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Corporate Governance, Internal Control and the Role of Internal Auditors – A Survey of Chinese Managers

Author details:
Dr. Jane J. Zhang
School of Accounting, Economics and Statistics
Edinburgh Napier University Business School
Craiglockhart Campus
Edinburgh EH11 1DJ, UK
Tel: 00-44-131-4554448
Fax: 00-44-131-4554460
Email: ja.zhang@napier.ac.uk

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Corporate Governance, Internal Control and the Role of Internal Auditors – A Survey of Chinese Managers

Abstract
This study investigates the role of internal audit in relation to corporate governance (CG). Despite the fact that the contribution of internal audit has been argued essential for organisations to achieve their business objectives, very little has been known of corporate managers’ perception as to the practical functions of internal audit in the context of CG. This study attempts to bridge the gap by examining the role of internal audit in China’s current CG system via seeking the views of corporate managers. This study finds that the managers view internal audit as an important part of CG and the role of internal auditors has been considered much wider beyond traditional financial control. It reveals that internal audit in China has been greatly influenced by the recent developments of CG and the internal audit function has changed towards more involvement in risk management and internal control. The survey results suggest China’s CG codes do not provide adequate explanations on internal audit. The results also indicate that Chinese companies have recognised the major role that internal audit function plays and have increasingly provided the resources to improve the quality and expertise of their internal auditors.

Key words: China; Corporate Governance; Internal Audit; Internal Control; Risk Management.

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I.

Introduction

This study explores and documents the relationship between corporate governance and internal audit. While prior studies have argued that successful internal audit has a positive impact on a firm’s operational performance (Holm and Laursen, 2007; Arena et al., 2006; Nagy and Cenker, 2002; Bou-Raad, 2000), a relationship between corporate governance and internal audit and to what extent this relationship contributes to business performance are relatively under-researched. Corporate governance is the process on which organisations are managed and controlled (Gao et al., 2008). It recognises “the inherent conflict in objectives between owner shareholders and managers” and thus “establishes institutions, policies, and procedures to protect shareholders’ interests” (McCarthy and Puffer, 2002, p.2). Though there is no single best corporate governance model, good corporate system should have effective organisational management and its approach to achieving the company’s objectives (Holm and Laursen, 2007; Ho, 2005). In the UK, the Combined Code of 2003 on Corporate Governance provides guidance on various issues in relation to board responsibility, accountability, audit committee and relations with shareholders (Sheridan et al., 2006). UK corporate governance stresses the importance of strengthening financial controls and accountability of the boards of directors to shareholders. All listed companies in the UK are now required as part of the listing rules to report the way they complied with the Code in their annual reports. The Combined Code also recommends that non-executive directors should be independent, underlining the important role that the non-executive directors play in contributing to and enhancing corporate governance. Many other countries and regions (such as US, Germany, China, and Hong Kong) have also developed their corporate governance guidance and legislations.

It has been widely recognised that the role of the internal auditor becomes increasingly more important in terms of creating good corporate governance structures (Allegrini et al., 2006; Carcello et al., 2005; Nagy and Cenker, 2002). It is...
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