Corporate Governance: The international journal of business in society

Audit committee pre-Enron efforts to increase the effectiveness of corporate governance

Patricia M. Myers, Douglas E. Ziegenfuss,
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Patricia M. Myers, Douglas E. Ziegenfuss, (2006) "Audit committee preEnron efforts to increase the effectiveness of
corporate governance", Corporate Governance: The international journal of business in society, Vol. 6 Issue: 1,pp. 49-63, doi:
10.1108/14720700610649454
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 Audit committee pre-Enron efforts to
increase the effectiveness of corporate
governance
Patricia M. Myers and Douglas E. Ziegenfuss
Patricia M. Myers is
Associate Professor at
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Brock University,
Department of Accounting
and Finance, Faculty of
Business, Saint Catharines,
Ontario, Canada. Douglas
E. Ziegenfuss is Professor
and Chair, Department of
Accounting, Old Dominion
University, Norfolk, Virginia,
USA.
The authors thank the Institute
of Internal Auditors for their
assistance. Thanks also to
Leslie Turner for helpful
comments
DOI 10.1108/14720700610649454
Abstract
Purpose This study of audit committee effectiveness, performed in the period immediately preceding
the Enron collapse, seeks to determine whether audit committees were beginning to accept more
responsibility for corporate governance before such behavior became mandatory.
Design/methodology/approach The period studied was approximately two years prior to the
Sarbanes-Oxley Act of 2002 and roughly one year after the Blue Ribbon Committee published its
recommendations on audit committee effectiveness. The efforts of 296 audit committees to improve their
effectiveness as reported by Chief Audit Executives (CAEs) to the Global Audit Information Network
(GAIN) database maintained by the Institute of Internal Auditors (IIA) were investigated.
Findings It was found that audit committees responsiveness to each of eight effectiveness steps was
surprisingly high. For instance, almost all (99.6 percent) audit committees meet with CAEs. It is
recommended that audit committees focus more on big picture/strategic concerns in their discussions
with CAEs.
Research limitations/implications The studys chief limitation is that only companies with internal
audit functions were studied and thus the results cannot be generalized to companies without internal
audit functions.
Originality/value This study was the first to utilize the GAIN database and provides specifics about 15
different topics that CAEs might bring to audit committees for discussion. Topics of communication more
often focused on specifics such as significant audit findings (95.9 percent) and less often dealt with
big picture/strategic concerns such as overall corporate control environment (68.9 percent).
Keywords Audit committees, Corporate governance, Financial reporting, Auditors, Boards of Directors
Paper type Research paper
Introduction
In recent years instances of fraudulent financial reporting have increased with such
frequency and in such dramatic ways that stakeholders at all levels have been astounded.
Even before the Enron collapse (late 2001) started the spate of front-page accounting
scandals, audit committee activities were being questioned. It was more than a decade ago
when an increasing number of stakeholders began to suggest that instances of fraudulent
financial reporting could be decreased by improving the effectiveness of audit committees
(NCFFR, 1987; POB, 1993; Levitt, 1998). A common thread that runs through suggestions
from these different sources is that audit committees need to assume greater responsibility
with respect to corporate governance by overseeing financial reporting and internal control
matters.
Beginning with the 1999 Blue Ribbon Committee on Improving the Effectiveness of
Corporate Audit Committees (BRC), more formalized approaches were taken to develop
and publish explicit recommendations that audit committees could address to improve their
effectiveness. By 2002, the occurrence of the Enron, WorldCom, and other accounting
frauds influenced the US Congress to enact the Sarbanes-Oxley Act (SOX) (see Hamilton
and Trautmann, 2002) containing specific provisions concerning audit committees[1]. In
VOL. 6 NO. 1 2006, pp. 49-63, Q Emerald Group Publishing Limited, ISSN 1472-0701 j CORPORATE GOVERNANCE j PAGE 49
 2003 the SEC issued more stringent regulations for audit committees of publicly traded
companies. Table I compares the specific calls for audit committee reforms from the 1999
BRC, the 2002 SOX legislation, and the 2003 SEC regulations. The effectiveness measures
advocated by these three major sources in 1999, 2002, and 2003 are strikingly similar.
The Blue Ribbon Committee was comprised of representatives of the NYSE and NASD, who
directed ten recommendations to NYSE, NASD, SEC, AICPA, and/or to listed companies.
The first two recommendations defined independence for audit committee members and
recommended that listed companies have an audit committee whose members are
independent.
The remaining eight effectiveness steps were designed to meet the goal of making the
audit committee more effective (BRC, 1999, p. 12). The third step suggests that listed
companies of a certain size have an audit committee and further specifies that the audit
committee should be comprised of at least three financially literate members. The fourth
step encourages audit committees to adopt a charter and to review it annually for
adequacy. The fifth, sixth, and seventh steps stipulate provisions that should be
included in the audit charter; these provisions concern disclosure, responsibility for
auditor relations, and discussions with auditors about auditor independence,
respectively.
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The eighth step is directed to outside auditors and recommends that outside auditors
discuss the quality not just acceptability of the companys accounting with the audit
committee (BRC, 1999, p. 15). The two final steps recommend that the annual report and
interim financial information be audited, reviewed by the audit committee, and discussed
with management.

