​Does Scandal Raise Awareness of Internal Audit's Value?

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Two investor groups issued recommendations last week urging rejection of the upcoming vote of confidence in VW's management board. The messages from investor advisory groups PIRC and Institutional Shareholder Services (ISS) are stunning in their frank and damning assessment of the troubled automaker's governance practices.

The recommendations, while significant in their implications for investors and VW management, also carry an important message that should not be overlooked about the value of internal audit.

At the heart of the PIRC and ISS recommendations is that they believe VW has not done enough to fix a variety of corporate governance weaknesses, according to published reports. Those identified weaknesses include a list of corporate governances "don'ts" that are contrary to best practices at all levels of the organization. According to PIRC, VW continues to have overlap in major shareholder and controlling functions, has a pay structure excessively linked to sales, has no whistleblower program, and has an inefficient internal audit function.

The ISS report, meanwhile, assigned VW its highest risk level and backs investor calls for four special audits intended to discover whether board members breached their duty in the highly publicized "dieselgate" emissions scandal last year. It added, ". . . there are justifiable concerns about the company's ability to investigate these matters internally and present their findings to shareholders in an impartial and transparent manner."

One doesn't have to be expert at reading between the lines to understand that both of the powerful investor groups believe there was a lack of a strong internal audit function within the organization.

For the record, I do not necessarily share the views of these investor groups about the quality of VW's internal audit function. However, it is disheartening that it would take something as shocking and disruptive as VW's dieselgate or other corporate scandals to raise internal audit's profile among investors, but it serves a good purpose in the long run. Investors who are knowledgeable about good governance, its value to the organization, and internal audit's vital role in providing assurance are more likely to support, indeed demand, strong and effective management that includes a healthy and independent internal audit function.

The growing recognition of internal audit's value shouldn't stop with investors.

A record number of activist-investor-led campaigns in 2015 have board members feeling vulnerable. Agenda's recent Directors' and Officers' Outlook Survey found nearly seven in 10 respondents said their boards discussed the risk of being approached by a hedge fund. What's more, Agenda reports that activist investor strategies are evolving to include governance and board composition.

All this relates to a point I made in a previous blog about internal audit's role when it comes to activist investors. Simply, good governance is the strongest hedge against the hedge-fund monster and internal audit must be part of that hedge. As I wrote then:

Companies can reduce the risk of becoming easy targets by deploying effective business strategies and processes that ensure good governance and position the business for sustained growth of shareholder value. Undervalued stock, mismanagement, excessive costs, or low profits — conditions that make a corporation a prime target for activist investors — likely are symptoms of risk failures elsewhere.

Growing awareness of internal audit's role in good governance by investor advisory services combined with heightened board concerns about vulnerability to activist investors place our profession in a strong position. I urge CAEs and other heads of audit to explore this growing awareness with their audit committees and boards.

As always, I welcome your comments. 

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