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1、The Role of the Audit Committee in Auditor-Client NegotiationsZalailah SallehAndJenny Stewart*Department of Accounting, Finance and EconomicsGriffith Business School Griffith UniversityAcknowledgements: We acknowledge with thanks the helpful comments of Jean Bdard, David Hay, Pam Kent, Robert Kneche
2、l, Donald Stokes, Ken Trotman and participants at the Auditing Mini-conference, University of Auckland, July 2006, and at a seminar at Bond University. We also thank Yves Gendron, Mike Gibbins and Hun Tong Tan for providing copies of research instruments used in prior studies. Corresponding Author:G
3、old Coast CampusPMB 50 gold Coast Mail CentreQueensland 9726AustraliaEmail: j.stewartgriffith.edu.auPhone: 617 55527711Fax: 55528068617The Role of the Audit Committee in Auditor-Client NegotiationsAbstractThis paper examines the role of the audit committee in the resolution of auditor-client dispute
4、s over accounting issues. A case study approach is used, involving structured interviews with chief financial officers, external auditors and audit committee chairs in three listed companies in Malaysia. Our interviews are guided by the general negotiation and mediation literature as well as the aud
5、itor-client negotiation model developed by Gibbins et al. (2001). The results of our study suggest that auditor-client negotiations concerning contentious accounting issues are commonplace and generally occur when issues are subjective and lacking in authoritative guidance from accounting standards.
6、 The audit committee becomes involved when the issues are very material. The committee plays a mediating role by gathering information, advising and solving problems. This role is strengthened by (i) the power and authority given to the committee by the board and by regulation; (ii) the committees u
7、nderstanding of possible issues due to its oversight and monitoring role; (iii) the committee members accounting and auditing expertise and knowledge of the business; and (iv) the committees commitment to ensuring that the financial statements present a true and fair view. In general, the outcome fr
8、om the negotiation and mediation process is a compromise solution that results in fairly presented financial statements which satisfy the auditors without being unduly conservative. The Role of the Audit Committee in Auditor-Client Negotiations1. Introduction It is widely recognized that audit commi
9、ttees play a key role in corporate governance by providing critical oversight of companies financial reporting and auditing processes (Blue Ribbon Committee (BRC), 1999; Malaysian Code on Corporate Governance, 2000). This role has been given greater emphasis since the enactment of the Sarbanes-Oxley
10、 legislation in the US (US Congress, 2002). By significantly increasing the responsibilities of audit committees, this legislation has focused global attention on the need to strengthen their effectiveness. Not surprisingly, there is a growing body of research examining audit committee effectiveness
11、 in improving both financial reporting quality and audit quality. Cohen et al. (2002), Turley and Zaman (2004) and DeZoort et al. (2002) provide excellent summaries of this literature. However, these studies tend to be “based on large samples, using publicly available and/or questionnaire data” (Tur
12、ley and Zaman, 2004, p.325). As a result, little is known about the operations of audit committees and the effect of these operations within an organizational context. The objective of this paper is to examine an important aspect of audit committee effectiveness, namely the role of the audit committ
13、ee in the resolution of auditor-client disputes over accounting issues. Audited financial statements are the outcome of a negotiation process between auditors and management (Antle and Nalebuff, 1991 and Gibbins et al., 2001). However, research examining this process is scant and has generally focus
14、ed on negotiations between audit engagement partners and Chief Finance Officers (CFOs), with little consideration of the involvement of audit committees (Gibbins et al., 2004 and 2005a; Beattie et al., 2000). Hence, “much work remains before researchers completely understand the process of auditor/c
15、lient negotiation, particularly as practice changes to involve audit committees” (Nelson and Tan, 2005, p.58).We contribute to this understanding by using an in-depth interview approach to document the role of the audit committee in auditor-client negotiations. Support for this research method comes
16、 from Turley and Zaman (2004), who argue that qualitative research methods have strong potential for studying audit committee activities in the contextual environment in which they operate. Furthermore, our study should form the basis for future research because we employ negotiation and mediation t