Table I Calls for audit committee reforms to increase effectiveness

1999 2002
Blue Ribbon Committee (BRC) Sarbanes-Oxley 2003
Effectiveness measuresa (SOX)b SEC Rulesc

BRC01 Defines independence (for audit committee members) Similar to BRC Similar to BRC
BRC02 Companies should have an audit committee; all members should be independent Similar to BRC Similar to BRC
BRC03 Audit committee should be composed of at least three members; all members Similar to BRC Similar to BRC
financially literate
BRC04 Audit committee should adopt a charter and reassess it annually Silent Silent
BRC05 Proxy statement should disclose information about audit committee Silent Similar to BRC
BRC06 Audit committee is responsible for outside auditor relations Similar to BRC Similar to BRC
BRC07 Audit committee must communicate with outside auditors about independence Similar to BRC Silent
issues (consulting assignments etc.)
BRC08 Auditors should discuss quality of company accounting Silent Silent
BRC09 10k MD&A discloses audit committee has reviewed audited financial statements Similar to BRC Similar to BRC
with management
BRC10 Auditors review quarterly reports and 10-Q before release Similar to BRC Similar to BRC
Audit committee Similar to SOX
must establish
fraud reporting
and
whistle-blowing
procedures
Audit committee
be properly
funded

Sources: a Blue Ribbon Commission on Audit Committees; b

Sarbanes-Oxley Act of 2002 (see Hamilton and Trautmann, 2002);
c
Securities and Exchange Commission (2003)

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PAGE 50 CORPORATE GOVERNANCE VOL. 6 NO. 1 2006
 The elements of SOX (2002) related to audit committees mirrored the majority of the BRC
effectiveness steps and added a requirement that audit committees establish fraud reporting
and whistleblower provisions. The SEC (2003) adopted the majority of BRC and SOX
provisions, including the fraud reporting procedures. They added a regulation that audit
committees be properly funded. Thus, SOX and SEC are in agreement with the concept of
audit committee effectiveness, put forth by BRC.
Although BRC effectiveness steps did not have the weight of SOX legislation or SEC
regulations, they were well-publicized and it was possible for companies to address many
effectiveness steps before the Enron collapse and before the 2002 SOX legislation and the
2003 SEC regulations.
Access to detailed information concerning audit committee efforts during 2001 enabled us
to learn about US audit committees efforts to improve their effectiveness in the period
immediately preceding the Enron collapse and to respond to calls for research that
elucidates audit committee processes and activities (Beasley, 1996). Such information was
obtained with the assistance of the Institute of Internal Auditors (IIA) from 296 chief internal
audit executives (CAE) from US companies with audit committees from 11 different industry
groups. In addition to data on audit committees efforts to improve effectiveness, this
information also details some of the topics of regular communication between audit
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committees and the organizations CAE. This information is used to investigate the following
specific research questions:
B What was the level of audit committee efforts to improve their effectiveness in the period
immediately preceding the Enron collapse?
B Are audit committees that adopt more efforts to improve their effectiveness more likely to
interact with internal auditors and what form does this communication take?
B Are audit committees to which chief audit executives report (functionally) more likely to
have adopted more efforts to improve their effectiveness?
This study adds to the literature by providing information on audit committees efforts to
increase their effectiveness in the period immediately preceding the Enron accounting
scandal. Past research on audit committees has focused on the characteristics of audit
committee members in the manufacturing industry (Raghunandan et al., 2001) and the
interaction of audit committees and external auditors (e.g. Carcello and Neal, 2003). Our
study examines audit committees from companies of various sizes in 11 different industry
groups with internal audit departments of various sizes. Additionally, our study examines the
effect of a possible on-going organizational relationship between the audit committee and
chief audit executive (CAE)[2], where the organizational status of the CAE calls for a
functional reporting line between the audit committee and the CAE. Our study also reports
on the prevalence of communication between audit committees and CAE with respect to 15
different sub-topics that audit committees might typically discuss with CAEs that could
improve audit committee effectiveness.
This paper is organized as follows. The next section provides further background and
develops research questions on audit committees efforts at improving their effectiveness in
the period immediately preceding the Enron collapse, the type of interaction that might
normally occur between CAE and audit committee, and the organizational status of CAE with
respect to audit committees. The third section describes the research method. The fourth
section reports results, and the final section summarizes conclusions.

