show the vitality of
corporate governance in terms of quality is significant when there is independent
audit department with requisite expertise of auditing. However, the reliability
of internal audit is primarily determines the characteristics of management of
corporate governance. Contrary to this, the implication of internal audit is
insignificant on the external audit workers as well as the board of directors
of MNCs in Pakistan.
Key words: Corporate Governance, Internal Audit, MNCS, Pakistan.
Introduction
This study
adds on value in producing a greater understanding into the implication of quality
of internal audit and corporate/organizational governance mechanisms in MNCs
working in Pakistan. The significance and efficacy of these results is valuable
for the regulators, investors, and overall stakeholders for their requisite
concerns in terms of value creation and performance.
The purpose
of this paper is to estimate the implication of good internal audit practices
on the organizational/corporate governing practices in MNCs of Pakistan. The
relationship in terms of quality of internal audit performance and its due
implications on organizational/corporate governance has been redefined in
larger spectrum (Abdullah, 2014; Sarens, et al., 2012).
The
importance of sound internal audit performance and the up-to-mark mechanisms of
organizational/corporal governance have becoming very imperative after the
world financial crisis of 2007-09 (Mohamad & Sori, 2011).
Literature Review
In the recent
two decades, the importance of corporate governance has gained a tremendous
attention because of various notorious financial scandals happened. The
critical aspect related to the smooth functioning of corporate governing is the
quality of internal audit of the firms. Due to financial turmoil and scandals,
that hampers many businesses across the globe from smooth working which
resultant in the economic activity deterioration which caused the higher
inflation and lowering the purchasing power of the incumbents (Ibrahim, 2011).
The
Securities Exchange Commission of Pakistan has initiated a strong and bold step
for the codes of corporate governance in 2002. These codes are better aligned
with the international codes, standards and guidelines for effectively
protecting the incumbent stakeholders. The essence of deploying good corporate
governance is to attain the sustainable economic development by increasing and
invigorating the requisite resources of the corporations for better financial
performance and attaining maximization of shareholders’ value at the end. Good
corporate governance mitigates the clashes of interests and aligns the
interests of all stakeholders in the better prospects of the corporations on
win-win phenomena. Congenial corporate governance reduces the clashes of
interests between shareholders and the management (Jensen & Meckling,
1976). The effective corporate governance places high value and satisfaction
for both entities by protecting their interest and attaining the overall goal
of the corporation with efficiency.
Internal audit function
Internal
audit is defined by Reding, et al. (2013) is a unit that provide a thorough
insights to the management and boards in terms of internal control, risk
management, governance parameters for the reasons to improve upon the
governance aspects, operational efficacies (reporting and compliance as per
standards) to cope up the strategic goals and objectives. The internal audit
function is having significantly positive association with
organizational/corporate governance mechanisms for improving upon the
strategies for risk management by augmenting the internal control, enabling
management for taking corrective measures when needed and catering all inputs
of audit committee for reaping more sophisticated outcome for the achievement
of the organizational objectives (Sarens, et al.,
2012).
The internal
audit provides with a deep insight of understanding the imminent risks with
appropriate suggestions and recommendations to hedge and mitigate it (Jie,
2012). Internal control is imperative for the system in terms of safeguarding
organizational assets and ensuring all the activities of the businesses
according to the incumbent organizational policies and rules. The domain of
internal control can be versatile i.e. financial as well as non-financial aspects
of the organization for its management and control. The internal audit function
is responsible for coping up with the adequate control of the organization for
ensuring smooth running of it (Boghean & Boghean, 2013).
According to
El-Kassar, et al. (2014) determined that the internal audit functions
critically impacting the organizational/corporate governance specifically for
audit committee and administration. Furthermore, the independence of audit
department with its due expertise is having far reaching positive implications
on the mechanisms of good corporate governance. Besides, it is also impacting
the characteristics of management in general.
