Track 3: An analysis of corporate governance in the big four auditing firms in South Africa

Rozanne Janet Smith

Ben Marx

Abstract:

The spate of corporate failures around the world, such as Enron, WorldCom, AIG and more

recently Patisserie Valerie and Steinhoff has attracted considerable attention from corporate

regulators and professional bodies. One of the many victims of these failures has been the

reputation of audit firms, the audit process and the accounting profession in general. Audit failures

are the product of the values governing auditing firms. Good audit firm governance is a way in

which the audit firms can maintain the public trust in their brands by being seen as exemplars of

best practice governance. In South Africa during 2018, the IRBA issued a call to audit firms to

introduce the public reporting of relevant internal information in the form of a transparency report.

This provides the public with limited information on the governance practice at the auditing firm.

Board composition is arguably one of the most critical components of a corporation’s governance,

and King IV also recommends disclosure with regards to the board composition. A content

analysis was performed to analyse the disclosure on the oversight board and its composition of

the big four audit firms in South Africa. From the findings it is evident that not all audit firms have

an oversight board, and it can be argued that the corporate structures of the audit firms are flawed.

Key words:

Corporate Governance, Audit Firms, Corporate Failures, Oversight Board, Transparency reports,

Governing Body.

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INTRODUCTION

The spate of corporate failures1 around the world, such as Enron and WorldCom (Segal, 2018),

has attracted considerable attention from corporate regulators and professional bodies. In South

Africa, before the recent Eskom and Tongaat scandals in 2019/2020, there was the Steinhoff and

VBS Bank corporate failures in 2017/2018. Although corporate failures are not new, what is of

increasing concern to stakeholders is the unexpected failures of many apparently financially

robust companies. One of the many victims of these failures has been the reputation of audit

firms, the audit process and the accounting profession in general (Kilgore, 2007).

There are several examples of corporate failures that led to audit firm failures2, such as the case

of Enron, where their auditors, Arthur Anderson, subsequently collapsed too (Crotty, 2019). In

South Africa, the auditing firm KPMG made headlines for their involvement in the Gupta Scandal

(Pilling, October 2017), which led to a series of leadership changes, changes in the governance

of KPMG South Africa, and enhanced quality control procedures in certain areas (Cotterill,

September 2017). This had a serious effect on the reputation of the auditing firm, and the

profession as a whole.

1 Corporate failure is defined as an event or situation involving the employment of financial resources, where questionable ethical behavior arises, and management misrepresents their financial statements, and auditors fail to discover or report on the misrepresentation, which then becomes the knowledge of the wide public. 2 Audit firm failure is defined as an event or situation involving auditing firms, where questionable professional and ethical behavior arises, which then becomes the knowledge of the wide public, thus affecting the reputation of the auditing firm, which could ultimately result in the closure of the auditing firm.

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These real or alleged financial scandals3 and audit failures4 have material consequences for

confidence in corporate governance and accountability. They raise the now familiar cry of ‘Where

were the auditors?’(Sikka, 2003).

According to Sikka (2003), audit failures are the product of the values governing auditing firms. It

is also supported by Allan Gray’s Peiter Koornhof, who states that the major crises usually reflect

a governance breakdown at multiple layers (Crotty, 2019). According to the Financial Reporting

Council (FRC) of the United Kingdom (UK) (2010), good audit firm governance is a way in which

the audit firms can maintain the public trust in their brands by being seen as exemplars of best

practice governance (Amirul, Salleh, Abu Bakar, 2015). Unfortunately at present, the corporate

structures of the audit firms are flawed, and they do not comply with the codes of corporate

governance (Aberian; March 2019). The literature has shown that the UK is the only country in

the world with a corporate governance code for audit firms. Currently in South Africa, there is no

corporate governance code which regulates the corporate governance of auditing firms, nor is

there a sector supplement in King IV for audit firms.

Audit firms often have different legal and governance oversight structures. Compared to that of

corporate entities, making it difficult for audit firms to simply apply the governance codes which

are already available, such as King IV. Audit firms can be either a partnership or incorporated as

a company. According to the APA (2005) if an audit firm is incorporated as a company, all

shareholders are directors and all directors have to be Registered Auditors (RA). If an audit firm

is a partnerships, all partners are directors and all directors have to be Registered Auditors (RA).

