The Internal Audit Function as a Corporate Governance Mechanism in a Developing Economy: An Empirical Study of the Nigerian Financial Sector. Page 114 IAF fulfills the management’s assurance need in the area of various internal controls as well as proactive consulting activities covering risks assessment and mitigation. Cooper et al. (1993) states that internal audit can also act as a support for management in terms of reviewing operational efficiency, investigating outcomes of financial initiatives, and providing knowledge of business activities. Sometimes, the function can also be engaged to work with the management in various temporary (ad-hoc) activities such as acquisition, mergers and system development and implementation (Brody and Lowe, 2000).
However, whenever issue of independence of IAF comes up for discussion, the above relationship model does attract continuous skepticism. For instance, Drent (2002) contends that most management team still see IAF as management’s instrument, perceiving IAF’s functional reporting relationship with the board as mere formality, to satisfy corporate governance’s formal requirements. These are some of the criticisms raised by Chambers and Odar (2015) who maintain that this dual reporting model is flawed. The issue of IAF ‘’serving two masters’’ through their recommended reporting model (earlier explained) has become a serious issue or perhaps a dilemma for the internal auditing practice.
Aside from this complication of where to direct its allegiance, IAF and organisation also face the issue of perception of being valueless and irrelevant once the function is seen not to possess enough degree of independence. Studies have established that external auditors place high premium and reliance on the work of an IAF that has remarkable organisational status. This enhanced status could be through either unflinching supports from management in form of appropriateness of the function’s budget or through unfettered access to the audit committee. Munro and Stewart (2011) while re- emphasising the essence of IAF’s unimpeded access to the audit committee, however indicate that IAF’s functional reporting relationship with audit committee, is not as essential as its regular meetings (both formal and informal (or private) with the committee. Studies such as Turley and Zaman (2007), and Zaman and Sarens (2013) underscore the impact of informal interactions of IAF with the audit committee on both
The Internal Audit Function as a Corporate Governance Mechanism in a Developing Economy: An Empirical Study of the Nigerian Financial Sector. Page 115 the IAF and corporate governance. Research has also indicated that regular meetings of the head of IAF with the audit committee assist greatly in improving the effectiveness of the function (see Scarbrough et al., 1998; Treadway Commission, 1987).
Chambers (2008) in emphasizing the need for a functional reporting relationship of the CAE with the board argues that it is logical that internal audit’s strongest relationship has to be with the top body that relies on its assurance services. He goes further by stating that if the board is to place reliance upon internal audit, then internal audit’s strongest relationship must be with the board. The author however indicates that presently, IAF’s strongest relationship is with management. Also, Goodwin (2004) study, where 36% of Chief internal auditors (CIAs) drawn from both Australia and New Zealand confirmed that they actually report to the CFO, affirm that most IAFs seem to have their strongest reporting relationship with management instead of with the audit committee of the board. These hints are suggestive of internal audit’s subservience to the management, by subordinating its judgment to that of management.
Unsatisfied with the current situation, Chambers and Odar (2015) went further to criticise the existing reporting relationship, where IAF reports functionally to the audit committee, and administratively to the management by arguing that the reporting model is flawed and therefore envisage situation where the IAF’s umbilical cord with the management is totally detached. The authors maintain that until this happens, the IAF’s independence from management is in jeopardy.
‘’We take the view that to be a reliable provider of assurance to the board, internal audit needs to report for all purposes, including ‘’pay and rations’’, to the board or to a chairman of the board,
He who pays the piper calls the tune’’ (Chambers and Odar, 2015, p.43).
It is argued in literature that IAF may not have the audacity to report management’s irregularities to the board (James, 2003), even with the functional reporting right it enjoys with the board due to the fear of intimidations and harassment that may ensue.
The Internal Audit Function as a Corporate Governance Mechanism in a Developing Economy: An Empirical Study of the Nigerian Financial Sector. Page 116 This is exactly what Van Peursem (2004) in Sarens and De Beelde (2006) has in mind when he submits that “Essentially, a key issue is that internal audit would assume whatever position is in the best interests of their employer and would be reluctant to counter management, irrespective of the consequences’’(Sarens and De Beelde, 2006, p. 225). James (2003) also shares in this sentiment by stating that ‘’If the Chief Audit Executive says anything serious to the Chairman which he or she hasn’t already said to the CEO, the Chief Audit Executive should not expect to be around for long’’. James (2003, p. 317).