The internal
audit is highly imperative for effective corporate/organizational governing
practices in any business environment for effectively coping up the objectives
of the management for enhancing value creation of stockholders. This is based
on the notion of effectively protecting their rights from any undue influences
(Mihiotis, & Konidaris, 2007). The importance of internal audit is highly
recognized throughout the whole globe after promulgation of Sarbanes-Oxley Act
of 2003. The core theme was to protect the incumbent shareholders by protecting
from unwanted anomalies happening in the businesses with the perspective of
adding more value in the requisite organization (D’Silva & Ridley, 2007).
Organizational/corporate governance
The
objectives of any organization can’t be effectively achieved without having
efficient organizational/corporate governance in place. The most imperative
role resides on the shoulders on board of directors for effectively deploying
the corporate governance mechanisms in true spirits. Their presence
necessitates that all the departments should congruently work for catering the
envisaged vision and objective for achieving higher value creation efficiently.
On the other hand, the external auditors provide the unbiased and impartial
reports regarding the working activities of the internal governance structure
for their boards and management’s role played for the creation and
sustainability of value for the shareholders (Saltaji, 2013).
The essence
of effective corporate governance has been initiated and coined by Organization
for Economic Cooperation & Development-OECD in 1999 as the mechanisms and
system through which corporations would be controlled and run effectively for
the better interest of the organization and stakeholders. This has been
validated by Kirkpatrick (2009). Similarly, Cadbury (2010) defined the
organizational/ corporate governance as it keeps balance between social and
economic goals of the organization.
The Method
Design
This research
utilizes comprehensive and objective questionnaire to determine and estimate
the implication of internal audit functionality and its due implications on
corporate/organizational governance parameters and practices deployed in MNCs
of Pakistan. The incumbent questionnaire entails questions regarding various
aspects related to the mechanisms of corporate/organizational governance: For
instance, Top Management; Board of Director; audit committee; external and
internal audit. The incumbent questionnaires were distributed to the internal
employees of the organizations i.e. heads/executives of internal audit; Heads
of audit committee; and chief executive officers for knowing the importance of
internal audit in shaping effective mechanism. For reliability and accuracy,
the survey results have been measured.
Methodology
An objective
questionnaire has been designed from the previous questionnaires of King 2 and
3 to determine relationship between the organizational/corporate governance
mechanisms in association to top management; board of directors; audit
committee; the quality work of internal as well as external auditors.
This study is
utilizing the suitable sample of 100 questionnaires distributed to the top
executives (Chief Executive Officers-CEOs); Heads of audit committee; and heads
of internal audit units. The completed questionnaires returned were 72. Each
questionnaire comprised a total of 34 related queries about the internal audit
and organizational/corporate governance mechanism in MNCs of Pakistan (a detailed
questionnaire can be found as Appendix-1 at the end).
·
The first section comprising questions related to demographics
·
The second section comprising questions related to internal audit
function quality
·
The third section comprising questions related to examine the
requirements and features of corporate/organizational governance.
This study
utilizes 5 points Likert scale for measurement. The scores obtained are
averaged of organizational/corporate governance quality mechanisms (CGQ) and
internal audit quality (IAQ). Besides the 03 sub-calculated internal audit
measures in terms of quality are determined as:
Ø The freedom and
independence of internal audit determined by IAQ-1 (IAF: 01 to 04).
Ø The trustworthiness
of internal audit practices/functions determined by IAQ-2 (IAF: 05 to 09).
Ø The testimonials
of audit staff (internal) determined by IAQ-3 (IAF: 10 to 14)
Similarly the incumbent 4 parameters of
organizational/corporate governance quality recognized are given as follow:
Ø The efficacy of
the boards of directors (BODs) determined by CGQ-1 (CG: 01 to 04).
Ø The efficacy of
the committee (audit) determined by CGQ-22 (CG: 05 to 10).
Ø The efficacy of
administration/management determined by CGQ-3 (CG: 11 to 12).
Ø The efficacy of
external audit role determined by CGQ-4 (CG: 13 to 14).
