1. The Internal Audit’s role in the Core Stakeholder Corporate
Governance
Chen Hongming, Guo Chunwei
Management School,
Changsha University of Sciences and Technology, P.R.China 410076
Abstract: More attention has been paid to the internal audit’s role in corporate governance. This paper
discusses the core stakeholders (shareholder, manager, and staff) have been allowed to participate in
corporate governance more effectively with the help of the internal audit, achieve the business goal.
Then point out the improvement approach to the problem of how the internal audit activity can play a
more important role in corporate governance.
Key words: Corporate governance, Core stakeholder, Internal audit
1 Introduction
The so-called corporate governance, is a series of systems that use to process the responsibility, the
power and the interests among different stakeholders, it not only include the relations between the firm
and the stockholder, but also included the relations between the firm and the other stakeholder(like staff,
customer, supplier, community and so on) .
①
Many studies have shown that the importance of the large number of stakeholders to enterprises is
different, scholars CHEN Hong-hui in 2004 first put forth the concept of core stakeholder. He named
those which have significant importance for the survival and development of an enterprise, and those
which have close interest with the enterprise, as core stakeholder, include shareholders, managers, and
employee.
The core stakeholders invested the material capital and the human capital in the enterprise, and
directly participate in company's daily management. Without them, the company will be unable to
survive and development, and will be more impossible to achieve company's goal, therefore this paper
also thought the main body of corporate governance is the core stakeholder.
Along with the continuous development of internal audit, the role of internal audit in corporate
governance has been well recognized. In April, 2002,the IIA’ s opinion stated about the SOX bill to the
United States Congress opinion out : internal audit, external audit, the board of directors and the senior
management personnel are called four big cornerstones of corporate governance . ②
In January, 2002, the China securities regulatory commission issued <The Rule of Corporate
Governance for Listed Companies> also especially mentioned the importance of the internal audit
activity in corporate governance.
In May, 2006, China internal audit association issued internal audit concrete standard No.23 – the
relationship between internal audit institution and the board of Directors – also depicts that the internal
audit institution should help the board of directors or senior officers take management responsibly, and
carry out the cooperating function of the board of directors, senior officers and internal audit in the
organization manage.
So the establishment of effective corporate governance, raising the efficiency of corporate
governance, need to build up and perfect the internal audit system of the company, promote the positive
interaction of internal audit and corporate governance.
2 The core stakeholders may more effectively participate in corporate governance
through internal audit
In modern companies forms different quarters of the contract have different motive to get
information. The shareholders care about the company’s achievements information, carry on the
compensation and supervision of management; The managers expect to grasps the present situation of
enterprise through the information,, guarantees the enterprise decision-making in scientific style, and
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2. better fulfills the fiduciary duty; Staff also hopes to know the information to ensure their legitimate
rights and interests. Since the external audit verification costs in the enterprise information for the
day-to-day ongoing operations are high, in a modern enterprise, only internal audit in a company can be
a independent third party status and with professional background to provide assurance and consulting
services, to guarantee the core stakeholders acquire the information they need and to ensure the
reliability of information.
2.1 About shareholders
The purpose of shareholder investments is to maximize investment returns, the nature of the
non-refundable investment of shareholders make the return to the shareholders mainly rely on the
income generated from the effective corporate governance. So out of the motivation to avoid risks and to
ensure the investment returns, the shareholder has most motive to participate in the company to
management ,and carry on supervision to the operation of the company property.
However, as the separation of ownership and management in the modern enterprise, information is
dissymmetrical between shareholders and the company's managers; the managers may make the choice
deviate from the goal of shareholders in the day-to-day operations, which in turn may damage the
interests of shareholders.
By making full use of internal audit reports and concluded information that shareholders receive
related to their business needs, to solve the problems of "adverse selection" and "moral hazard".
Through internal audit can fully understand the daily information of production to ensure that the goal of
the company accurately and so on. Therefore the shareholder may draw support from the internal audit,
then to make effective choices, compensation and supervision the managers.
2.2 About managers
As the competition that the enterprises face getting more and more intense, and the ever-changing
external environment, managers need to take more responsibility. Without the help of internal audit,
managers can’t effectively take the responsibility and ensure proper management of the company. For
instance the SOX bill, requests the listed company’s CEO, CFO must under take the legal
responsibility for the validity of the finance statement, however, if CEO, CFO want to guarantee the
validity of the financial statement, they must establish the effective internal control mechanism and
internal audit system. Simultaneously the managers want to prove the company operational result to the
board, also need to have the certification which provide by the internal audit in independent status.