3 Toms (2019) defines a financial scandal as a situation or event that has occurred as a result of financial resources being employed in a morally questionable manner where there are serious consequences for third parties, which are widely known 4 An audit failure takes place when an auditor indicates to the public that a client’s financial statements are fairly presented in accordance with generally accepted accounting principles when in fact they are not (Pearson, 1987).

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Audit firms will elect directors to form an Executive Committee (EXCO) which is responsible for

the day-to-day management of the firm. All members of the EXCO are partners or directors of the

firm, and therefore it is not possible to appoint independent individuals to the EXCO. For this

reason, some audit firms appoint an independent oversight structure which is not part of the day-

to-day management of the firm, but rather provides oversight over the EXCO and governance of

the audit firm. This oversight structure is often referred to the oversight board and is responsible

for corporate governance. This is also the governance structure that this study will focus on.

According to Deloitte (2016), board composition is arguably one of the most critical components

of a corporation’s governance. For this reason, this study aims to investigate if the corporate

structures of the four large South African auditing firms practice and disclose the King IV Report

on Corporate Governance for South Africa, 2016 (hereafter referred to as King IV Report), with

specific reference to principle 7: Composition of the governing body. The disclosure will be

analysed from the 2018/2019 transparency reports for the four large auditing firms in South Africa.

The analysis will focus specifically on the oversight board composition, due to the independence

that is allowed on the oversight board. For the purposes of this paper, the term ‘governing body’

will refer to the oversight governance structure in the audit firm, and not the EXCO.

PROBLEM STATEMENT / RESEARCH QUESTION

Stated Research Problem:

The research problem is derived from the deliberations that auditing firms might not have

effective independent governance structures, and are not applying the King IV Code principles

and practices on corporate governance and board composition. This is evident from the amount

of corporate scandals and failures that have taken place recently and which can directly be

linked to a lack of corporate governance and independence at audit firms.

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The primary objectives of this study is to:

• Determine whether the four large South African auditing firms practice the King IV Code

principles and practices with reference to their governing body/oversight board

composition.

• Analyse the disclosure about the composition of the oversight board of the four large South

African auditing firms in the 2018/2019 transparency reports.

DEVELOPMENTS THAT HAVE GIVEN PROMINENCE TO CORPORATE GOVERNANCE

Corporate governance background

Although corporate governance issues have been well debated and discussed over the years, it

was only with the release of the Cadbury Report on Corporate Governance in the UK in 1992 that

the concept of corporate governance was really formally defined (Marx, 2008). The Cadbury

Committee define corporate governance as “the system by which companies are directed and

controlled” (The Committee on the Financial Aspects of Corporate Governance, 1992:18).

The Organisation for Economic Co-operation and Development (hereafter OECD) (2015) states

that effective corporate governance is meant to guide those charged with governance in their

decision-making processes in order to create sustainable, long-term value through market

confidence and business integrity. It forces companies to actively engage with the society in which

they exist and not only consider financial prosperity in a strategic objective setting but to also take

into account social and environmental value creation systems (Raemaekers, 2014). Kakabadse

and Korac-Kakabadse (2002) agree, by stating that good governance requires processes and

procedures that serve as guidelines for accepted behaviour for both companies and society as

well as, if appropriately applied, an environment for creating opportunities.

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In simple terms, good corporate governance is characterised by ethical and effective leadership.

It requires those charged with governance to exemplify ethical leadership in discharging their

responsibilities by demonstrating high levels of integrity, competence, responsibility,

accountability, fairness and transparency. Good corporate governance also requires those

charged with governance to lead their companies towards the achievement of strategic objectives

(IoDSA, 2016).

After the release of the Cadbury Report on Corporate Governance in the UK in 1992, many other

countries developed their own corporate governance codes. The next section will briefly explore

the corporate governance developments that took place in South Africa.

Corporate governance developments in South Africa

Corporate collapses and business failures, combined with fraudulent financial reporting practices,

stimulated corporate governance developments and gave rise to various corporate governance

codes that have been issued since 1992 (Marx, 2008).

In 1994, retired judge, Mervin King was appointed to form a commission to establish a code on

governance in South Africa. South Africa’s corporate governance reforms now centre around four

reports, namely the King Report on Corporate Governance (King I) issued in November 1994, the

King Report on Corporate Governance for South Africa – 2002 (King II) issued in March 2002

(West, 2006), the King Report on Corporate Governance for South Africa – 2002 (King III) issued

in 2009, and lastly the King Report on Corporate Governance for South Africa – 2017 (King IV

Report) issued in November 2016.