Background and research questions

Audit committees efforts to improve their effectiveness

Raghunandan et al. (2001) looked at the characteristics of audit committee members of 114
manufacturing firms. They defined audit committee quality as independent and financially
literate audit committee members. They found that almost three-quarters of their
manufacturing firms reported independent audit committee members while less than
one-quarter reported financially literate audit committee members. Audit committees were

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VOL. 6 NO. 1 2006 CORPORATE GOVERNANCE PAGE 51
 given more guidance when the BRC report was published, SOX was enacted, and major
revisions of SEC audit committee regulations were adopted. The Raghunandan et al. (2001)
study provides valuable information about beginning steps in audit committees efforts
towards improving their effectiveness in one major industry.
More recently, Imhoff (2003) reviewed historical developments of accounting, auditing,
and corporate governance and proposed changes with the goal of stimulating debate.
Epstein and Roy (2004) applied the balanced scorecard to boards of directors enabling
interested parties to more fully evaluate board performance. Klein (2003) described many
stock exchange proposals, put them in historical context, presented the likely effects of
the new corporate governance proposals on future boards of directors, and assessed
their impact on the financial reporting system. Eng and Mak (2003) provided evidence
that ownership structure and board composition are related to voluntary disclosure. They
found that lower marginal ownership and significant government ownership are
associated with increased disclosure. They also found that larger firms and firms with
lower debt had greater disclosure. An increase in outside directors reduces corporate
disclosure.
Other studies have looked at the interaction of audit committees and external auditors. For
instance, Carcello et al. (2002), Carcello and Neal (2003), and Lawrence et al. (2003) looked
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at that interaction in terms of fees and auditor dismissals. DeZoort et al. (2003a, b) found that
more experienced audit committee members and those audit committee members who
were CPAs are more supportive of the external auditor.
Our database allows us to examine audit committees from eleven different industry groups
and their efforts at improving their effectiveness along several different dimensions.
Raghunandan et al. (2001) examined two personal characteristics of audit committee
members. They found that 74 percent of the 114 manufacturing firms in their study reported
independent audit committee members and 21.9 percent reported financially literate
members. While the BRC did emphasize the importance of independence and financial
literacy, the BRC went beyond personal characteristics and specified eight steps to improve
the effectiveness of audit committees. The majority of these steps were subsequently
adopted by SOX and the SEC.
RQ1. What was the level of US audit committee efforts to improve their
effectiveness in the period immediately preceding the Enron
collapse?[3]

Audit committees interactions with internal auditors

While the 1999 BRC did not make explicit recommendations with respect to audit committee
interaction with internal auditors, it does encourage establishment of direct communication
channels between the audit committee and the CAE[4]. The Institute of Internal Auditors (IIA
1993) has long encouraged audit committees to meet with the CAE. And, more specifically,
those meetings should occur at least quarterly. In addition to information about the existence
and frequency of meetings between the audit committee and the CAE our data includes
information about 15 different potential communication topics that CAEs might typically
review with audit committees. These communication topics fall into three different
categories:
1. internal audit operations;
2. corporate control environment matters; and
3. internal audit results.
We constructed a continuous variable [EFFORT] by determining the proportion of
effectiveness steps addressed by the audit committee. This variable was used to investigate
the second research question:
RQ2. Are audit committees that adopt more efforts to improve their effectiveness more
likely to interact with internal auditors?

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PAGE 52 CORPORATE GOVERNANCE VOL. 6 NO. 1 2006
 Communication topic categories
B Control environment matters that the CAE might typically review with the audit committee
include: risk assessment system, overall assessment of corporate control environment,
assessment of control environment by major subsidiary or operating entity, and
coordination of internal auditing with external auditors plan.
B Internal audit department results that the CAE might typically review with the audit committee
include: significant findings, audits performed, fraud and conflicts of interest, corporate-wide
compliance with laws and codes of conduct and ethics, and other internal audit results.
B Internal audit department operations that the CAE might typically review with the audit
committee include: percentage of internal audit plan completed, internal audit expense
budget, internal audit actual expenses compared with budgeted expenses, internal audit
productivity measures, internal audit benchmark comparisons with similar companies,
and internal audit organizational structure.
RQ2a. What topics do audit committees and internal auditors (CAE) discuss?

Organizational status of CAE (functional reporting to audit committee)

Long before the BRC, SOX, and recent SEC regulations many CAEs organizational status
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called for a functional reporting line to the board of directors or audit committee. The first
section of the five-section Standards for the Professional Practice of Internal Auditing[5] states:
The organizational status of the internal auditing department should be sufficient to permit the
accomplishment of its audit responsibilities (IIA, 1998, p. 110).