It is therefore based on these contentious positions that the objective of this study is inclusive of investigating the level of relationship between IAF and management on one hand, and between the function (IAF) and audit committee on the other hand, in the financial sector in Nigeria. Understanding the level of relationships that exist between the parties is aimed at gaining valuable insights on the level of independence of IAF in the nation’s financial sector, and consequently the level of value-addition of IAF to corporate governance in the sector.
To start with, Paape, Scheffe, and Snoep (2003) in their study on ‘’The relationship between the IAF and corporate governance in the EU’’ using questionnaire survey to gather data from the CAEs across countries within the European Union (EU) also gave insights on the manner of IAF’s reporting line across countries in the EU. Using responses from 105 CAEs, the study revealed that almost half of the respondents report to the audit committee. According to the outcome of the survey, the percentages of CAEs that report to their audit committees in Belgium, Greece, Ireland, the UK and Spain range from 80% and 100%. In the other countries however, the percentage is far less, and ranges between 25% and 67%. The authors indicated that in Austria and Denmark, all respondents report to the Board of management (i.e. the senior management). The survey indicates an exceptional pattern of reporting for the Netherlands, where almost 90% of the CAEs report to the CFOs. Overall, further insight from the study indicates that relatively few (30%) CAEs report to the CFOs in the EU.
The Internal Audit Function as a Corporate Governance Mechanism in a Developing Economy: An Empirical Study of the Nigerian Financial Sector. Page 117 Also, Goodwin (2004)’s study earlier mentioned (a questionnaire survey of 120 CIAs drawn from Australia and New Zealand, aimed at exploring the similarities and differences between private and public sectors’ internal audit) suggests that the issue of CAE or IAF’s report line is not in line with the international best practice as championed by the IIA. As revealed by the study, out of the 120 CIAs (who are also IIA members) drawn from both Australia and New Zealand for the survey, none actually indicated that they have any reporting line to their audit committees. Instead, the author indicates that from the 72 CAEs from public sector, 57%, 7%, and 36% report to their CEOs, CFOs and other senior management respectively while for the 48 CAEs drawn from the private sector, 38%, 35% and 27% indicate they report to their CEOs, CFOs and other senior management respectively. This is quite puzzling as the mention of audit committee was not made at all in the survey. One is therefore wondering whether the responding CAEs are conversant with the IIA standards at all or formation of board audit committee is not fashionable in the two countries.
The referenced study of Christopher et al. (2009), a study that used empirical evidence obtained from an electronically-administered questionnaire survey of 34 CAEs from the Malaysia corporate sector, established the significance of IAF’s reporting line, CAE’s hierarchy, the use of IAF as a training ground, invitation of the CAE to the audit committee’s meetings, and private contacts between CAEs and the audit committee’s chair on IAF’s independence. The study found that it was only in 38% of cases in the sample that their IAFs report functionally to the audit committee (in line with the IIA’s standard) while 47% indicate that their IAFs report functionally to senior managers (such as CEO and CFO). The authors argued that this is a deviation from the best practices and contend that such reporting relationship constitutes serious threat to IAF’s independence.
Contrarily, Abbott, Parker and Peters (2010) in their questionnaire study of 134 CAEs, selected from Fortune 1000 non-bank companies, regarding their interactions with ACs and their budget allocations for the fiscal year 2005, established that IAF appears to be reporting to both the audit committee and senior management (CFO or CEO). The
The Internal Audit Function as a Corporate Governance Mechanism in a Developing Economy: An Empirical Study of the Nigerian Financial Sector. Page 118 authors concluded that such dual reporting line indicates a ‘’solid line’’ or functional relationship with the audit committee and a ‘’dotted line’’ or administrative relationship with the CFO or CEO. Functional reporting line of IAF to the audit committee, and its administrative reporting line to management is the ideal reporting framework according to the international best practice of internal auditing as espoused by the IIA.
Similar to the outcome of Abbott, Parker and Peters (2010) on adequacy of IAF’s reporting line, Sarens, De Beelde, and Everaert (2009) in their study (titled ‘’Internal audit: A comforter to the audit committee’’) involving 4 Belgian companies, found out that the IAFs at all the four selected companies had direct reporting lines to their audit committees. Also, Allegrini and D’onza (2003), a study aimed at verifying the main features of internal audit activities in large Italian listed companies through questionnaire survey of 52 companies found that 92% of the CAEs (in their case CIAs) periodically report to the audit committee and to the board of auditors.
