Should the Chief Audit Executive Report to the Audit Committee or the Full Board?

Recent writings, including by Professor Andrew Chambers, discuss the potential for chief audit executives (CAEs) to have a real or perceived problem with their reporting relationship — even where they report functionally to the audit committee (or equivalent) and only administratively to a member of executive management.

Do you believe any of these could result in either a real or perceived limitation on the objectivity or the performance of the CAE and the internal audit function?

  • The CAE receives a bonus based primarily on corporate performance. While even a substantial part of the bonus may be based on individual or team performance, typically no bonus is paid unless the entity achieves financial or operating targets.
  • The CAE has the title of "vice president" or similar, which sounds like a member of the management team.
  • The CAE's compensation is set by management, with the concurrence of the audit committee.
  • The CAE reports to the audit committee, but has no formal relationship with any other board committee (e.g., risk or governance) — or the full board.
  • Although CAEs are hired only after an interview with the chair of the audit committee of the board, the only candidates presented are those selected by the finance organization.

 

Posted on Dec 29, 2008 by Norman Marks

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  1. I am interested in your comments on the following:

    "Recent writing, including by Professor Andrew Chambers, discuss the potential for chief audit executives (CAEs) to have a real or perceived problem with their reporting relationship -- even where they report functionally to the audit committee (or equivalent) and only administratively to a member of executive management.

    "Do you believe any of these could result in either a real or perceived limitation on the objectivity or the performance of the CAE and the internal audit function?

    * "The CAE receives a bonus based primarily on corporate performance. While even a substantial part of the bonus may be based on individual or team performance, typically no bonus is paid unless the entity achieves financial or operating targets" -- This describes my situation and I continue to be uneasy with it. We fully vetted it with the Compensation Committee of the Board and they were comfortable leaving my bonus, and that for my department, in the regular pool. I don't think this is best, but the benchmarking done by our HR team couldn't find sufficient evidence to justify another arrangement. My actual bonus payout is discussed with and approved by the Audit Committee, which helps to an extent. More so, I have to remind my IA team annually of our fiduciary responsibility to a variety of stakeholders and reinforce the importance of "doing the right thing."

    * "The CAE has the title of "vice president" or similar, which sounds like a member of the management team" -- I don't think this is an issue at all. Titles don't matter, responsibilities do. As long as the CAE does not make management decisions, it doesn't matter what title they have.

    * "The CAE's compensation is set by management, with the concurrence of the audit committee" -- This is OK as long as the Audit Committee takes their role seriously and challenges management on the reasons for compensation changes. Management is more familiar with the company's HR and compensation practices, as well as external benchmarking that helps assess compensation ranges. I see no problem with management recommending compensation, with the requirement that it be vetted with the Audit Committee.

    * "The CAE reports to the audit committee, but has no formal relationship with any other board committee (e.g., risk or governance) -- or the full board" -- Ideally, the CAE should have some visibility with other Board committees. I attend all Nominating & Governance Committee meetings because they oversee the compliance program and we do compliance audits. Certain audit reports go to the Compensation Committee. And most of the board members sit in on other committee meetings so I have at least met them and they know me.

    * "Although CAEs are hired only after an interview with the chair of the audit committee of the board, the only candidates presented are those selected by the finance organization" -- Similar to the compensation question, I think it's fine for management to run the search. This should not be driven solely by financial management since the CAE needs to develop relationships with the entire C-Suite. However, the Audit Committee must have a strong hand in the selection process and ultimately approve the hiring/firing of the CAE. Frankly, I wouldn't join a company as CAE unless I had the opportunity to interview with the AC Chair, at a minimum, and preferably with the full AC (even if it's just over the phone).

  1. Hi guys

    My five cents worth:

    "The CAE receives a bonus based primarily on corporate performance.  While even a substantial part of the bonus may be based on individual or team performance, typically no bonus is paid unless the entity achieves financial or operating targets."

    I see a big risk here. One of the major issues in the audit scope is to verify the quality of information that executive management sends through to the board. One of the major fraud areas is where executive management "pump up" the profit numbers in order to achieve bonus thresholds or improve the value of share options. By doing this you put the CAE into a conflict situation, where they perhaps notice that the numbers are inflated or that executives are following a very risky short-term strategy but they have a personal vested interest in allowing this to pass unnoticed.

    "The CAE has the title of "Vice President" or similar, which sounds like a member of the management team."

    I don't think this is a major risk. Although we stick to the title CAE, the CAE generally sits on the ExCo. It is obviously up to the CAE to maintain independence, but having them on ExCo does not mean they are automatically conflicted -- in fact they would not be able to do their job properly if they are too far out of the loop. The only issue would be where the title of VP automatically brings profit-share etc, in which case refer above.


    "The CAE's compensation is set by management, with the concurrence of the Audit Committee."

    This is always a problem. If executivesare involved in deciding on salary increases and other remuneration aspects, then they have bargaining power over the CAE. The remuneration decisions should be taken by the Audit Committee, with the concurrence of the CEO, and other executives should have no influence at all.

    "The CAE reports to the Audit Committee, but has no formal relationship with any other board committee (e.g., Risk or Governance) -- or the full board."

    The more communication, the better. We generally encourage the board to interact with the CAE freely, or at least with the Chairman of the Board, who is the CEO's "boss" but is not usually a member of the audit committee.


    Although CAE's are hired only after an interview with the chair of the Audit Committee of the board, the only candidates presented are those selected by the finance organization”

    The finance organisation should not be involved here at all. The recruitment of a CAE should be handled by the Nominations Committee of the board, or by a special task team of the board set up for that purpose only (in which case it usually falls to the audit committee). The key responsibility of the CAE is going to be to make sure the non-executive directors are properly informed about the possible failings of the executives, and therefore the competencies, integrity and loyalties of the CAE must be carefully managed by the board from day one.

    Hope this helps.

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