Further, the standard calls for the CAE to . . .have direct communication with the board
(110.01.2). This standard has been in effect for decades and has been interpreted to mean
that ideally, the CAE should report functionally to the audit committee and administratively to
the CEO or equivalent.
Such a functional reporting relationship might expose audit committee members to best
practices for effective audit committees and suggests that audit committees to whom CAEs
report might have addressed more effectiveness steps than audit committees to whom
CAEs do not report, which leads to our third research question:
RQ3. Are audit committees to which CAEs report (functionally) more likely to have
adopted more efforts to improve their effectiveness?

Research method
In order to learn more about audit committee activities, we obtained information with respect
to audit committee activities in the period immediately preceding the Enron collapse. The
information was contained in the IIAs GAIN database. The IIA developed the GAIN
database to allow CAEs to benchmark their departments performance against other
departments in their industry. The GAIN database for 2000/2001 contained self-reported
information supplied by the CAEs from 296 different US organizations with audit committees
in eleven different industry groups[6]. CAEs are a good source of information because they
are part of the corporate governance structure (NCFFR, 1987).

Characteristics of companies in sample

The firms surveyed are quite diverse: annual revenues ranged from $35 million to more than
$200 billion. The companies came from 11 different industry groups. The number of internal
auditors on staff ranged from one to 479.

Method
Survey data from 296 CAEs was used to determine audit committees efforts to increase their
effectiveness during the period immediately preceding the Enron collapse (see Tables II and
III). A measure of audit committee efforts was developed that encompasses the level at
which audit committees addressed effectiveness steps advocated by BRC, SOX, and SEC.

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VOL. 6 NO. 1 2006 CORPORATE GOVERNANCE PAGE 53
 Table II Characteristics of sample industry groups in sample
Industry Number of firms in sample Percent of firms in sample

Agriculture, Mining, or Construction 3 1.0

Petroleum 11 3.7
Chemical or Drug 13 4.4
Manufacturing 87 29.4
Transportation 15 5.1
Communication 20 6.8
Utilities 45 15.2
Wholesale or Retail 21 7.1
Banking 32 10.8
Insurance 24 8.1
Services 25 8.4
Total 296 100.0

Table III Characteristics of sample internal audit department size

Number of internal auditors Frequency Percent of sample
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1-5 62 20.9
6-9 60 20.3
10-19 68 23.0
20-40 52 17.6
41-479 55 18.6
Total 296 100.0

Using the eight effectiveness steps initially identified by the BRC, as important in improving
the effectiveness of audit committees, we constructed a measure of audit committee efforts
to increase effectiveness [EFFORT] that encompasses all eight effectiveness steps. EFFORT
is the proportion of all eight effectiveness steps addressed by an audit committee. Thus, an
audit committee that addressed all eight effectiveness steps would be coded as 8/8 or 1.00
whereas an audit committee that addressed only four effectiveness steps would be coded
as 4/8 or 0.50.
We examined the relationship between audit committee efforts to increase effectiveness and
audit committee communications with internal auditors, using the measure of audit
committee efforts to increase effectiveness [EFFORT] described above. Similarly, we
constructed measures of the depth of communication between CAEs and audit committees
across the breadth of three different topics: internal audit department operations [COMM1],
corporate control environment [COMM2], and the results of internal audits [COMM3].
Because COMM1 consists of six potential subtopics related to the operation of the internal
audit department, the maximum depth is 6/6 or 1.0. Because COMM2 consists of four
potential subtopics related to the corporate control environment, the maximum depth is 4/4
or 1.0. Because COMM3 consists of five potential sub-topics related to the results of internal
audits, the maximum depth is 5/5 or 1.0.

Results

Implementation of effectiveness steps

RQ1. What was the level of audit committee efforts to improve their effectiveness in the
period immediately preceding the Enron collapse?

We found the post BRC, pre-Enron efforts to increase effectiveness for 11 different industry
groups to be surprisingly high. More than three-quarters (232) of the 296 companies had
taken steps to address all eight effectiveness recommendations. Conversely, only 5 percent
of the 296 companies made no effort to address any of the eight effectiveness
recommendations.

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PAGE 54 CORPORATE GOVERNANCE VOL. 6 NO. 1 2006
 To further examine EFFORT, we divided the 296 companies into three categories: High
effort, Med effort, and Low effort. High effort audit committees were those that
addressed between six and eight of the eight effectiveness steps; medium effort audit
committees were those that addressed between three and five of the eight effectiveness
measures, and low effort audit committees were those that addressed between zero and two
of the eight effectiveness measures. We found that 269 (91 percent) audit committees fell
into the high effort category with a mean effort of 7.8 out of eight. A total of 11 (4 percent)
audit committees fell into the medium effort category with a mean effort of 4.3 out of eight.
While 16 (5 percent) audit committees fell into the low effort category. The low effort category
included 15 audit committees that did not address any of the eight effectiveness measures.
Thus, the mean effort was 0.1 out of eight (see Tables IV-VI).
Raghunandan et al. (2001) surveyed 114 manufacturing firms (before or shortly after BRC
was published) and reported that 74 percent had independent audit committee members
and 21.9 percent had financially literate audit committee members. By the year after the BRC
publication, we found that efforts in the manufacturing industry group had increased such
that the percentage of companies reporting all independent audit committee members
increased from 74 percent to 92 percent and the percentage of companies reporting all
financially literate audit committee members increased from 21.9 percent to 86.2 percent.
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When all 11 industry groups are examined, the percentage of companies reporting all
independent (financially literate) members was 93.2 percent (90.9 percent).