Evidence coming from Australia as documented in Soh and Martinov-Bennie (2011), a semi-structured interview study conducted to provide insights into the current roles and responsibilities of the IAF and the factors perceived to be necessary to ensure its effectiveness drawing evidences from Australia context also indicate that majority of the IAFs in the country report functionally to their audit committee. The authors found out that out of the 7 CAEs interviewed, 6 confirmed that they report to their audit committees while only one of them indicate that he reports directly to both the CEO and the audit committee for all functional matters.
The general notions that can be formed from the various results from the highlighted studies on the reporting line of the IAFs are that first, IAF’s reporting line is considered one of the critical measures of IAF’s independence. Second, majority of the IAFs of developed countries do enjoy functional reporting relationship with their audit committees in line with the international best practice in internal auditing, championed by the IIA. Other inference that can be drawn from the above is that IAF’s functional
The Internal Audit Function as a Corporate Governance Mechanism in a Developing Economy: An Empirical Study of the Nigerian Financial Sector. Page 119 reporting line to the audit committee is positively related to the IAF’s independence, and the ability of the function to enhance corporate governance.
Extending the discussion to developing economies however, Al-Twaijry et al. (2003) through a study of the development of internal audit in Saudi Arabia, taking insights from directors of internal audit departments (i.e. CAEs), and external auditors, discovered that their IAFs report to General managers instead of their BoDs. In addition, the study of Ebaid (2011) provides evidence from Egypt. The referenced study which explores the nature and characteristics of IAFs in Egyptian listed firms using mixed methods of interview and questionnaire survey of managers of IAF (CAEs) of Egyptian listed companies (exclusive of banks and financial institutions), revealed that 48% of the CAEs indicate that they report functionally to the BoDs or audit committees while 52% indicate that they report functionally to senior management (i.e. CFO or CEO).
Also, Al-Hroot (2012) provides perspectives on this matter from Jordan. From responses to a questionnaire survey from 121 respondents, the study indicates that in only 53.7% of the cases, the IAF reports functionally to the audit committee. 28.1% of the respondents indicate an administrative reporting relationship with the CEO only. Also, about 33.9% of the respondents indicated that they report administratively to the audit committee and CFO.
Looking at evidence from the domain of the current study (Nigeria), Akinteye, et al. (2015) through a questionnaire survey involving 5 heads of internal audit, and semi- structured interviews of 3 heads of IAF of listed companies in Nigeria, established that 80% of the CAEs reports to their audit committees while the remaining 20% reports to their BoDs. This implies that almost all the IAFs involved in the study indicated that they report to their audit committees. This finding aligns with the results of Sarens, et al. (2009), where CAEs from four Belgian companies that were included in the study indicate that they all report to their audit committees.
The Internal Audit Function as a Corporate Governance Mechanism in a Developing Economy: An Empirical Study of the Nigerian Financial Sector. Page 120 The study (Akinteye, et al. (2015))’s finding on IAF’s reporting model is however divergent from Christopher et al. (2009) on Malaysia, Al-Twaijry et al. (2003) on Saudi Arabia, Ebaid (2011) from Egypt, and Al-Hroot (2012) from Jordan where the practice of IAF’s reporting functionally to audit committees appears yet to fully diffuse into the developing countries.
Also, in line with the findings of Akinteye et.al (2015) about IAF’s reporting relationship in Nigeria, Barac et al. (2009), a study from another developing economy (South Africa) involving the Chief Executive Officers (CEOs), or the Chief Operating Officers (COOs), audit committee chairpersons (ACCs), as well as the CAEs of 30 large South African companies show that more than 50% of the companies followed the acceptable practice of having IAF with a functional reporting relationship with the company’s audit committee.
The findings from Akinteye, et al. (2015) and Barac et al. (2009) notwithstanding, the overwhelming evidences on the reporting line of IAFs from developing countries seem to suggest that the international best practice on IAF’s ideal reporting line is yet to diffuse fully into the developing climes. Consequently, it is doubtful if IAFs of developing countries (e.g. Nigeria) is independent based on their reporting lines (or their organisational status).
Based on the position above, the researcher is curious to investigate same issue among firms in the NFS. Therefore, the study’s first proposition is stated as below:
P 1: Internal audit function of the Nigerian financial sector reporting to audit