Corporate Governance and Quality of Government
As discussed in Chapter 4, governance in general and corporate governance in particular enable those charged with the authority to control and direct management to do so in a manner that promotes ethical behavior and enhances competence, accountability, and transparency. Thus, when there is good corporate governance, financial scandals, fraud, or corruption may be avoided (see Arsalidou and Krambia-Kapardis ).
Additional Ways of Preventing Corruption and Corporate Fraud
Some other approaches to preventing corruption and limiting corporate fraud are recruitment and promotional procedures; auditing with skepticism; tendering and contracting; and transparency and disclosure. In the private and public sectors, recruitment and promotion ought to be based on merit and not nepotism and favoritism, or even be influenced by one’s political affiliations. Thus, recruitment ought to comply with basic principles of open advertisement, precise job descriptions and selection criteria, interview panels, and transparent procedures for assessing and appointing candidates. Promotional procedures ought to be ethical and unbiased and guard against gender and minority inequality, while at the same time bullying and harassment should be addressed within the public and private sector.
In the discussion of regulation in Chapter 2, the case of accountants and auditors was considered. There is no doubt that auditors, especially external auditors, are in a very good position to prevent fraud and corruption in an organization, as long as they apply a holistic approach when auditing. Dicksee’s Auditing, published in England in 1892, stated that the objectives of an audit were “the detection of fraud; the detection of technical errors; and the detection of errors of principle.” Some years later, a close look at Montgomery’s Auditing 1934 and 1940 editions shows a shift in fraud detection responsibility. In the 1934 edition of the book, it is stated that “an incidental objective of an audit is the detection of fraud,” whereas six years later there is greater emphasis on fraud detection in that the “primary responsibility.. . for the control and discovery of irregularities necessarily lies with management.” A close examination of common law cases in the United Kingdom and Australia revealed them to be a mixed blessing for the auditing profession. While auditors do not have a legal duty to detect fraud per se, they do have a legal duty to audit with due care and skill, and that includes considering the possibility of fraud. While the auditing profession acknowledges that it is not the auditors’ primary role to detect fraud and error but to form an opinion on the truth and fairness of the financial statements, the American Institute of CPAs (2002) SAS 99 and International Federation of Accountants (IFAC 2009) ISA 240 states that “the primary responsibility to prevent and detect fraud rests with management and those charged with governance” (IFAC 2009, par. 4).
The revised auditing standards aim to have the auditor’s consideration of fraud blended into the audit process and continually updated until the audit’s completion. SAS 99 describes a process in which the auditor (1) gathers information needed to identify risks of material misstatement due to fraud, (2) assesses these risks after taking into account an evaluation of the entity’s programs and controls, and (3) responds to the results.
The American Institute of CPAs (2002) SAS 99 and International Federation of Accountants (2009) ISA 240 remind auditors they need to overcome some natural tendencies—such as overreliance on client representations— and biases, and approach the audit with a skeptical attitude and a questioning mind. In doing so, the auditor must set aside past relationships and not assume that all clients are honest. According to Marks (2013), a healthy sense of skepticism is needed to detect and prevent fraud, i.e., “a ‘trust but verify’ mentality for navigating everyday business processes and financial reporting” (p. 6). An imbalance of those two mind-sets will be counterproductive. He stated that “trust and skepticism are inversely related when it comes to managing fraud” (p. 6). Marks also suggested that skepticism is maintained by having a first line of defense, which is maintaining the right balance, and a second line of defense which is deterring what can go wrong. In the first line of defense an individual with the right mind-set ought to
- • continuously question and verify processes and information;
- • have the courage to speak up when red flags and inconsistencies appear;
- • listen to, check, and test information that seems to defy common sense or reason;
- • be unafraid to ask for second opinions from others, including supervisors; and
- • make informed decisions based on a balance between trust and skepticism.
- (p. 8)
Individuals in the second line of defense ought to
- • climb the knowledge hierarchy;
- • cultivate a skeptical mind-set;
- • not accept evidence at face value;
- • know the perpetrators and where fraud is most likely to occur; and
- • beware of the perfect-place syndrome. (Marks 2013, 8)
It can be argued that auditors, including internal, external, and government auditors, need to audit outside the books if they are to cultivate a skeptical mind-set and thus be more likely to detect and to prevent fraud and corrupt practices. For instance, external auditors need to assess if the income earned is reasonable for an employee’s or manager’s lifestyle. Nowadays forensic and fraud auditing is becoming a recognized profession, and practitioners have the skills and know-how not only to investigate whether fraud or corruption has taken place but also to make recommendations for prevention.