Table IV Efforts to increase effectiveness efforts of 296 companies

Audit committees
addressing
recommendation
Effectiveness recommendation Number Percentage

BRC03 Audit committee should be composed of at least

three members; all members financially literate 269 90.9
BRC04 Audit committee should adopt a charter and
reassess it annually 265 89.5
BRC05 Proxy statement should disclose information
about audit committee 262 88.5
BRC06 Audit committee is responsible for outside
auditor relations 270 91.2
BRC07 Audit committee must communicate with outside
auditors about independence issues (consulting
assignments etc.) 271 91.6
BRC08 Auditors should discuss quality of company
accounting 277 93.6
BRC09 10k MD&A discloses audit committee has
reviewed audited financial statements with
management 267 90.2
BRC10 Auditors review quarterly reports & 10-Q before
release 271 91.6

Table V Efforts to increase effectiveness efforts of 296 companies by level of effort

Category Effort Number of audit committees Percentage of audit committees

High 8=8 1:00 232 78.4

High 7=8 0:875 25 8.4
High 6=8 0:75 12 4.1
Med 5=8 0:625 5 1.7
Med 4=8 0:50 4 1.4
Med 3=8 0:375 2 0.7
Low 2=8 0:25 1 0.3
Low 1=8 0:125 0 0
Low 0=8 0:0 15 5.1

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VOL. 6 NO. 1 2006 CORPORATE GOVERNANCE PAGE 55
 Table VI Efforts to increase effectiveness effort of 296 companies by category of effort
High effort Med effort Low effort
91 percent of sample 4 percent of sample 5 percent of sample
firms firms firms

Effort 8/8 7/8 6/8 5/8 4/8 3/8 2/8 1/8 0/8
1 0.875 0.75 0.625 0.5 0.375 0.25 0.125 0
Number of firms 232 25 12 5 4 2 1 0 15
Mean effort (out of 8) 7.818 4.273 0.125

To investigate whether some characteristic of the audit committee might be driving EFFORT,
we examined the effort of audit committees based on whether the audit committee was
chaired by an independent (outside) director or by an inappropriate director (e.g. the CEO
or the BOD chair). A total of 276 (93 percent) report being chaired by an outside director
leaving only 20 being chaired by potentially inappropriate directors. There were three
reports of a CEO audit committee chair, which is clearly an inappropriate chair. Each of these
audit committees reported a lowered level of effort with a mean of 2.6 out of 8 (0.33).
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There were ten reports of a BOD chair also serving as audit committee chair. While we
cannot know whether the BOD chair is independent or not, it does seem that the importance
of the audit committee is downplayed on boards where the BOD chair also serves as audit
committee chair. The mean effort for the ten audit committees chaired by the BOD chair was
0.43 out of eight (0.237). The remaining seven audit committees did not report the identity of
their chair (see Tables VII and VIII).

Table VII Audit committee chair who chairs the 296 audit committees by industry group
Industry group Outside director BOD chair CEO Other or N/A Total

Agriculture, Mining, or Construction 3 3

Petroleum 11 11
Chemical or Drug 10 2 1 13
Manufacturing 83 1 1 2 87
Transportation 13 1 1 15
Communication 18 1 1 20
Utilities 43 1 1 45
Wholesale or Retail 20 1 21
Banking 30 1 1 32
Insurance 22 2 24
Services 23 1 1 25
Total 276 10 3 7 296
Percentage 93.2 3.4 1.0 2.4 100

Table VIII Audit committee chair effort of 11 audit committees with inappropriate chairs
Industry group BOD chair CEO

Chemicals or Drugs 0.0

Chemicals or Drugs 0.0
Manufacturing 0.0 0.0
Transportation 1.0
Communication 1.0 0.5
Utilities 0.0
Wholesale or Retail Trade 1.0
Banking 0.5
Insurance 0.5
Insurance 0.0
Services 0.87
mean effort 0.24 0.33

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PAGE 56 CORPORATE GOVERNANCE VOL. 6 NO. 1 2006
 Six of the 15 (40 percent) lowest EFFORT audit committees had inappropriate chairs while
only 3 of the 232 (1.3 percent) highest EFFORT audit committees had inappropriate chairs.
The EFFORT of audit committees with inappropriate chairs is lower than those with
appropriate chairs.

