The Rotational CAE Model: Is it Good for Internal Auditing?

Richard Chambers, CIA, shares his personal reflections and insights on the internal audit profession.

There was a time when a career goal for many internal audit professionals was to rise through the corporate internal audit ranks to become their company’s general auditor — what is known as today’s chief audit executive (CAE). My first CAE had been an internal audit professional for almost 20 years when I joined the organization. He was still the CAE 13 years later when I took his place (having left and returned to the department twice).

Today’s CAE, however, is quite a different executive than in the past. In the modern corporate model, the CAE position frequently is a rotational assignment that is filled for 3-5 year tenures by upwardly mobile executives out of the chief financial officer (CFO) organization. In fact, recent studies indicate that as many as 40 percent of Fortune 500 CAE positions are now considered rotational. The question is no longer whether this model is widely practiced. The question is now: Is this good for internal auditing?

Why the rotational model is good for internal auditing. I have had the opportunity to work closely in recent years with scores of CAEs in Fortune 500 companies. Many of them were career financial executives who were in a rotational assignment as a CAE. In most cases, they brought a tremendous level of energy and enthusiasm to the role. Having not spent their careers in internal auditing, they also brought a fresh and innovative perspective to such fundamental tasks as risk assessment and audit planning. Some of them became leaders in the internal audit profession and even took and passed the Certified Internal Auditor exam. Because they transitioned into internal auditing from “the business,” they had a strong appreciation for key risks and opportunities facing the enterprise, as well as strong relationships with other key executives in the company. These relationships often help create an environment where management is open and receptive to internal audit findings and recommendations. In short, there are many benefits that have accrued to the profession in general — and corporate audit functions in particular — by virtue of the proliferating rotational CAE model.

Why the rotational model is bad for internal auditing. Despite the many positive aspects of the rotational model, there also are clear drawbacks. The most obvious drawback relates to the actual or perceived objectivity of CAEs who are slated to only spend a short tenure in an internal audit leadership role. As mentioned above, these executives often are from the CFO area of the organization — with a clear expectation of returning there after serving as the CAE. Without exception, each of the CAEs with whom I have had the opportunity to work has had an independent mind-set. In addition, their CFOs have made it clear that they respected the independence of internal auditing. Regardless of the realities, however, the perception can still present a problem. I have had many conversations with executives in companies where the CAE is actually a career CFO organization professional, and their colleagues believe their objectivity is impaired when auditing CFO functions or programs. If this belief is widely held, it can erode the stature of the CAE and the entire internal audit function.

Another potential drawback to the rotational model occurs when tenure in the position is intentionally designed to be brief (i.e., less than three years). In such instances, it sometimes is difficult for the CAE to achieve the level of effectiveness that often comes with tenure in a senior executive position. In addition, if the entire internal audit department is rotational, including the CAE, there is a significant challenge in accumulating the institutional knowledge of the company’s risk and controls that an effective internal audit function needs.

Safeguards for rotational CAE models. Whether the rotational model is good or bad for internal auditing is not black and white. Regardless of one’s views on the subject, it is a practice that appears to be here to stay. To minimize the risks associated with such a model, I offer five safeguards:

  1. The audit committee should understand the advantages, disadvantages, and risks of the rotational model, and be engaged in the selection and evaluation of the CAE.
  2. The audit committee should pay particular attention to the risk assessment results and audit coverage of the area from which the individual is drawn — and would be expected to return.
  3. If possible, the CAE should have an administrative reporting relationship outside of the area from which he or she is drawn and expects to return. For example, a CAE from the CFO organization could report administratively to the chief executive officer or general counsel.
  4. The terms of the rotation should preclude the individual from returning to the same functional area from which he or she is drawn.
  5. The rotation should be at least a five-year assignment. The longer the individual is expected to serve as the CAE, the lower the perceived risk of objectivity impairment.

 

Posted on Feb 17, 2009 by Tim McCollum

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  1. Richard, this is an excellent discussion.  One question you don't ask is whether a rotational program is good for the company.  I suspect the answer is going to be that "it depends".

    I would advise an audit committee that a rotational program has the potential disadvantages you have identified, and they should have monitoring processes to ensure the effectiveness of the operation is not impaired.  These should include discussions with the external auditor and management on a more frequent basis, and close questioning of the CAE on how proficiency and understanding of best practices is ensured.  For example, is the rotational auditor supported by a second tier of experienced practitioners who manage the overall risk assessment and day-to-day management of the department?  What training is the CAE receiving?

    The chair of the audit committee might want to have quarterly or semi-annual meetings with the CAE and his direct reports to ensure objectivity, competence, and quality assurance activities.

  1. Richard,

    A key "leadership" responsibility often overlooked by CAE's is "the rookie in-tow".  If the rotation is for 3 to 5 years, a reasonable suitable replacement should be identified somewhere in the middle with clear designation as the replacement by the final months of tenure.  I have seen instances where this is not done and the internal audit function is left to fend for themselves while the new CAE is hired and/or rotated in.

    Of course, I have also seen this oversight in CAE career roles as well.

  1. Richard,

    Another aspect of this problem is the AC's role in approving or at least approving the new CAE. Their task is not an easy one. Essentially they must know that they may be inviting the fox into the hen house. This is a problem that I think goes a bit beyond independence and objectivity, in that it may require the CAE to target financial policies that he or she may have put in place, and controls that were put in place by the rotational CAE that may or may not be effective. 

    The compensating controls that Norman Marks suggests are excellent. But I wonder if they would be enough. Going outside for the CAE seems more likely to ensure the requisite level of independence and objectivity.

  1. Richard,

    This continues to be a good dicussion topic.

    There are a few other things that could also be explored such as how beneficial is it for a company to bring in an outsider as the CAE who is not or has not been in internal audit!  Another would be to explore the tenure of the staff in the department particulary the direct reports to the CAE. If they also are rotating or not long in their positions, this could/should  lead to some concern for the audit committee.

  1. Richard,

    Really a good discusson, yours and the other comments.

    I think it is also important for AC to care about what are the initiating conditions for the concept of rotation, it would be better if the rotational CAE is a part of the well designed career system. AC must also be sure especially for the big companies with complex processes, rotational period is enough for deep understanding and real value addition to the enterprise.

  1. Good Day

    I want to know more about the benefits of rotational programs for Internal auditors,how independence and objectivity will be handled with care?

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