The first King Report on Corporate Governance (hereafter King I) was published in 1994. It was

considered ahead of its time (Marx, 2008) as it set an international benchmark for standards and

best practice (Jansen van Vuuren & Schulschenk, 2013). King I drew extensively on the Cadbury

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Report and similarly adopted a self-regulatory approach of ‘comply or explain’ (Mangena &

Chamisa, 2008). This meant that companies which complied with the report needed to disclose

their level of compliance, and in instances where they did not comply, explain their reasons for

non-compliance.

King II was drafted in 2001 and issued in 2002. Its effective date of implementation was 1 March

2002. Vaughn and Ryan (2006) and Marx (2008) described it as a more comprehensive report,

which was built on the foundation laid by its predecessor. King II maintained its original stance

and was not in favour of legislation which forced companies to comply with its recommendations

but rather, it stayed true to the ethos of self-regulation (Miles & Jones, 2009). However, the report

expanded on its ‘inclusive approach’ to corporate governance, recommending the introduction of

‘triple bottom line’ reporting to incorporate the economic, environmental and social aspects of a

company’s activities (Miles & Jones, 2009; Hendricks & Wyngaard, 2010).

The third report on corporate governance in South Africa came as a result of the new Companies

Act of 2008 and changes in international trends in governance (IoDSA, 2009). King III, which was

initially issued in 2009, promoted an integrated approach to governance and reporting, providing

extensive guidance on integrated reporting and disclosures of governance-related matters (PwC,

2009; Maseko, 2015).

Unlike its predecessor, King III became applicable to all entities irrespective of their size or

whether they were listed or not. However, King III placed no statutory obligation on companies to

comply with its recommendations and principles, thus moving away from the traditional ‘comply

or explain’ approach to an ‘apply or explain’ basis of reporting (PwC, 2009). This allowed

governing bodies to apply the recommendations differently or to apply other practices, where they

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consider such practices to be in the best interests of the company while still abiding by the

overarching principles of fairness, accountability, responsibility and transparency.

The most recent of the King reports, King IV Report, was published on 1 November 2016. The

report replaced King III altogether and is applicable to companies with financial years

commencing on or after 1 April 2017 (IoDSA, 2016).

From an application perspective, King IV Report is a framework which can be adopted across

listed and unlisted companies, profit and non-profit as well as public and private entities (IoDSA,

2016). King IV Report steps away from the ‘apply or explain’ approach and recommends an

‘apply and explain’, relieving governing bodies from the burden of compliance by reducing the 75

recommended practices in King III to 16 basic principles. The 16 principles can be adopted by

any company and are all necessary to substantiate the practice of good governance (IoDSA,

2016). The required explanation gives effect to each principle and enables stakeholders to make

an informed decision on whether a company is well governed or not. The explanation also helps

in shifting the focus of companies from a compliance mindset to a qualitative mindset, which

encourages the achievement of objectives through careful consideration of the entity’s

circumstances (IoDSA, 2016; Piek, 2016).

The section below will briefly discuss well known corporate failures that took place as a result of

weak corporate governance.

CORPORATE FAILURE

For the purposes of this paper, a corporate failure will be defined as an event or situation

involving the employment of financial resources, where questionable ethical behavior arises, and

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management misrepresents their financial statements, and auditors fail to discover or report on

the misrepresentation, which then becomes the knowledge of the wide public.

Most of the well-known corporate failures have involved a failure of corporate governance and

auditing processes, and accountancy procedures that have been compromised (Maranga, 2018).

The section below will briefly discuss well known corporate failures in South Africa as well as

explain the auditor involvement in each corporate failure.

Corporate failures in South Africa

Corporate collapses, business failures and fraudulent financial reporting have shocked the world

over the years (Terry, 2007). More “Enron scandals” have also taken place in African countries

with auditors and accountants who have exposed stakeholders to huge financial losses (Maranga,

2018). Well-known instances of fraudulent financial reporting and corporate scandals in South

Africa include, inter alia, Masterbond, LeisureNet, Regal bank, Unifer Bank, Saambou Bank,

Tigon, Macmed, South African Airways, Randgold & Exploration, JCI and Fidentia (Marx, 2008),

and more recently VBS Bank, Steinhoff, Tongaat and Eskom. The most recent scandals in South

Africa involving auditing firms include KPMG, Deloitte, PwC and Nkonki, to mention only a few

(Maranga, 2018).

