18 Sep. 2017 | Comments (0)
On Governance is a new series of guest blog posts from corporate governance thought leaders. The series, which is curated by the Governance Center research team, is meant to serve as a way to spark discussion on some of the most important corporate governance issues.
The following post was originally published on Cindy Fornelli’s LinkedIn Influencer blog on August 21, 2017.
In governance and business, transparency is vital. Transparency builds trust in day-to-day transactions and investments. Globally, in the words of the G20/OECD Principles of Corporate Governance: "A strong disclosure regime can help to attract capital and maintain confidence in the capital markets. By contrast, weak disclosure and nontransparent practices can contribute to unethical behavior and to a loss of market integrity."
There can, however, be too much of a good thing when it comes to transparency and disclosure. The OECD principles also assert, for example, that disclosure should not place "unreasonable administrative or cost burdens on enterprises." In its white paper, The Principles of Trust and Evolution of Trust, PwC warns of the danger of relevant facts getting "lost in the firehose of data," especially as technology continues to accelerate the generation of information.
As they continue efforts to enhance transparency and disclosure practices, policymakers face a daunting task: opening the information spigot so that the proverbial hose is refreshing and sustaining investors and businesses—not blasting them away.
In the United States, we've observed three recent instances of regulators rising to this transparency challenge.
The auditor's report
With a concept release issued in 2011, the Public Company Accounting Oversight Board (PCAOB) launched a project to update and enhance the auditor's report. In June 2017, the PCAOB adopted a final standard, which is now before the Securities and Exchange Commission (SEC) for approval.
Between those 2011 and 2017 milestones unfolded a journey of gathering input, fostering robust discussion, and refining policy proposals. The public company auditing profession engaged constructively and energetically, hosting workshops with key stakeholders, proactively field testing aspects of PCAOB proposals, and submitting multiple comment letters. Meanwhile, concurrent efforts on the auditor's report in the United Kingdom and elsewhere added a global dimension.
As it proceeded, the PCAOB was responsive to stakeholder concerns and recommendations, a fact evident in the final standard. While retaining the current “pass/fail” opinion of the existing auditor’s report, the new standard enhances the report in targeted ways.
One important way is through auditor communication of critical audit matters (CAMs). Through the policymaking process, the PCAOB gradually refined the concept of CAMs to include matters that are "communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved especially challenging, subjective, or complex auditor judgment."
While much work lies ahead—and we encourage the PCAOB to monitor the implementation and effectiveness (perhaps through a post-implementation review)—this new standard represents a positive step in transparency and one toward continuous improvement of the audit to better serve investors and our capital markets.
The PCAOB undertook a similarly deliberate transparency journey regarding disclosure of key audit participants, including the audit engagement partner. A 2009 PCAOB concept release first explored the idea of requiring the audit engagement partner to sign the auditor's report.
As with its work on the auditor's report, the PCAOB gradually refined its proposals in response to robust feedback from a range of stakeholders. For its part, the public company auditing profession provided substantial input, including views on the practical challenges and significant legal impediments that would arise from naming the engagement partner in the auditor’s report.
The final standard, approved by the SEC in May 2016, responded to stakeholder concerns by taking a fresh approach. The name of the engagement partner (along with other accounting firms participating in the audit) would be disclosed on a new PCAOB Form AP. The information is now available in a searchable database on the PCAOB’s website, thus creating a transparency resource for investors and audit committees.
For more on Form AP, see the Center for Audit Quality (CAQ)'s June 2017 tool, Form AP - Auditor Reporting of Certain Audit Participants: A Tool for Audit Committees.
Audit committee disclosure
The drive to enhance transparency often spurs policymakers into action. Yet in some cases, not taking prescriptive action can also be a desirable and beneficial path.
Consider audit committee disclosure. Investors and other stakeholders are increasingly interested in the valuable work of audit committees, and regulators are clearly attuned to this interest. The SEC, for example, issued a 2015 concept release on possible revisions to audit committee disclosures.
To their credit, regulators have not rushed forward with rulemaking in this area: a prudent course, given demonstrable trends happening organically in the marketplace. The Audit Committee Transparency Barometer, an annual report issued jointly by the CAQ and Audit Analytics, reveals double-digit growth since 2014 in the percentage of S&P 500 companies disclosing information on key areas of external auditor oversight, including auditor appointment and audit partner rotation.
In an ever-evolving global economy, and given its importance to the vitality of businesses and markets, the work of enhancing transparency will never be done. Recent progress on disclosure around the auditor's report, audit participants, and audit committees can serve as models for future efforts.
The views presented on the Governance Center Blog are not the official views of The Conference Board or the Governance Center and are not necessarily endorsed by all members, sponsors, advisors, contributors, staff members, or others associated with The Conference Board or the Governance Center.