Communication between audit committee and CAE

RQ2. Are audit committees that implement more effectiveness steps more likely to
communicate with internal auditors?

Frequency of audit committee and CAE meetings. A basic measure of communication

between audit committee and CAE is the frequency of audit committee meetings with the
CAE. A total of 241 CAEs provided specific frequency responses to this question and 82.2
percent (97.9 percent) audit committees met with the CAE at least four (two) times a year
(see Tables IX-XII).

Table IX Audit committee meetings with CAE number of audit committees reporting in
each frequency
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Annually 4
Semi-annually 38
Quarterly 193
Monthly 5
Never 1
Sub-total of AC reporting specific frequencies 241
Other (52) and missing data (3) 55
Total 296

Table X Audit committee meetings with CAE number of audit committees reporting in
each frequency by effort
Monthly Quarterly Semi-annually Annually Never Other N/A
5 193 38 4 1 52 3 296

Effort (%) 1.7 65.2 12.8 1.4 0.3 17.6 1.0 100
8/8 3 159 25 4 40 1 232
7/8 16 4 5 25
6/8 8 4 12
5/8 1 1 3 5
4/8 1 3 4
3/8 2 2
2/8 1 1
0/8 1 6 2 4 2 15
5 193 38 4 1 52 3 296

Table XI Audit committee meetings with CAE meeting frequency of 241 firms reporting
specific frequency
At least twice a
Effort At least four times year Once Never Total reporting

8/8 162 84.8% 187 97.9% 4 (2/1%) 191

7/8 16 80.0% 20 100.0% 20
6/8 8 66.7% 12 100.0% 12
5/8 2 40.0% 5 100.0% 5
4/8 1 100.0% 1 100.0% 1
3/8 2 100.0% 2 100.0% 2
2/8 1 (100%) 1
0/8 7 77.8% 9 100.0% 9
198 82.2% 236 97.9% 4 (2/1%) 1 (100%) 241

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VOL. 6 NO. 1 2006 CORPORATE GOVERNANCE PAGE 57
 Table XII Audit committee meetings with CAE frequency of meetings between audit
committee and CAE
At least four times per
year Once per year Never

High effort 83.4% 186/223 1.8% 4/223

Med effort 62.5% 5/8
Low effort 70.0% 7/10 10.0% 1/10

To further investigate whether audit committees with higher levels of effort to increase
effectiveness are more likely to meet more frequently with the CAE we compared the
frequency of meetings between CAE and audit committee by EFFORT and by level of effort
(High, Med, Low). We found the majority (83.4 percent) of the high effort audit committees
met with the CAE at least four times per year while only 10 percent of the low effort audit
committees met with the CAE once or less per year. We also found the majority (70 percent)
of low effort audit committees met with the CAE at least four times per year, while only 1.8
percent of the high effort audit committees met with the CAE once (or less) per year.
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In this highly skewed and therefore non-scientific sample, audit committees in the high
EFFORTcategory met more frequently with the CAE and audit committees in the low EFFORT
category met less frequently with the CAE.
Audit committees communication with CAE
RQ2a. What topics do audit committees and internal auditors (CAE) discuss?

Communications between internal auditors and the audit committee can take a number of
forms and cover a wide variety of topics. We categorized these topics into three different
areas:
1. COMM1 corporate control environment;
2. COMM2 internal audit results; and
3. COMM3 internal audit operations.
The content (topics discussed) of meetings between the audit committee and CAE is of
greater importance in ensuring effective corporate governance than the frequency of such
meetings. For example, Enron and WorldCom chiefly failed because they had poor strategic
plans or business models. Likewise, we argue that strategic/big picture items found in
COMM1 topics dealing with an organizations control environment are more important items
for discussion than COMM2 topics dealing with audit results or COMM3 topics dealing with
internal audit operations and that COMM2 items are more appropriate than COMM3 items.
We found that on average audit committees discussed more than half of the subtopics in
each of the three topical areas. Only two of the 296 audit committees did not discuss any
topical areas with the CAE. At least 99 percent of the audit committees communicated with
the CAE concerning at least one sub-topic within each of the three categories. While the level
of communication within each topic is close to half of the available subtopics in each topical
area, as a whole, COMM1 topics were discussed less frequently (48.1 percent) than
COMM2 topics (60.7 percent.) and COMM3 topics (61.3 percent) (see Tables XIII-XVI).