Recent corporate failures such as the retail giant, Steinhoff, caused the public to doubt the audit

profession. Steinhoff suffered a big setback in 2017, with accounting irregularities resulting in an

investigation (Putzier, 2019). Top executives were misrepresenting financial data, and the

auditors at the time, Deloitte, failed to act on time (Open Secrets, 2020). Deloitte had been an

auditor to Steinhoff for two decades. This kind of strengthened relationship ultimately

compromises the independence an auditor can exercise. The long-running work which Deloitte

had done with Steinhoff meant that Deloitte should have had much greater insight into the

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business and how it worked (Open Secrets, 2020). It can be argued that an independent oversight

board could have provided the independence which was needed.

In 2018, the VBS Bank failure shocked everyone, especially the role of the auditors, KPMG, in

this failure. KMPG partners, including those who jumped the ship, may be held responsible for a

possible R1.89 billion lawsuit following the catastrophic VBS audit by the company (de Wet &

Wasserman, 2018; Ritchie, 2018). The independence of the auditor was a major contributor to

the VBS scandal. In the same year, accounting firm Nkonki Inc. closed its doors (Haffajee, 2018).

An audit partner and Gupta lieutenant Salim Essa worked together to give the shady Gupta deals

a stamp of auditor approval. Nkonki was no longer allowed to provide word for the public sector.

Issues of auditor independence, unethical behaviour and a lack of corporate governance resulted

in the failure of Nkonki (Institute of Certified Bookkeepers and Accountants, 2018).

During 2017 to 2018, audit firm KPGM made many media headlines. Their involvement with the

Gupta’s, and in the VBS Bank failure had a serious effect on their reputation. KPMG undermined

the very underpinnings of corporate governance and the reputational credibility of the external

audit (Abedian, 2017; Hosken, 2017). KPMG has since strengthened their procedures in

corporate governance. They agreed to follow additional criteria as outlined in the King IV Report

on Corporate Governance for South Africa, and to nominate an independent non-executive

member to support the existing members of the Executive Committee (KPMG, 2017).

In 2019, Tongaat announced that an analysis uncovered some past activities that are of serious

concern to the board and the auditors of the firm. It was found that their financial results were

overstated by between R3.5 billion to R4.5 billion (Stoddard, 2020). The investigation of this case

is still in progress. Very recently, Eskom announced that their auditors PwC owed them R95

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million. Eskom claimed that PwC charged them for work that Eskom had already done themselves

(Burkhard, 2020). The investigation is still underway.

These South African examples of corporate financial misconduct, especially where the auditor is

implicated, have resulted in the public and the IRBA questioning the independence and

professional scepticism of the South African audit industry, especially with regard to public interest

entities and exchange-listed companies (IRBA, 2016, 2017).

The governance of audit firms is perceived to have a significant influence on audit quality and an

audit firm's ability to continuously provide audit services to the market (La Rosa, Caserio &

Bernini, 2018). It is clear from the literature that a lack of corporate governance and independence

within the audit firms has contributed to some extent to these corporate failures. The next section

will briefly discuss the corporate governance in audit firms.

CORPORATE GOVERNANCE IN AUDITING FIRMS

As mentioned above, there have been various corporate failures, as well as audit firm scandals

recently in South Africa, but it was only after the Gupta and VBS corporate failures that KPMG

decided to start with the implementation of King IV Report in their organisation. This raised the

question, “why have auditing firms not been implementing King IV principles?”

The International Auditing and Assurance Board (IAASB) believes that governance and

leadership of an organisation is of vital importance to the quality of service, as it is the way the

company embeds its culture and ethics. It is also the basis of how decisions in the business are

made. Governance of a firm often influences the understanding of the firm by the public; and a

firm without a successful governance structure may be viewed as one that does not work in the

public interest (IRBA, 2018).

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In South Africa there is no specific corporate governance code for auditing firms like there is in

the UK. The King IV Code is applicable to any organisation, and includes specific sector

supplements for several sectors, but audit firms are not included in these sector supplements.

The codes, regulations or legislation which addresses audit firms include the Audit Profession Act

(APA), ISQC 1 and ISA 220. The Brydon and SAAPTI reports also provide some guidelines for

audit firms. At present, the corporate structures of the audit firms are flawed (Aberian, 2019), and

there is a need for a corporate governance code to be developed for audit firms. Below is more

detail on some of the audit firm codes, regulation or legislation which is currently available.