The Results
Statistical
analysis
This part comprises the
statistical analysis of data gathered from the respondents cater descriptive
statistics, correlation and regression analysis. The data from the requisite
respondents are analyzed through descriptive statistics for larger under-standing
of the incumbent association. Besides, the gathered data are analyzed through
correlation and regression for understanding the imperativeness of the given
parameters. The data are analyzed for its reliability. Given the value of
Cronbach alpha, the various aspects relevant to organizational/corporate
governance are obtained in terms of quality, which are: for board of directors’
questions it was 0.821; for audit committee it was 0.832; for management it was
0.758 and for external audit, it was 0.768. Similarly for internal audit, the
Cronbach alpha values were as follow: independence related questions cater
0.835; reliability related questions cater 0.864; and education related
questions of internal audit workers, it was 0.895. Here it is safe to summarize
the outcome achieved through the incumbent objective questionnaires is highly
valid and reliable for thorough and complete analysis.
The outcomes in terms of
demographic can be précised as follow: 82 percent of the questionnaire
respondents were male and 18 percent were female; 67 percent were in the age
bracket of 30 to 40 years -11.80 percent of less than 30, and 20.60 percent
were over more than 40 years of age; Master degree holders stood the highest as
60.30 percent, 25 percent were having bachelor degrees, 8.8 percent were having
high school diploma, and 5.90 percent were having doctorate degrees; 47 percent
were having a CPA qualification, while 7.4 percent were having CFA, and 6
percent were having CIA; 46 percent were having specialization in auditing and
accounting, 44 percent in business administrative studies, and 10 percent in
finance; in terms of experiences, 50 percent were having minimum of 10 years of
experience in the same field while 44.5 percent were having work experience in
between 5-10 years.
The above mentioned facts and
figures in terms of qualifications, knowledge, experience and maturity of
respondents enhances the reliability of the information with trustworthy
conclusion at the end.
The descriptive statistics
regarding the quality of internal audit are scored against IAQ, IAQ-1, IAQ-2,
and IAQ-3. The mean scores were varying in between 4.26 and 4.45. Based on
compiling these results against 5 point Likert scale approach, it shows that
all the multinational corporations working in Pakistan are effectively
complying up with all essential criteria and requirements to cope up with high
quality of independence, skillful internal audit workers and reliability in all
parameters.
On the other side, average for
corporate/organizational governance ratings CGQ, CGQ-1, CGQ-2, CGQ-3, and CGQ-4
put together to be in the range of 4.21 and 4.74. Therefore, all such
corporations have excellent corporate/organizational governance efficiency in
conditions of well-governing boards of directors (BODs), well-working audit
committees, efficient control of management/admiration, and good worth of
external audit workers.
The Discussion
Correlation analysis
Having
obtained the critical value of ±0.240* at significance level of 5%
and critical value of ±0.311** at a significant level of 1%, the
following outcomes can be established:
At 5% degree
of significance, there is no connection and correlation exists between 3
internal Audit’s scores i.e. IAQ-1, IAQ-2, and IAQ-3 offered by correlation
coefficient with lower level. This facilitates the determination of the given
ratings for the implication of internal audit on organizational/corporate
governance of MNCs working in Pakistan.
A
significant correlation occurs between corporate governance quality and
internal audit quality, indicating the largely quality of internal audit and
corporate governance. Corporate governance quality has been found to be having
significantly positive correlation with the freedom of internal audit IAQ-1 at
1% and with the qualifications and knowledge of the internal auditors
represented through IAQ-3 at 5% significance level. While the internal audit
reliability represented through IAQ-2 does not show correlation with corporate
governance quality represented through CGQ. Thus it can safe to conclude from
these findings that independence and level of expertise of internal audit
workers significantly effecting the corporate governance quality.
Considering
and evaluating the rest of the corporate governance sub-measures, it showed no
correlation existed between the board quality represented through CGQ-1 and the
quality of external auditors represented through CGQ-4 with any of the internal
audit scorings. This showed that the internal audit work does not have any
impact on the quality of the board and the functionality of external auditors.