Table XIII Communication between CAE and AC communication by category type

Type of communication Mean (%)

Four control environment sub-topics 48.4

Five IA results sub-topics 60.9
Six IA operations sub-topics 61.6

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 Table XIV Communications by category and by effort COMM1 CAE reviews control environment with audit committee
1 2 3 4
Risk Overall control Subsidiary control Coordination with
Sub-topics assessment environment environment external auditor Total

Number of firms 253 204 151 247 855

Percentage 85.50 68.90 51.00 83.40 48.1

Table XV Communications by category and by effort COMM2 CAE reviews internal audit results with audit committee
1 2 3 4 5
Sub-topics Significant findings Audits performed Fraud and COI Laws, codes of conduct, and ethics Other Total

Number of firms 284 275 228 196 95 1,078

Percentage 95.90 92.90 77.00 66.20 32.10 60.7

Table XVI Communications by category and by effort COMM3 CAE reviews internal audit operations with audit
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committee
1 2 3 4 5 6
Sub-topics Audit plan Budget Actual versus budget Productivity Benchmarks Organization structure Total

Number of firms 265 154 115 153 141 260 1,088

Percentage 89.5 52.0 38.9 51.7 47.6 87.8 61.3

Audit Committees involvement in control environment matters [COMM1]. The category

Control environment matters includes four sub-topics that might be discussed with the
CAE. We found the following percentages for discussions by the 296 audit committees:
1. 85.5 percent discussed the risk assessment system;
2. 68.9 percent discussed the overall assessment of corporate control environment;
3. 51.0 percent discussed the assessment of control environment by major subsidiary or
operating entity; and
4. 83.4 percent discussed the coordination of internal auditing with external auditors plan.

The mean number of these four topics reviewed with the audit committee was 2.06 out of
four.
Audit committees involvement in internal audit results [COMM2]. The category Internal
audit results includes five sub-topics that might be discussed with the CAE. We found the
following percentages for discussions by the 296 audit committees:

1. 95.9 percent discussed significant findings;

2. 92.9 percent discussed audits performed;
3. 77.0 percent discussed fraud and conflicts of interest;
4. 66.2 percent discussed corporate-wide efforts to increase effectiveness with laws and
codes of conduct and ethics; and
5. 32.1 percent discussed other sub-topics.
The mean number of these five topics reviewed with the audit committee was 3.12 out of five.

Audit committees involvement in internal audit operations [COMM3]. The category Internal
audit operations includes six sub-topics that might be discussed with the CAE. We found
the following percentages for discussions by the 296 audit committees:

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VOL. 6 NO. 1 2006 CORPORATE GOVERNANCE PAGE 59
 1. 89.5 percent discussed the percentage of audit plan completed;
2. 52.0 percent discussed the expense budget;
3. 38.9 percent discussed actual expenses compared with budgeted expenses;
4. 51.7 percent discussed productivity measures;
5. 47.6 percent discussed benchmark comparisons with similar companies; and
6. 87.8 percent discussed organizational structure.
The mean number of these six topics reviewed with the audit committee was 3.2 out of six.

Organizational status of CAE

RQ3. Are audit committees to which CAEs report (functionally) more likely to have
adopted more efforts to improve their effectiveness?

It is common for CAEs to have a number of reporting relationships. Often the administrative
reporting relationship is with the CFO or equivalent while the functional reporting relationship
is with the audit committee. A total of 280 CAEs provided data about their functional
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reporting relationship. More than half 161 (54.4 percent) report functionally to the audit
committee (see Tables XVII and XVIII).
To investigate whether audit committees with higher levels of effort to increase effectiveness
are more likely to have functional reporting responsibility for the CAE, we compared the
functional reporting of CAEs for audit committees in each category of EFFORT. While more
than half (55 percent) of the high EFFORT audit committees have functional reporting
responsibility for the CAE, med EFFORT and low EFFORT audit committees are not far
behind with 45.5 percent and 50 percent, respectively. These inconclusive results shown in
Table XVIII, may be explained by the fact that 269 (91 percent) audit committees are in the
High EFFORT category. The 11 med EFFORT and 16 low EFFORT audit committees do not
constitute a large enough number to influence the results.

Table XVII CAE reports functionally by entity to whom CAE reports

Number of firms Percent

Audit Committee 161 54.4

CEO 26 8.8
President 8 2.7
CFO 75 25.3
Controller 10 3.4
Other 16 5.4
Total reporting 296 100

Table XVIII CAE reports functionally by appropriateness of entities to whom CAE reports
by level of effort of audit committee
Appropriate reporting entity
(CAE reports to audit committee)
By level of effort
High effort 148 55.0%
Med effort 5 45.5%
Low effort 8 50.0%
Inappropriate reporting entity
(CAE reports to CFO or controller)
By level of effort
High effort 79 29.4%
Med effort 3 27.3%
Low effort 3 18.8%

