Corporate Governance – the Role of the Audit Committee

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Corporate Governance – The Role of the Audit Committee

Deborah L. Lindberg, D.B.A. Associate Professor Department of Accounting Illinois State University

April 2004

Direct all correspondence to: Deborah L. Lindberg, Illinois State University, College of Business, Department of Accounting, Campus Box 5520, Normal, IL, USA 61790-5520; Telephone: (309) 438-7166; Fax: (309) 438-8431; E-mail: lindberg@ilstu.edu. The Katie School of Insurance & Financial Services at Illinois State University, whose support is gratefully acknowledged, funded this research. The author is also grateful for work performed by Illinois State University Research Assistants Drew Olson and Yan Zheng.

Corporate Governance – The Role of the Audit Committee

ABSTRACT: The provisions of the Sarbanes-Oxley Act have far-reaching ramifications for insurance companies and the organizations they insure (Stein 2003). A direct cost to many insurance companies due to poor corporate governance practices was that they suffered devastating losses to their investment portfolios, since some of the largest institutional investors are insurers (Larkin & Casscles 2003). Another significant cost to insurance companies as a result of fraudulent activities, insider trading, and other instances of corporate malfeasance is the likely increase in payouts by insurers on Directors & Officers (D & O) and Errors & Omissions (E & O) liability insurance policies (Larkin & Casscles 2003; Zacharias 2002). The Sarbanes-Oxley Act attempts to improve the accountability of corporations and to strengthen the role of “corporate governance.” While the Act’s new rules govern companies that are publicly traded, non-public companies should also attempt to comply with the provisions of the Sarbanes-Oxley Act to help establish “best practices” for their organizations. The Audit Committee of the Board of Directors provides one very significant aspect of corporate governance, since an Audit Committee can be effective not only in providing objective oversight of the accounting of an organization, but also in helping to set an ethical “tone at the top.” This paper summarizes the implications for Audit Committees of key provisions of the Sarbanes-Oxley Act. Further, the paper examines corporate governance concepts that can be discussed with members of an Audit Committee, and provides practical suggestions on how members of the Audit Committee of an organization can effectively meet their newly expanded responsibilities. Key Words: corporate governance; insurance industry; Audit Committees; Sarbanes-Oxley; Enron.

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Corporate Governance – The Role of the Audit Committee
Introduction The United States’ Public Company Reform and Investor Act of 2002 – commonly referred to as the Sarbanes-Oxley Act of 2002 (the “Act”) – attempts to improve the accountability of corporations and to strengthen the role of “corporate governance.” The Act directed the Securities and Exchange Commission (SEC) to adopt rules to accomplish these objectives that must be followed by companies listed with national securities exchanges, such as the NYSE, and with Nasdaq. While the new rules govern companies that are publicly traded, non-public companies should also attempt to comply with the provisions of the Sarbanes-Oxley Act to help establish “best practices” for their organizations. A direct cost to many insurance companies due to poor corporate governance practices was that they suffered devastating losses to their investment portfolios, since some of the largest institutional investors are insurers (Larkin & Casscles 2003). Another cost to the insurance industry as a result of fraudulent activities, insider trading, and other instances of corporate malfeasance is the likely increase in payouts by insurers on Directors & Officers (D & O) and Errors & Omissions (E & O) liability insurance policies (Larkin & Casscles 2003; Zacharias 2002). The Audit Committee of the Board of Directors provides one very...
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