The
quality of the audit committee represented through CGQ-2 has shown with
significant positive correlation with internal audit scorings of IAQ-1 and
IAQ-3 at 1% significance level but its opposite with the reliability measures
at the same significance level. This shows that internal audit impact the audit
committee in terms of effectiveness and functionality while it does not have
any impact on reliability measures.
The quality of management which is represented through CGQ-3 shows
significant correlation with internal audit at 1% level of significance. That
means that internal audit practices has a significant impact on
management/adminstration in terms of quality.
Table 1 Correlation Matrix
|
|
IAQ |
IAQ1 |
IAQ2 |
IAQ3 |
|
CGQ |
0.311** |
0.359** |
0.013 |
0.287* |
|
CGQ1 |
–0.03 |
0.100 |
–0.09 |
–0.09 |
|
CGQ2 |
0.425** |
0.444** |
0.099 |
0.389** |
|
CGQ3 |
0.487** |
0.347** |
0.249* |
0.379** |
|
CGQ4 |
–0.156 |
–0.09 |
–0.16 |
–0.09 |
Regression analysis
Table-2 shows the regression analysis which are as follow: The quality of board and external auditors
represented through CGQ-1 and CGQ-4 respectively, both dependent variables, has
shown no significant effect. This outcome is in line with the already availed
results of correlation coefficients. While the quality of internal audit has
shown positive implication in terms of board independence and qualification of
audit team which could influence positively the audit committee governance
represented through CGQ-2.
At
the end the regression analysis having CGQ-3 (as dependent variable) is
indicating that the internal audit quality clearly impacting the audit
committee domination for its individuality at 1% degree of significance. While
the reliability of internal audit workers along with qualifications are showing
positive significant result at 5% level of significance.
Table 2 Regression
Model
|
Variable |
|
Intercept |
IAQ1 |
IAQ2 |
IAQ3 |
Overall |
|
CGQ1 |
Coefficients |
4.1179 |
0.1127 |
–0.0239 |
–0.040 |
|
|
|
p-value |
0.0000 |
0.4047 |
0.8276 |
0.6557 |
0.8189 |
|
CGQ2 |
Coefficients |
0.0649 |
0.5967 |
0.029 |
0.3389 |
|
|
|
p-value |
0.9580 |
0.0015 |
0.8229 |
0.0098 |
0.00012 |
|
CGQ3 |
Coefficients |
0.3116 |
0.4809 |
0.2986 |
0.2907 |
|
|
|
p-value |
0.7767 |
0.006 |
0.0518 |
0.0276 |
0.0002 |
|
CGQ4 |
Coefficients |
6.1789 |
–0.1656 |
–0.3120 |
–0.008 |
|
|
|
p-value |
0.00012 |
0.5817 |
0.1417 |
0.9649 |
0.4679 |
Conclusion
In the recent
decade there has been an imperative focusing on corporate governance practices
specifically how to improve upon its quality. In this connection, the internal
audit is the main element that determines the effective corporate governance in
firms. This study evaluated the impact of internal audit quality in stimulating
and promoting the corporate governance measures related to the multinational
corporations working in Pakistan. This study analyzed and investigated the
association and relationship between quality of internal audit, reliability,
independence, qualifications and expertise of team working for the firms and
the effectiveness of corporate governance in light of board of directors,
management, committee for audit and external auditors.
The
outcomes show substantial association and relationship between the
characteristics of internal audit quality and corporate governance. It has been
evident that the audit committee and management have been largely affected due
to internal audit quality. Furthermore, it has been revealed that keeping high
grade of independence and audit department expertise, could have significant
implication on the corporate governance quality. Besides, the internal audit
reliability has shown significant implication on management. Contrary to that
the external auditors and the board of directors are relatively less impacted
by the internal audit.
