The ripple effect: international corporations are feeling the effects of governance practices that are evolving on a global scale and adjusting the way they operate accordingly

Internal Auditor, Feb, 2005 by Scott Green, Holly J. Gregory

As demonstrated graphically over the past several years, when seismic events shake investor confidence in large international corporations, the worldwide landscape of public company governance changes. Corporate scandals and the regulatory reaction in one nation reverberate in distant economies. Rules, regulations, and norms around the world influence the way public companies operate globally. In addition to affecting decisions related to capital market access, new laws may increase the regulatory risks of doing business in various jurisdictions. New lending requirements, evolving judicial expectations, and increasing shareholder activism may add to the risks of not meeting the raised governance bar. Smart internal auditors know that this new world order is significant and are revising their approach to governance risk. They are scrutinizing their organizations' governance models and comparing them to national norms and international best practice.

Governance practices and the laws that regulate corporate governance differ among countries. Even within countries, approaches to governance may vary due to the different needs of organizations. On the following pages, we explore the variation of global governance practices, discuss what are arguably the most important topics that should concern chief audit executives (CAEs), and provide best practices for each area identified. This macro look at the differing stages of corporate governance development in major world markets and the key areas important to CAEs can help internal auditors evaluate their organization's governance practices and respond accordingly.

A Global Overview

Corporate governance reform efforts have been developing over the years in response to the needs of individual nations and their corporations. In the early 1990s, the United Kingdom explored governance reforms on a "comply or explain" basis through the adoption of the Cadbury Code (later, the Combined Code). An important initiative to produce a set of international corporate governance standards was undertaken in 1999 by the Organisation for Economic Co-operation and Development (OECD). The Paris-based group published its Principles of Corporate Governance as a benchmark for policy-makers, corporations, and others who would benefit from such guidance ("OECD Principles of Corporate Governance" on page 52 presents the organization's most current guidance). As well, the Asian crisis of the late 1990s stimulated interest in governance reform in that region. More recently, the reform movement has accelerated in reaction to perceived governance failings.

The new regulatory focus on corporate governance in the United States is in response to the numerous and massive frauds that came to light in 2001 and 2002. At first, many saw the governance failures as strictly an American problem. The far-reaching response by the U.S. Congress, which imposed new practices on many foreign-based companies whose securities trade in the U.S. financial markets, was criticized as overreaching.

As other jurisdictions experienced their own scandals, however, some countries have responded by studying, debating, and strengthening their governance practices. The European Union (EU), for example, has issued a phased action plan to underscore its claim to regulate the corporate governance and audit standards of EU companies. In October 2004, EU member states formally recommended for implementation several specific action plan reforms relating to director independence--at the supervisory body level--and executive compensation disclosures. Profound changes may result.

What began as an American response to a series of disturbing revelations of corporate malfeasance and fraud eventually created a governance revolution that is making its way through sovereign capitals worldwide.

THE UNITED STATES

To restore public confidence in the markets damaged by corporate scandals, Congress passed the U.S. Sarbanes-Oxley Act of 2002. The act significantly expanded regulatory oversight and guidance for auditors, lawyers, and analysts and mandated that the U.S. Securities and Exchange Commission (SEC) impose several structural board reforms through the New York Stock Exchange (NYSE) and the National Association of Securities Dealers (NASD) listing standards.

Most auditors are conversant with the parts of the Sarbanes-Oxley act that require the principal executive and financial officer of public companies to certify their financial statements (Section 302) and to document their systems of internal control (Section 404), but there are other provisions of the act that have a considerable impact on how public companies are governed. Among these provisions are mandates that audit committees be composed of independent directors and that they establish procedures for bringing questionable accounting and audit matters to light, including implementation of a mechanism for the confidential and anonymous submission by employees of such complaints or concerns. Sarbanes-Oxley requires listed companies to adopt and disclose a code of ethics for key executives or explain why they have not done so.