Globally there is the ISQC 1 and ISA 220 which provides limited information on audit quality and

governance. In 2009 the IAASB issued the International Standard on Quality Control (ISQC) 1.

The ISQC 1 addresses the “Quality Control for Firms that Perform Audits and Reviews of Financial

Statements, and Other Assurance and Related Services Engagements”. It is applicable to all audit

firms. The ISQC does not make any specific reference to audit firm corporate governance, but

rather individual auditors (IRBA, 2018). The International Standard on Auditing (ISA) 220 deals

with the specific responsibilities of the auditor regarding quality control procedures for an audit of

financial statements. It addresses, where applicable, the responsibilities of the engagement

quality control reviewer (IAASB, 2010). Therefore no specific reference is made to audit firm

governance. The drafts for the International Standard on Quality Management 1 (ISQM) and

ISQM 2 was released in 2019, but they are not yet applicable, and will thus not be considered for

the purposes on this paper.

The Brydon Report was published in the UK in 2019. Sir Donald Hood Brydon is the author of the

Brydon Report. The report discusses “the quality and effectiveness of audit”. According to the

Brydon Report, there are certain principles that will provide a framework for the behaviour of

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auditors beyond that which simply follows standards and the law (Brydon, 2019). The Brydon

Report makes no specific reference to audit firm corporate governance. The emphasis is also

placed on the individual auditor.

According to South African Auditing Profession Trust Initiative (SAAPTI) (2020) there is a need to

set out the principles and best practices that the audit firms should apply in order to achieve good

governance (tone from the top). There should be a set of principles for best practice on the

effective governance of ethics within the audit firms. Governance structure for audit firms should

be clearly defined. According to SAAPTI there is uncertainty as to whether audit firms have ethical

leadership and effective structures to govern ethics, and whether firms are structured in a way to

be good corporate citizens that serve the public interest (SAAPTI, 2020).

From the above it is clear that even though there are regulation and legislation which address

governance, very little detail is provided on the matter. In most cases the legislation focusses on

the individual auditor’s governance, and not the governance of the audit firm. Regardless of this,

audit firms, such as KPMG, have realised the need to implement and practice corporate

governance, and have implemented some corporate governance principles as set out in King IV

(KPMG, 2019). The transparency reports of the audit firms will be able to provide some insight

into their corporate governance practices currently implemented at audit firms.

In South Africa during 2018, the IRBA issued a call to audit firms to release transparency reports

in order to disclose the relevant internal information to the public. The release of a transparency

reports by audit firms have been voluntary in South Africa. Transparency reports will provide users

with the information that help them understand the firm's approach to leadership, culture and

ethics; the firm's risk management practices; its relationship with staff and service providers;

independence; and addressing its external and internal inspection and monitoring results. With

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the current unprecedented level of scrutiny on audit firms, it is in a firm's best interest to be

transparent, and for the audit industry to embrace the attitude of disclosure and transparency that

is encouraged among their clients (IRBA, 2018).

Due to the fact that the transparency reports will be able to provide some information on the audit

firm’s practice of corporate governance, the transparency reports of the four large South African

Auditing firms will be analysed. The content analysis will analyse the audit firm’s application of

principle 7 of the King IV Code. As stated above, the oversight board will be the focus of the

analysis.

RESEARCH METHODOLOGY

Secondary data is gathered from textbooks, publications, the internet, online journal articles, and

the online library of the University of Johannesburg. Secondly an empirical study was conducted.

For the empirical study, the content analysis research design was selected. Content analysis

enables researchers to sift through large volumes of data with relative ease in a systematic

fashion (Krippendorff, 1989). Qualitative content analysis is one of numerous research methods

used to analyse text data. It focuses on the characteristics of language as communication with

attention to the content or contextual meaning of the text (Hseih & Shannon, 2009). This is

supported by Elo and Kyngäs (2007), who state that content analysis is a technique whereby the

researcher analyses existing documents to test theoretical subjects in order to enhance

understanding of the data collected. A content analysis is thus the technique that formed the

research design for the purposes of this study. A descriptive analysis was performed to describe

the findings of the empirical study.

The sample which was selected for this study is the big four auditing firms, namely KPMG,

Deloitte, PWC and EY (Bhaskar & Flower, April 2019). According the IRBA (2020) these four

audit firms have the most audit partners, ranging from 89 – 195 partners. The most recent

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transparency reports from 2018/2019 were obtained from their websites and analysed. The

empirical study aims to determine whether the auditing firms practice the requirements of the King

IV Report principle 7: The composition of the governing body.

