The state of investor confidence in audit committees is strong in 2019, with a recent Center for Audit Quality (CAQ) survey finding that 81 percent of U.S. retail investors feel independent audit committees are effective in their investor protection role.
How can this foundation of confidence in audit committees be strengthened further? The CAQ believes that greater transparency about the audit committee’s role and responsibilities is key, as detailed in a new report by the CAQ and Audit Analytics on audit committee transparency.
The CAQ, together with Audit Analytics, launched the Audit Committee Transparency Barometer in 2014 to gauge how public companies’ audit committees approach publicly communicating their external auditor oversight activities. The Barometer measures the percentage of certain proxy disclosures by companies in the S&P Composite 1500, an index that comprises the S&P 500 index of large-cap companies (S&P 500), the S&P MidCap 400 (S&P MidCap), and the S&P SmallCap 600 (S&P SmallCap).
Overall, the Barometer has shown that audit committees have made considerable progress on the transparency front in recent years. This year’s Barometer, specifically, shows that several areas of disclosure have reached robust levels, including discussion of non-audit services (e.g., 84 percent of S&P 500 companies) and length of auditor tenure (e.g., 71 percent of S&P 500 companies).
The report also notes that cybersecurity has become a disclosure hotspot, with double-digit increases since 2016 in the amount of information available on cybersecurity risk oversight and related topics.
Areas of Concern
picture is not entirely positive, however. Two developments should at least give
- Many disclosure levels are stagnant or slowing compared with 2018. Excluding new cyber disclosures, only two categories have increased by more than 2 percent since 2018 among S&P 500 companies; the largest increase (criteria considered when evaluating the external auditor) was 4 percent. Trends for smaller companies are similar.
- Disclosure levels in some categories remain low. Areas of no or minimal disclosure include the significant areas of discussion between the audit committee and auditor (0 percent for S&P 500), discussion of audit fees and their connection to audit quality (4 percent for S&P 500), and how the audit committee considers auditor compensation (2 percent for S&P 500).
Opportunities to Enhance Transparency
where might audit committees focus their attention as they look to enhance
transparency? Three areas stand out from the Barometer findings:
- Significant areas of discussion: 2019 was the fourth year that significant areas discussed between the auditor and audit committee were disclosed in 0 percent of proxy statements for S&P 500 companies. As auditors are beginning to disclose critical audit matters (as required by the Public Company Accounting Oversight Board), we believe audit committees have an opportunity to provide their perspective on these matters and others, if appropriate.
- Disclosures around audit firm evaluation and audit engagement partner selection: Criteria considered when evaluating the audit firm and the audit committee’s involvement in audit engagement partner selection upon rotation are still only disclosed in 50 percent of S&P 500 companies; these figures are 39 percent and 22 percent, respectively, for S&P MidCap, and 33 percent and 10 percent, respectively, for S&P SmallCap. These disclosures are critical and should be tailored to company-specific policies and procedures. Useful disclosures may include:
- How often is the audit firm evaluated?
- What is the mechanism for evaluation, and who is involved?
- What are the key considerations when evaluating the audit firm?
- What is the process for selecting the audit partner, and who is involved?
- Disclosure around audit firm compensation: There is room to increase transparency, especially when providing investors with insights into audit firm compensation. For example, audit committees can provide more insights into how the audit fee is negotiated and considered in connection with audit quality, explain changes in fees, and disclose the audit committee’s responsibility for fee negotiation. Important disclosure may include:
- What level of detail is provided to the audit committee related to fees?
- How does the audit committee consider the appropriateness of hours in balancing the need for an effective and efficient audit?
- What caused changes in fees, including advances in technology, implementation of new accounting standards, or company-specific activities such as mergers and acquisitions?
I urge you to read our full 2019 Barometer report, which, in addition to data, provides concrete examples of effective disclosure drawn from CVS Health, Triumph Bancorp, JetBlue Airways Corp., and other companies.
Julie Bell Lindsay is the executive director of the Center for Audit Quality.