17、heories to examine the role of the audit committee in auditor-management interactions. We therefore provide a stronger theoretical underpinning to the study of the relationship between auditors, audit committees and management. Interviews were undertaken in three publicly listed companies in Malaysi
18、a. Although a developing country, Malaysias corporate governance systems are comparable to those of developed countries. This is because “the development of corporate governance and audit committee sic in Malaysia seems to replicate what had happened in the UK and other developed countries” (Kuppusa
19、my et al., 2003:510). Hence, our research adds to the existing literature by presenting current evidence on auditor-client negotiation and the role of audit committees in a developing country. This enables us to assess the generalizability of prior research on auditor-client negotiation and also pro
20、vides an opportunity for researchers to examine the generalizability of our findings on the role of the audit committee in these negotiations.In each company, interviewees comprised a member of management responsible for financial statement preparation, the audit committee chair and the companys ext
21、ernal auditor. The results of our study suggest that auditor-client negotiation over contentious accounting issues is commonplace and generally occurs when issues lack authoritative guidance from accounting standards. Material issues that cannot be resolved are raised with the audit committee and th
22、e committee then plays a mediating role as problem solver. The outcome from the negotiation and mediation process is generally a compromise solution.The paper is structured as follows. The next section provides the background to the study and discusses prior literature. The third section describes t
23、he research method while the fourth section reports and analyses the results. Finally, some conclusions are drawn in the fifth section. 2. Background and Prior Literature 2.1 Audit committees in MalaysiaSince 1994, Bursa Malaysia (formerly known as Kuala Lumpur Stock Exchange) has mandated that all
24、listed companies must have an audit committee. According to Zulkarnain et al. (2001a), in 1998 all companies in Malaysia had audit committees which complied with this listing requirement. Fuelled by the economic crisis in 1997 and 1998, the Malaysian Code on Corporate Governance (MCCG) was introduce
25、d by the Malaysian Institute of Corporate Governance as a voluntary requirement to enhance companies corporate governance. The MCCG outlines the functions of the audit committee. In 2001, Bursa Malaysia revised the listing requirement by changing the voluntary basis of the MCCG to a mandatory requir
26、ement. In addition, Bursa Malaysia revamped the listing requirements to require at least one member of the audit committee either to be a member of the Malaysian Institute of Accountants or to have at least three years working experience in accounting. They also delineated several functions of the a
27、udit committee which include discussing with external auditors the audit plan, accounting policy changes, significant audit adjustments and the audit report. Thus, the functions and effectiveness of audit committees have received considerable attention from Malaysian regulators to promote better qua
28、lity financial reporting among listed companies. A high standard of financial reporting is important because, as a developing country, the Malaysian economy relies heavily on foreign capital investment. Moreover, investors confidence is needed to recover from the financial crisis. While the Malaysia
29、n regulator highlights the importance of audit committees in relation to the financial reporting and audit process, no studies have been conducted to investigate the actual involvement of audit committees in the audit process in Malaysia. Previous studies in the Malaysian environment focus only on p
30、erceptions of external auditors and audit committee chairs concerning the effectiveness of audit committees (Zulkarnain et al., 2001a and Zulkarnain et al., 2001b). Findings from these studies suggest that audit committees in Malaysia are effective in their traditional role which includes the review
31、 of annual financial statements. However, knowledge is scant about audit committee practices and the extent of audit committee involvement in the audit process in Malaysia. 2.2. Qualitative studies on audit committeesAs previously noted, most prior studies on audit committee effectiveness have been
32、based on large samples. The studies that have used a qualitative approach have explored practices carried out in audit committee meetings (Gendron et al., 2004) and the meaning of effectiveness from the perspective of corporate governance players (Spira, 1999; Gendron and Bdard, 2006). Gendron et al
33、. (2004) suggest that the main roles of audit committees are to ask challenging questions and to assess responses provided by managers and auditors. Spira (1999) employed actor-network theory to explore the perceptions of participants on audit committee effectiveness, whereas Gendron and Bdard (2006