Recommendations
In
light of the above results, it is safe to recommend that
organizational/corporate governance in light of audit committee, the executive
of internal auditors should properly maintain accurate, in-time, reliable and
independent reporting to the head of audit committee and to the top executive
of the organization i.e. CEO for larger disclosures and compliance as per
standards. Apart from that the audit committees are supposed to develop the
annual financial planning couple with budgeting independently. Such development
on the part of audit committee may not bear any influence from the management.
This notion of carrying along with the standards and governmental regulations
would eventually be protecting the interest of the stakeholders in larger
spectrum which would contribute to the smooth functioning of management.
To
cater and enhance the measures of corporate governance, it is imperative to
have a team of internal audit well equipped with appropriate qualifications,
skills, experiences and training to comply audit according to the given
charters and standards independently.
References
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R. B. (2014). Redefining Internal Audit Performance: Impact
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Appendix-1: Questionnaire
The first section comprising six questions related to demographic.
|
01 |
Level of qualifications (High school, Bachelor, Masters,
Doctorate) |
|
02 |
Specialization (banking, business administration,
accounting & auditing ,other) |
|
03 |
Experience (<5 , 5-10 , >10) |
|
04 |
Specialized certifications/qualifications (CIA, CPA,
CFA, no certification, other) |
|
05 |
Age bracket (<30, 30-40, >40) |
|
06 |
Sex (male, female) |
The 2nd section comprising fourteen questions related to
internal audit function quality
|
01 |
Internal audit function’s head has a functional and
effective reporting line to the chairman of audit committee. |
|
02 |
The internal audit head has managerial reporting
link to the chief executive officer (CEO). |
|
03 |
The plan of internal audit and budget are prepared
without taking into account for the senior management recommendations. |
|
04 |
The head of internal audit sees confidentially with
the board of directors or Head of audit committee with-out administration
presence. |
|
05 |
The internal audit department has formal and official
strategy in the shape of audit contract. |
|
06 |
Does the internal audit comply the standards set by
the government? |
|
07 |
The internal audit workers work as per the
guidelines and formulated procedures and techniques developed by the board. |
|
08 |
The practice of in-time and real time reporting from
internal auditors are intact for avoiding any unlawful and unwilling
functionality to the requisite top management. |
|
09 |
To cater higher quality of job and accuracy in
formulating audit report, the internal auditors are having privilege to
conveniently accessibility to information and the incumbent people. |
|
10 |
Sufficient training and development programs are
carried for enhancing the capabilities of internal auditors. |
|
11 |
The quality of the job is intact due to requisite
skills and expertise from the internal auditors. |
|
12 |
Professional qualifications/certifications are
acquired by the majority of the internal audit workers. |
|
13 |
The head of internal audit unit is
having the requisite skills and experiences for doing the due tasks
effectively. |
|
14 |
The head of internal audit unit is normally coming
from a versatile business background rather than effectively from the
background of appropriate and professional audit’s prospective. |
The 3rd section
comprising fourteen questions related to examine the requirements and features
of corporate/organizational governance.
|
01 |
The composition of board if fair and
independent. |
|
02 |
The board members are having the
requisite sills, expertise and related information. |
|
03 |
The member of the board is entertaining
sufficient timing for moving along with their duties effectively. |
|
04 |
Each year, there used to hold at-least 4
meetings of the board. |
|
05 |
The composition of boards’ member is
fairly independent. |
|
06 |
At-least one of the board’s member is
having good knowledge of finance. |
|
07 |
The plans and key changes of the
internal auditors are supported by the audit committee. |
|
08 |
The internal audit reports are analyzed
by the audit committee. |
|
09 |
The work responsibility carried out by the
audit committee in terms of appraisal of the performance and even termination
of the head of internal audit is effectively tackled by audit committee. |
|
10 |
The working relationship between the
audit committee and internal audit workers are congenial. |
|
11 |
The internal controlling parameters given in the
policy framework are in place. |
|
12 |
The controlling mechanisms given in the
policy books of the organization are effectively operational. |
|
13 |
External auditors are intact in one of
the big 5 accounting firms. |
|
14 |
The internal and external auditors are
synchronized in terms of working of the audit of the incumbent organization. |