A 100% response rate was achieved and all the transparency reports for the four auditing firms

in the population were analysed for disclosure. Only publicly available sources were used and no

changes were made to these sources. The identities of these companies have been kept

confidential, except for stating which entities were included in the sample.

EMPIRICAL FINDINGS

The importance of transparency and accountability has been widely recognised by both

academics and market regulators (Fung, 2014). This follows two decades of corporate failures

and scandals such as falling stock markets, dubious accounting practices, fraud and the abuse

of corporate power associated with various global companies such as WorldCom, Arthur

Anderson, Enron, Murray and Roberts and more recently, Steinhoff and KPMG (Arjoon, 2005;

Monahan, 2012; Steyn, 2015; Lungisa, 2017). These acts of self-interest have undermined the

confidence of all stakeholders, resulting in a relationship of broken trust between themselves and

governing bodies (Arjoon, 2005; Monahan, 2012).

Although still to be prescribed in South Africa, audit firms are encouraged to voluntarily issue

transparency reports for their South African activities. This early practice will encourage the

maturing of systems, and learning ahead of regulation (IRBA, 2018).

The empirical findings below present the result of the content analysis on the disclosure of the

composition of the oversight boards of the largest four auditing firms in South Africa. As the UK

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is the only country in the world with an Audit Firm Governance Code, the UK Code will be used

to support the findings.

The following symbols will be used to indicate the disclosure:

YES Disclosure is in terms of King IV Report.

NO Nothing is disclosed in the Transparency Report.

TSE To some extent, there is disclosure in terms of King IV Report.

According to the IoDSA (2016), the following practices should be disclosed in the integrated

and/or transparency reports with regards to the composition of the governing body.

TABLE: Disclosure requirements according to King IV Report.

Principle 7: disclosure requirements according to

King IV Report.

A B C D

1 Whether the governing body (oversight board) is

satisfied that its composition reflects the appropriate

mix of knowledge, skills, experience, diversity and

independence.

TSE NO TSE TSE

2 The targets set for gender and race representation in

the membership of the governing body, and progress

made against these targets.

YES YES NO YES

3 The categorisation of each member as executive or

non-executive.

YES NO NO YES

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4 The categorisation of each non-executive member as

independent or not, and the independence of non-

executives who have served for longer than nine years.

TSE NO NO NO

5 Each member’s period of service on the governing

body.

NO NO NO NO

6 The age of each member. NO NO NO NO

7 Other governing body and professional positions held

by each member.

NO NO NO NO

8 The reasons why any members of the governing body

have been removed, resigned or retired.

YES NO NO NO

9 The qualifications and experience of members. TSE NO TSE NO

10 Whether the chair is considered to be independent. YES NO NO NO

11 Whether or not an independent non-executive member

of the governing body has been appointed as the lead

independent, and the role and responsibilities assigned

to the position.

YES NO NO NO

(Source: Own analysis; IoDSA (2016))

From the empirical study, the following conclusions can be made:

As stated above, according to Deloitte (2016), board composition is arguably one of the most

critical components of a corporation’s governance. This is supported by SAAPTI (2020) who state

that there should be a set of principles for best practice of corporate governance (tone at the top)

in audit firms. According to the FRC (2016), owner accountability is important, and the

management of a firm should be accountable to the firm’s owners and no individual should have

unfettered powers of decision.

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1. Whether the governing body is satisfied that its composition reflects the appropriate

mix of knowledge, skills, experience, diversity and independence.

According to the Audit Firm Governance Code in the UK (FRC, 2016), the independent non-

executives’ duty of care is to the firm. They should command the respect of the firm’s owners and

collectively enhance shareholder confidence by virtue of their independence, number, stature,

experience and expertise. They should have a balance of relevant skills and experience.

Audit firm A does disclose to some extent that they are satisfied with the composition of the

governing body. This audit firm has appointed a South African oversight board to provide

oversight on governance. They have recently appointed independent non-executive members to

the oversight board. They do however disclose that they are still in the process of improving the

application of King IV Report, and intend to continuously evaluate areas for improvement. This is

the only audit firm which has independent members on their South African oversight board.

