Why audit committees need strengthening

Post Satyam, the investors' confidence in the corporate governance system is low. Audit is being questioned by investors. Subhiksha is an example. In the case of Siemens India, institutional investors questioned the valuation in a deal involving the sale of Siemens Information Systems to German parent Siemens AG.

This shows the low level of investor confidence in the corporate governance system. The audit committee mechanisms need strengthening.

Audit committee

The Companies Act requires that every public company with a paid-up capital of not less than Rs 5 crore (Rs 50 million) should constitute an audit committee of the board. It is not necessary the company should be listed. Clause 49 of the listing agreement also requires a listed company to form an audit committee of the board. Both regulations detail the constitution, powers and responsibilities of the audit committee.

Under Clause 49, an audit committee comprises at least three directors. Two-third of them should be independent. At least one member shall have accounting or related financial management expertise. The committee chairman should be an independent director.

Role and powers

The role of the audit committee includes: Oversight of the company's financial reporting process and the disclosure of its financial information to ensure the financial statement is correct and credible; Recommending to the board, the appointment, re-appointment and, if required, the replacement or removal of the statutory auditor and the fixation of audit fees; Reviewing, with the management, performance of statutory and internal auditors, adequacy of the internal control systems; Reporting structure coverage and frequency of internal audit, among others.

The powers of the audit committee include: To investigate activity within its terms of reference; seek information from any employee; obtain outside legal or other professional advice; secure attendance of outsiders with expertise, if it considers necessary.

Should the audit committee get into details?

The core responsibility of the audit committee is to oversee, assess and review financial reporting and the internal control system and protect auditor independence to ensure integrity of financial information. The committee is not expected to directly monitor the systems and get into details.

Sometimes, the audit committee is required to do time consuming and intensive work. How many audit committees in India are ready to put in that extra effort?

Many audit committees require the statutory auditor and the internal auditor to make presentations. This may lead to penetrating questions, which may give comfort to the audit committee members that they have contributed to ensure integrity of financial information. But this is not enough to give comfort to investors.

Audit committee members also should not devote time to a 'honorary' assignment that cannot be performed well.

Should we throw out the baby with the bath water?

The obvious answer is no. Should we reduce the scope of work of the audit committee? The selection should go through the same rigorous process as in the appointment of CEO. The company should provide adequate resources to the chairman to enable her to perform her duties.

To enforce accountability of the chairman, Clause 49 requires that she be present at the AGM to answer shareholder queries. The mechanism for enforcing accountability exists in the extant regulation. The initiative to enforce accountability should come from institutional investors.

Conclusion

We have seen a spurt of shareholder activism, but will it sustain? Yes, but only if institutional investors and financial institutions understand their responsibilities in leading shareholder activism. Let us not leave everything to regulators.