External Auditing UK Modern Corporations Essay

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" This project is considered to be the first major update to the Smith Guidance. It was felt that the update was required to shore up some of the deficiencies in the Smith Guidance that have emerged since it was published. There were characteristics of the market that it was felt needed to be addressed, in particular the oligopolistic nature, which exposed the market to considerable uncertainty in the event of a failure of one of the Big Four (FRC, 2008). This report remains a work in progress at this time.

Corporate Examples

One company that has been impacted by the changes brought about by the Combined Code is oil services firm Lamprell. The company joined the London Stock Exchange in early 2008 and was immediately required to make changes to its governance structure in order to comply with the Combined Code. The company needed to make several changes to its traditional Board structure. The first was that it needed bring in several new independent non-executive directors. Lamprell also needed to split the roles of chief executive and chairman (Bland, 2008).

In September 2008 Lamprell moved closer to Combined Code compliance by adopting a Policy on External Auditor Independence. The company's policy states that they will not use auditors for non-auditing services unless such services do not conflict with the auditor's independence (Lamprell, 2008). The external auditor must be independent of the company both in fact and in appearance. The policy specifies a wide variety of situations that would be interpreted to compromise auditor independence, and lays out ground rules for hiring auditors. All of these moves were new to the company, a consequence of listing on the LSE.

When the Combined Code was implemented, many UK firms were thus obligated to make changes to their corporate governance programs. One such company was Reed Elsevier, a content provider. This company has a strong Netherlands presence and was forced to comply with the Dutch corporate governance codes as well. Reed Elsevier's board, based in the Netherlands, was presented in 2005 with the need to improve their governance measures, to bring them in line with the Combined Code.

Ultimately, the changes enacted by the company were in compliance with the Combined Code, rather than the Dutch code. However, the company could have opted out of the Combined Code had it so desired, by taking advantage of the Code's "comply or explain" philosophy. The situation is an interesting parallel to the experience of British firms that evacuated the U.S. markets as a result of SOX, in that they could have opted out of the Combined Code if they complied with SOX, but the added expense of the American regulation negated any desire to take such action. Likewise, the Reed Elsevier experience also favoured the Combined Code vs. The Dutch regulations.

Among the changes enacted as a result of compliance with the Combined Code was the creation of an audit committee comprised of all independent non-executives. Another initiative was the establishment of a remuneration committee, again comprise of independent non-directors. The company had become cognizant of the corporate governance issues in the UK, and reacted accordingly.

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Future Direction

The Combined Code is subject to frequent evaluation and update. While the results of recent studies and audits have found the Combined Code to function effectively, there is no particular reason why this should be the case. The Combined Code is a system based on principles rather than rules. Thus, enforcement capabilities are limited. Indeed, some recent studies have shown as few as 33% of LSE-listed firms adhere to the Combined Code in its strictest sense.

There are several ways in which the current UK corporate governance model can fall down. These include having a dominant CEO, having an ineffective or incompetent board, deliberate distortions of published financial figures, and employees who exploit their positions for personal gain. These are precisely the scenarios that led to many of the governance problems that provided the impetus for the Combined Code in the first place.

With the Financial Reporting Committee organizing another evaluation of the Combined Code for 2009, it is not expected that any significant changes are going to be made. The FRC is content with the current system, as is the business community in the UK. The currency system has all the right rules on the books, but because they are not mandatory, firms are not obliged to fulfill each and every component of the Combined Code.

However, it is fully reasonable to expect that the impetus for change will come as it has before, at the conclusion of a crisis. The Cadbury Report was precipitated by a crisis, as was the flurry of reports in the early 2000s. The corporate community in the UK prefers their version of corporate governance rules because they appear to be equally effective but without high cost. The London Stock Exchange certainly views the Combined Code as an advantage because it provides the LSE with a competitive advantage over New York and the SOX.

The Financial Reporting Committee's current work on updating the Smith Guidance is unlikely to yield any major changes to the role of auditors. The industry is heavily involved in the process. Additionally, the mandate of the updates does not speak directly to the role of auditors, but more towards how the market can be made to function better.

When the time comes -- when another crisis forces the Financial Reporting Committee into action -- the role of external auditor will again be called into question. The last ten years have seen the evolving of the Combined Code, which has resulted in a wide range of changes to the external auditing industry. Another crisis will likely result in a tightening of regulations, such that external auditors will no longer be able to do any non-auditing work for companies. Other than that, there is little indication that any regulatory changes will be made. There are definitely issues with the current version of the Combined Code -- as noted above -- but there is little if any impetus to address any of these issues, and there will not be as long as the London Stock Exchange gains competitive advantage for its low-cost governance program.

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