34、) used actors reflectivity to construct perceptions of audit committee effectiveness. None of these studies examines the role of audit committees in auditor-client negotiations.2.3. Auditor-client negotiation and dispute resolution2.3.1. Dispute resolution proceduresCarnevale and Pruitt (1992) sugge
35、st four main procedures for dealing with disputes or opposing preferences. These procedures are: (i) struggle; (ii) arbitration; (iii) negotiation; and (iv) mediation. Since we do not expect auditors and management to engage in physical confrontation, we can eliminate the first procedure. For arbitr
36、ation to be a viable option, the arbitrator or adjudicator must have the authority to enforce judgment (Wall et al., 2001). We do not believe that the audit committee has such authority as external auditors have the right to issue a qualified opinion or to terminate their relationship with their cli
37、ent. Hence, we focus only on negotiation and mediation. Negotiation is a process whereby two or more parties with differing preferences jointly make decisions that affect the welfare of both (or all) parties (Murnighan and Bazerman, 1990). Mediation involves the assistance of third parties to resolv
38、e disputes (Carnevale and Pruitt, 1992). 2.3.2. An overview of negotiationA basic negotiation model comprises three elements: (i) issues; (ii) process; and (iii) outcome (Pruitt and Carnavale, 1993). Issues or topics under dispute can be single issues or a group of issues (Carnevale and Pruitt, 1992
39、). “Each issue entails two or more options” (Pruitt and Carnevale, 1993:14). Consider, for example, pay negotiation between employees and an employer. Employees may want to increase their salary by 10% but the employer considers a 5% increment to be fair. To resolve this issue, the employees and emp
40、loyer engage in a negotiation process. The negotiation process involves two or more parties who have opposing preferences on certain issues, which in turn leads to the disputants finding techniques to resolve the dispute (Lewicki et al., 2004). The parties to the dispute can be individuals, groups,
41、organizations, or political units such as nations (Rojot, 1991; Pruitt and Carnevale, 1993). In the above example, employees and employer are the parties involved in the pay negotiation. Opposing preferences means that the parties have incompatible preferences among a set of available options due to
42、 misunderstandings and divergence of interest (Lewicki et al., 2004). Based on the pay negotiation example, the employees desire a 10% increment in their salary but the employer only wants to give a 5% increment. Techniques and strategies refer to overall plans that are used by disputants to accompl
43、ish respective goals (Lewicki et al., 2004). The three main techniques or strategies used in negotiation are concession making, contending, and problem solving (Carnevale and Pruitt, 1992). In the above example, from the employers perspective, concession making would refer to the employer trying to
44、accommodate the employees needs while contending would involve the employer trying to persuade the employees to accept a 5% increment. Finally, in problem solving, both parties are trying to locate options that satisfy both of them. The main purpose of negotiation is to resolve disputes between the
45、opposing parties and thus the outcome from the negotiation is important (Pruitt and Carnavale, 1993). The four possible outcomes of a negotiation are no agreement, victory for one party, a simple compromise or a win-win agreement (Carnevale and Pruitt, 1992). Using the previous illustration, no agre
46、ement means that the employees and employer do not find any solution to their dispute. A victory for one party is described as a distributive outcome because the outcome confers to one party. As a result, the other party loses what the victorious party wins (Lewicki et al., 2004). The result from th
47、e pay negotiation would be that either the employees gain a 10% increment and the employer loses, or the employer gives a 5% increment and the employees lose. A simple compromise refers to some middle ground on the two parties initial preferences (Carnevale and Pruitt, 1992). For example, the employ
48、ees could accept a 7.5% increment, so that both parties give up 2.5% of their initial preferences. Finally, a win-win agreement (integrative agreement) is defined as an option that increases the size of the joint benefit to the disputants (Lewicki et al., 2004). In this case, the employees may recei
49、ve a 10% increment, however in return they agree to increase productivity to satisfy the employers need. Thus both parties reach an agreement that benefits them and no party loses in the negotiation. 2.3.3. Auditor-client negotiation“Negotiations are a pervasive feature of the audit process (e.g. the resolution of proposed audit adjustments and disclosures).” (Trotman et al., 200
