The Role of External Auditors in Corporate Governance: Agency Problems and the Management of Risk

Abstract

This paper not only recommends means whereby principal-agent problems could be addressed, but also considers various ways in which the external auditor and audit committees contribute as corporate governance tools. The impact of bank regulations on risk taking and the need for a consideration of ownership structures are amongst other issues which are considered. In acknowledging the issues raised by ownership structures, it considers theories such as the banking theory and corporate governance theory. It also considers other alternatives whereby risk taking could be controlled. In recommending the external auditor’s expertise to address principal agent problems, it draws attention to the audit committee’s roles, both as a vital and complementary corporate governance tool, and also considers recurring problems which still persist with some financial reporting standards. It also highlights the importance of measures which need to be in place if the external auditor’s contribution to corporate governance is to be maximised.

Finally the paper will propose criteria which should determine whether or not executives should be compensated, as well as consolidate on why (compensation) incentives should be aimed at generating improved long term performance and results rather than a focus on short term performance and results.

Keywords: corporate, governance, external, auditor, agency, problem, risk, ownership structures, disclosure, principal, agent, regulation, moral hazard, Efficient Markets Hypothesis, value relevance, compensation schemes, fair value accounting, Finance Theory