The internal audit has a set of systematic, standard methods to appraisement and enhance the
enterprise risk management, the risk control and the efficiency of the government process, helps the
。③
enterprise achievement its business goal Risk is an unavoidable to achieve business goals, managers as
part of the founders and executants of risk management process, they need the internal audit’s advisory
services to evaluate the effectiveness of risk management procedures and made recommendations to
help managers effectively prevent and reduce risks. First, the modern risk guidance internal audit take
the effective risk management as the priority target, actives carry on auditing before and during the
event process, helps the senior officers evaluate the enterprise risk, Pointed out the enterprise in the
risk management loophole and the insufficiency, and provides the improvement opinions, distinguishes
the risk and confirm the key risk domain, then effective guard risk. Secondly, a reasonable internal
control can provide better protection for the efficiency and effectiveness of the business activities, assets
security, economic information and the reliability of financial reporting. As part of internal controls, the
internal audit provides protection through the strict supervision of auditing for effectiveness of internal
controls. No doubt that after the internal audit’s help in ensure better management the internal control
system can ensure the legality of their internal management and efficiency.
The Internal audit by valuation the risk, help management layer find out the potential risk and
opportunity of the enterprise, helping governor to implement the trusteeship responsibility effectively,
then reducing the agency cost of each proprietor of enterprise and management layer, improving the
results of management.Also, internal audit provide a certificate for managers completed their
management responsibility; provide a basis for the enterprise incent managers. Thus, management is not
only the internal audit “supervisor”, but also “collaborators”.
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3. 2.3 About employee
Nowadays more and more value of the enterprise are created by employee, employee’s benefits and
the enterprise’s benefits relation became more close than before, and employee play a more and more
important role in enterprises.
Now, more and more enterprises are encouraged staff, the board of directors, board of supervisors
and managers communicate directly, encourage the staff to express their views about financial situation
and the interests of themselves. Company Law of the People’s Republic of China prescribes: “A
company shall seek advices from its trade union when discussing and deciding upon important issues on
the restructuring or operation of the company, or formulating important rules and regulations and shall,
through the congress of the workers and staff members or other forms, seek advice and suggestions from
its staff and workers.”
Company Law of the People's Republic of China also prescribes: State-owned investment entities
shall include representatives of the staff and workers of the company; the number of the staff and
workers’ representatives shall not be lower than one third of all the supervisors. Obviously these
measures effectively guarantee the rights of employees to participate corporate governance.
If employees want to express their views on matters related to their own interests or the major
operating issues but with an obstructed channel, then it will undoubtedly be difficult for the staff to carry
out effective supervision of managers. As part of the company's independent third party, internal audit
evaluates the effectiveness of enterprise communication channels, and makes objective
recommendations for improvement, guarantees the voice of employees in corporate governance.
The internal audit institution can make a independent evaluation about public, fair, equity of
directors, supervisor’s election, the internal audit can stand at an objectively angle and put forward an
improved suggestion of the election method, guarantee employee execute their right to vote more
effectively.
3 How internal audit can play a greater role in corporate governance
3.1 Internal audit services for the achievement of the corporate governance objectives
The goal of corporate governance decides enterprise strategic direction, and then decides the
concrete company management goal and management measures. The internal audit as one of four big
cornerstones of the effective company governances, must penetrate the understanding of the goal core
benefit correlation carries on the company governances, assists the core benefit correlation
establishment effective governance structure and the government mechanism.
Take new principle as a guide; reform the tradition audit mode, innovation audits method, setting up
the modern internal audit concept. Helping the core benefits acquire dependable information, making
everybody participate in company management effectively, carrying out company manage objectives.
3.2 More efforts must be made to maintain internal audit’s objectivity
Because the internal audits a section of inner part organization, generally speaking, the higher the
layer of the internal audits report in the organization, the stronger its independence, but even is internal
audit report directly toward the audit committee organized by the independent director, its independence
is still relative.