Firm B has appointed a South African oversight board, but does not have any independence on

their oversight board. Firm C only has a global oversight board, and no specific oversight board

in South Africa. Firm C does however have six independent non-executive members on their

global oversight board. Firm D has an Africa oversight board which provides oversight on key

matters including governance, strategy, alignment, risk issues, transformation and regulatory

matters. Firm D has appointed two independent non-executive members to their oversight board.

Thus only two of the 20 members are independent.

2. The targets set for gender and race representation in the membership of the governing

body, and progress made against these targets.

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The King IV Report (IoDSA, 2016), highlighted the specific need to disclose the progress towards

targets for race and gender diversity on the governing body.

Firm A, B and D clearly disclosed the race and gender representation on the oversight board.

Firm D disclosed that it is their goal to achieve a fair representation of both genders, by increasing

the number of women in leadership and governance bodies. They also disclose that they have

bridged the gap of inequality by increasing the number of black owners in South Africa.

Firms C does not make specific reference to race and gender representation on the oversight

board.

3. The categorisation of each member as executive or non-executive.

According to the UK Audit Firm Governance Code, (FRC, 2016), an audit firm should appoint a

majority of independent non-executive directors. The audit firms should have at least three

independent non-executives. They will be responsible for to oversee the public interest matters.

They should have full visibility of the entirety of the business but should pay particular attention to

and report on risks to audit quality and how they are addressed. If a firm considers that having

three independent non-executive directors is inappropriate given its size or number of public

company clients, it should explain this in its transparency report and ensure a minimum of two at

all times. This reference is also applicable to point 4 below.

Firms A and D categorised some or all of their members as executive or non-executive directors.

Firms B and C did not provide any specific categorisation of the members of the oversight board.

4. The categorisation of each non-executive member as independent or not, and the

independence of non-executives who have served for longer than nine years.

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According to the IoDSA (2016), having members of the governing body who are independent in

appearance is an essential element in most governance codes. The governing body should

comprise a majority on non-executive members, most of who should be independent. Non-

executive members of the governing body may be categorised by the governing body as

independent if it concluded that there is no interest, position, association or relationship which,

when judged from the perspective for a reasonable informed third party, is likely to influence

unduly or cause bias in decision making in the best interest of the organisation. According to the

FRC (2016), the firm should state in its transparency report the names and job titles of all

members of the firm’s governance structures and its management, and their length of service.

According to the UK Audit Firm Governance Code, Independent non-executives should be

appointed for specific terms and any term beyond nine years should be subject to particularly

rigorous review and explanation (FRC, 2016).

From the disclosure in the transparency reports, only auditing firm A provided information to some

extent on the independence of some of the governing body members. Firm A did not provide

information on the period which the members have been serving on the governing body, thus no

further analysis could be made should a member have been serving for more than nine years.

Not firm B, C nor D provided disclosure regarding the periods that the members have been on

the governing body, and thus there was no disclosure on the independence of members that have

possibly been serving for more than nine years.

5. Each member’s period of service on the governing body.

According to the FRC (2016), the audit firm should state in its transparency report the length of

service of the members. None of the firms provided disclosure on the period of service on the

governing body.

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6. The age of each member.

According to the FRC (2016) the audit firm should state in its transparency report the relevant

biographical details of the members of the governing body. None of the firms provided the ages

of the members of the governing bodies.

7. Other governing body and professional positions held by each member.

None of the firms disclosed information on the other professional positions held by each of the

members of the governing body. The firms disclosed in which divisions and regions some of the

governing body members were involved in, as well as which committees they are involved in, but

no reference was made to other profession positions that are held.

8. The reasons why any members of the governing body have been removed, resigned or

retired.

Firm A disclosed information detailing the reasons why some of the governing body members had

left the firm.

Firms B, C and D did not make any disclosure with regards to members that had been removed,

resigned or retired from the governing body.

9. The qualifications and experience of members.

According to the IoDSA (2016), the overriding concern in terms of independence is whether the

governing body is knowledgeable, skilled, experienced, diverse and independent enough to

discharge fully its governance role and responsibilities. This is supported by the UK Audit Firm

Governance Code (FRC, 2016), which states that the independent non-executive members

should have competence in accounting and/or auditing, gained for example from a role on an

audit committee, in a company’s finance function, as an investor or at an audit firm. Firm A

22

provided very little information about the independent non-executive members, but nothing

specific. Firm C does state that they have senior leaders in the public and private sector, but no

specific details are provided with regards to qualifications. None of the other audit firms disclosed

any details on the qualifications or experience of their members.