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PAGE 60 CORPORATE GOVERNANCE VOL. 6 NO. 1 2006
 Summary
Based on the discussion above, we can summarize our findings thusly:
B One year after the BRC publication, we found that efforts had increased such that the
percentage of manufacturing industry companies reporting independent audit committee
members increased from 74 percent to 92 percent and the percentage of companies
reporting financially literate audit committee members increased from 21.9 percent to
86.2 percent.
B Audit committees with higher levels of efforts to increase effectiveness tend to
communicate more with the CAE. Specifically, they meet more frequently with the CAE
than audit committees with lower efforts to increase effectiveness.
B The EFFORT of audit committees with inappropriate chairs is lower than those with
appropriate chairs.
B In this highly skewed and therefore non-scientific sample, audit committees in the high
EFFORT category met more frequently with the CAE and audit committees in the low
EFFORT category met less frequently with the CAE.
B Having an independent audit committee chair and communicating more frequently with
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CAE is more often linked with higher levels of EFFORT than is a functional reporting
relationship between CAE and audit committee.
B Of audit committees, 93 percent are (appropriately) chaired by an outside director.

Conclusion
Based on responses of 296 chief internal audit executives, we found that audit committees
responsiveness to each of the eight effectiveness steps was surprisingly high in the period
immediately preceding the Enron collapse. The percent of audit committees addressing
each effectiveness step ranged from a low of 88.5 percent for appropriate proxy statement
disclosures to a high of 93.6 percent for discussing quality of company accounting with
auditors. Audit committees that addressed a larger proportion of the eight effectiveness
steps were more likely to interact more frequently with internal auditors. This study was the
first to utilize the data found in the GAIN database and provides specifics about 15 different
topics that CAEs might bring to audit committees for discussion The sub-topic audit
committees most frequently (95.9 percent) discussed with CAEs, significant internal audit
findings came from the topical area we designated as secondary in importance. The topical
area discussed least often was the area we designated a primary in importance. Based on
our examination of the topics of discussion, we recommend that audit committees focus
more on big picture/strategic concerns in their discussions with CAEs.
There appears to be an increase in the number of audit committees with financially literate
members in the period studied. While this time period roughly coincides with the year after
the BRC published its findings, one cannot conclude that the BRC recommendations
caused these findings. Rather, a more plausible explanation lies in the self-selection bias of
the sample companies studied. Recall that all 296 companies studied had internal audit
functions and that all of the internal auditing functions were headed by CAEs who paid a fee
and took considerable time to complete a fairly exhausting questionnaire. These are the
types of companies one would expect to have more effective audit committees.
A limitation of this study is that only companies with internal audit functions were studied and
thus, it would be a mistake to assume that the results of this study extend to companies
without an internal audit function. Nevertheless, this paper sheds light on audit committee
processes by studying audit committee efforts to increase effectiveness in the period
immediately preceding the Enron collapse. It appears audit committees were trying to
accept more responsibilities for corporate governance even before they were required to do
so by SOX and SEC. Perhaps subsequent accounting scandals were actually ongoing
problems that came to light sooner than they might have partially as the result of increased
diligence on the part of audit committees.

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VOL. 6 NO. 1 2006 CORPORATE GOVERNANCE PAGE 61
 Notes
1. In addition to provisions covering audit committees, SOX contained provisions dealing with many
other topics such as Officer certification, regulations of officers and directors, new disclosure
requirements, corporate governance (other that audit committee), accounting profession reforms,
securities analysts, and criminal sanctions, enforcements and litigation. The focus of this study,
however, is the provisions related to audit committees.
2. NYSE requires listed companies have an internal audit function and prescribes close
communication between the CAE and audit committee.

3. In other words, were audit committees beginning to accept more responsibility for corporate
governance before such behavior became mandatory with 2002 SOX and new 2003 SEC
requirements?
4. Subsequent to this survey, during the summer of 2002, NYSE revised the listing rules to require listed
companies to have an internal audit function This demonstrates how valuable and knowledgeable
internal auditors are and/or can be on audit committee matters.
5. The IIA has updated and revised its standards. The point of this reference is to show that the
professional association for internal auditors has a long-standing history of encouraging a high
reporting level of the CAE. Although the standards do not specify audit committee or board of
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directors it has been understood that that is the high level to which internal auditors should aspire to
report functionally.
6. The GAIN database includes a total of 518 US companies with audit committees. We eliminated 181
companies classified as EXEMPT and forty-one additional companies in the Education industry
and in the non-classifiable industry.

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Further reading
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Geiger, M.A. and Taylor, P.L. III (2003), CEO and CFO certifications of financial information,
Accounting Horizons, December.

Corresponding author
Patricia M. Myers can be contacted at: pmyers@brocku.ca

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com

Or visit our web site for further details: www.emeraldinsight.com/reprints

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VOL. 6 NO. 1 2006 CORPORATE GOVERNANCE PAGE 63
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