Although the objectivity of the internal audits is subjected to independent of organization, it is more
decided by the occupation morals character of the internal audits, the profession competence ability with
whether can avoid the internal audit benefits conflict. Compared with independence, the objectivity may
more possible to be attained by the effort of internal audit institution.
Therefore, while the internal audits carry out" guarantee" business of independent evaluation, they
should evaluate in the independent position as far as possible and point out the disadvantage in corporate
governance, the financial management, the inner controls of the enterprise.
At provide the suggestion and the consultation service for management layer, because themselves
became an member to assess the result of the action they participant, having bigger influence to the
independence of themselves, this wills make the internal audit adopt measures to assurance objectivity,
evaluate the factor that may influence objectivity, and consider whether the measure adopt to lower the
influence to objectivity is valid or not.
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4. And when the objectivity is severely injured, stop performance relevant business and report to
④
board of directors or senior officers in time .
3.3 Follow up study for the problem discovered in auditing
After put forward improving an opinion for the company managing environment, manage procedure
and manage process and carry on an evaluation, internal audit institution should follow up the scent for
the problem discovered in auditing. The internal audits organization can build up a simple database
record problem discovered and to follow. Draw up the innovate plan, completion time and the
representative director etc. for innovate rule after the communication with the board of directors and
high governor.
The internal audit section still should periodically gather the innovation discover by follow up audit,
to evaluate again for the audit problem carry on in the innovation. Pay attention to those have no
innovation without proper reason, and report to audit the committee in time.
3.4 The internal audit should operate under the employee's support
First, the employee are one of core stakeholders of the enterprise, is the main participant who
carries on daily business activities for the company, is the main executor of the enterprise internal
control system, and usually is the earliest finder of the internal control system loophole .The internal
audit institution should, under the support of all employee, detect and investigate fraud availably, perfect
company internal control system, restrict senior officers effectively through employee participate in the
company manage.
Secondly, the employee is the performance of good corporate culture. The good corporate culture
can produce valid morals standard, control self benefit behavior in every aspect of corporate governance,
lower the business enterprise risk effectively, and make good foundation for the setting up of a
reasonable perfect corporate governance procedure.
3.5 Build up a reasonable mechanism for the internal audits institution and construct an audit
troop of keeping competition ability
Changes of the internal audit’s function require a higher quality of the auditors. For example, in
2003 IIA Global Auditing Information Network survey results show that the internal auditor must
① ②
possess the following qualities: versatile, Involvement, ③ ④
Technology, Advisor, ⑤ Leader. On
one hand, internal audit institution should employ competent auditors and regular training and
re-education auditors; on the other hand, internal audit institution should set up performance evaluation
and incentive mechanisms incent or punish the auditors.
Finally, the internal audit mechanism should be brought in wash out system unqualified auditor
should be washed out, construction the audit team that can remain competitive in the long run.
4 Conclusion
Core stakeholders provide material capital and human capital for the enterprise, and directly
involved in the day-to-day operation of the companies, putting their own interests and the enterprise
interests closer together, without their participation and supervision, it is difficult for enterprises to
survive and develop, the goal will be more difficult to achieve.Comparing with other stakeholders, they
are more motivated and the ability to participate in corporate governance. On one hand, through the
evaluation of the company's environmental management, process management and control procedures , ⑤
internal audit provide all the information need by the core stakeholders, in all relevant stakeholders to
create an effective equilibrium mechanism and provide assistance for their effective corporate
governance; On the other hand, the effective corporate governance can be effective coordination of the
relationship among the parties, and take the interests of all parties into consideration and construct a
reasonable framework for corporate governance, promote internal audit system construction, as well as
safeguard independence, objectivity and authority of the internal audit. Therefore, an effective internal
control system and effective corporate governance can create a virtuous interaction, and jointly promote
the realization of the objectives of the enterprise.
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5. References
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3(2005), p37~39
[2] ZHANG Qiaoliang, CHEN Jun. A comparison and summary of internal auditing. Journal of
Anhui University (Philosophy and Social Sciences), 6(2006), p130~134
[3] The Institute of Auditing Research Foundation. Research Opportunities in Internal Auditing, 2003
[4] Internal audit standard No. 22-Internal audit’s independence and objectivity. China Institute of
Internal Audit, 5(2006)
[5] ＆
Xu Wenguan, The practice policy of strengthen internal audit’s role. Events Trends .2005,7
www.pwc.com/tw
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