How Transparent Is Your Audit Committee? Three Reasons to Increase Disclosures
Since the Sarbanes-Oxley Act passed in 2002, audit quality in the United States has never been stronger. Thousands of high-quality audits are performed each year, promoting investor confidence in public company financial reporting. Sarbanes-Oxley requires that public companies’ independent audit committees hire, compensate, and oversee the external auditor’s work.
This ensures the external auditor remains independent of the company management that the auditor interacts with day to day throughout the audit process. The Center for Audit Quality, in partnership with Audit Analytics, measures how public companies’ audit committees approach communicating about their external auditor oversight activities. We’ve published our findings annually since 2014 in the Audit Committee Transparency Barometer.
While our 2021 findings continue to demonstrate a positive, long-term trend of increased voluntary audit committee disclosures, opportunities remain for public companies to increase their transparency around audit committee activities. But why do these disclosures matter?
1. Disclosures are positively correlated with audit quality.
A 2021 study found that disclosure around the audit partner selection process is positively associated with audit quality. Specifically, the study found the following:
Increased audit committee involvement resulted in the selection of rigorous audit partners.
Audit committees that disclosed their involvement tended to be more engaged in the selection process.
Accurate, transparent, and reliable financial statements are the backbone of our capital market. It is incredibly important to choose the right audit partner to lead and manage the audit. Increasing disclosures around the audit committee’s involvement in the audit partner selection process can contribute to high-quality audits.
2. Investors are increasingly using disclosures to make investment decisions.
Investors depend on the information they receive from public company management to make investment decisions. One area that investors are increasingly interested in is cybersecurity—and for good reason. According to PwC’s 2020 Global Economic Crime and Fraud Survey, cybercrime made up 34 percent of all fraud events, outpacing accounting and financial statement frauds, asset misappropriation, and tax fraud.
Even before the pandemic, public companies were increasing—and disclosing—their use of cybersecurity technologies. Our report found that the most dramatic voluntary audit committee disclosure increase continues to relate to responsibility for cyber-risk oversight, growing from 11 percent to 46 percent of S&P 500 companies disclosing this between 2016 and 2021.
This is a positive step toward increasing investor trust. Public companies and their audit committees should consider what other information outside of financial statements are of high interest to investors, such as environmental, social, and governance issues.
3. Transparency can dispel criticism.
From time to time, critics argue that audit committees don’t exercise enough oversight and that they are ceremonial in nature. Disclosures are a powerful tool for audit committees to increase transparency on the many important activities they perform on behalf of investors.
While public companies have made great strides in increasing their disclosures, there are opportunities for improvement, including as they relate to the following:
Fee negotiation. This does not mean simply stating the audit committee’s responsibility to compensate the external auditor but also providing insight into how fees were negotiated. Were they negotiated with audit quality in mind?
Explanation for changes in audit fees. Specific reasons for changes in the fees paid to the external auditor can increase transparency and help stakeholders understand the correlation between fees and efficiency and quality.
Significant areas addressed. What areas did the audit committee focus on and spend time addressing? The answer to this can demonstrate the seriousness with which audit committees take their oversight role and gatekeeper function.
To learn more, read the full 2021 barometer report. The report includes data on disclosures for the full S&P 1500 and provides examples of effective disclosure from companies such as MetLife, Darden Restaurants, and KeyCorp.
Julie Bell Lindsay is the CEO of the Center for Audit Quality.