10. Whether the chair is considered to be independent.

According to the IoDSA (2016), the governing body should elect an independent non-executive

members as chair to lead the governing body in the objective and effective discharge of its

governance role and responsibilities. The UK Audit Firm Governance Code (FRC, 2016) states

that an audit firm should appoint independent non-executives to the governance structure who

can collectively enhance the firm’s performance.

Firm A disclosed that they currently do not have a chairman due to the chairman moving to an

executive position. Thus no information is known about the independence of the chairman. Firm

B and D does not have an independent Chairman on their oversight boards. Firm C does not

disclose whether the chair of their global oversight board is independent, even though there are

independent non-executive member on their oversight board, I cannot assume that the chair

would be an independent non-executive director.

11. Whether or not an independent non-executive member of the governing body has been

appointed as the lead independent, and the role and responsibilities assigned to the

position.

According to the IoDSA (2016), the governing body should appoint an independent non-executive

member as the lead independent to lead in the absence of the chair, to serve as a sounding board

for the chair; to act as an intermediary between the chair and other members of the governing

body if necessary; to deal with shareholders’ concerns where contact through the normal

23

channels has failed to resolve concerns, or where such contact is inappropriate; to strengthen

independence on the governing body if the chair is not an independent non-executive member of

the governing body; to chair discussions and decision making by the governing body on matters

where the chair has a conflict of interest; and to lead the performance appraisal of the chair

(IoDSA, 2016).

Firm A disclosed that a lead independent non-executive director was appointed whilst there was

(at that point) no chairman (see point 10 for more information).

Firms B, C and D made no disclosure in this regard.

RECOMMENDATION AND AREAS FOR FUTURE RESEARCH AND LIMITATIONS OF THE

STUDY

Limitations

This article is limited to only to the disclosure of the King IV Report, principle 7: composition of

the governing body of the four large auditing firms in South Africa. The other disclosure

requirements with regards to corporate governance was not analysed, and will be done in future

research which is already in progress.

The empirical study was limited to only the top four auditing firms. Future research will include the

top 10 audit firms whom all have 20 or more audit partners.

The analysis is based on the 2018/2019 transparency reports, as the most recent reports were

not available for all four of the auditing firms.

Recommendations and areas for future research

24

Future research should be done on the full disclosure requirements in the King IV Report. More

auditing firms could also be included in the population.

CONTRIBUTION TO BODY OF KNOWLEDGE

While many studies have explored the determinants of corporate governance disclosures of listed

companies (e.g., Bauwhede & Willekens, 2008; Collett & Hrasky, 2005; Markarian, Parbonetti, &

Previts, 2007; Parum, 2005), little empirical evidence exists on corporate governance practices

and disclosures of audit firms (La Rosa, Caserio & Bernini, 2018). For this reason this study aims

to add to the very limited existing body of knowledge, and also encourage research on audit firm

corporate governance practice and disclosure.

CONCLUSION

From the literature provided it was clear that many current corporate governance codes were

developed as a result of corporate scandals or failures. In many of these corporate failures, the

auditor’s lack of independence and corporate governance contributed to the failure. For this

reason the study aimed to determine whether the top four audit firms in South Africa have an

independent oversight boards which will contribute to the independence and governance

oversight of the audit firm. From the above it is evident that the big four auditing firms within South

Africa does not adhere to the King IV Report disclosure requirements with regards to the

composition and disclosure of the governing body. There is also a lack of independence on all

the audit firm oversight boards.

The findings from this study is supported by Aberian (March 2019) who argue that at present, the

corporate structures of the audit firms are flawed. Seeing that auditing firms service the public

interest, it would be in the best interest of the public if auditing firms apply and practice the King

IV Report principles, and ensure that there is proper disclosure as per the King IV requirements.

25

As stated by SAAPTI (2020), corporate governance guidelines should be developed specifically

for audit firms, in order to ensure they know how to apply corporate governance within their

organisations. As the UK Cadbury Report was initially the basis for the development of the King

Code, the UK Audit Firm Governance Code could also be used as a basis to develop corporate

governance guidelines for audit firms in South Africa.

The IAASB believes that governance and leadership of an organisation is of vital importance to

quality of service, as it is the way the company embeds its culture and ethics. It is also the basis

of how decisions in the business are made. Governance of a firm often influences the

understanding of the firm by the public; and a firm without successful governance structure may

be viewed as one that does not work in the public interest (IRBA, 2018).

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