The recently completed IIA International Conference in New York brought together more than 2,500 internal audit practitioners to share knowledge, network professionally, strengthen old friendships, and create new ones. It also offered the opportunity for the kind of interactions that can draw out insights into the profession.
One discussion I was made aware of involved a longtime chief audit executive (CAE) who was lamenting the growing use of the rotational CAE model in his industry. The number of firms turning to the model, including some of the largest within that industry, is alarming, the executive confided.
I have written in the past about my apprehensions about the rotational CAE model. Proponents can make a strong case that rotating future organizational leaders through the CAE chair affords them the opportunity to gain valuable knowledge of various business units and a broad view of the organization's challenges, risks, and opportunities. And, I would be the first to say that many outstanding CAEs have come from business units within their companies. They frequently bring deep knowledge of the business and relationships that are important for internal audit. A rotational assignment into the CAE role can be of great benefit to the individual.
However, a number of concerns arise when individuals with little to no previous internal audit, risk management, or assurance experience are tasked with temporarily leading the internal audit function. In fact, I would argue that rotational CAEs create long-term risks for organizations that embrace the model. Here are five risks or challenges that management and audit committees should carefully consider before adopting a rotational CAE model.
Internal Audit Knowledge Recently appointed CAEs without an internal audit background often share with me that they had no idea how complex the role would be. For example, they felt totally unprepared to play a leadership role in addressing serious risk management weaknesses that may well focus on one of their former peers in the business. CAEs must possess more than just the basic internal auditing skill sets to lead a modern internal audit function. CAEs need to be masters of professional best practices, such as deployment of continuous risk assessments or interaction with the audit committee. Otherwise, they are often forced to defer to less senior internal audit staff for key topics.
Institutional Knowledge Rotational CAE assignments are often for around three years or less. As a result of such short tenures, organizations that rotate three or more CAEs through the role over the span of a single decade are deprived of the institutional knowledge about organizational risks, control, and culture that CAEs attain when they fill the role for a longer tenure. The internal audit staff can fill those gaps; however, companies that rotate their CAEs often rotate other senior posts in the internal audit function as well. I have observed fully rotational internal audit functions where every single member has less than five years of tenure.
Knowledge of the Business One of the key reasons the rotational model is attractive is that it affords an executive the opportunity to develop a holistic view of the organization. The trade-off that management and the board must recognize is that it will take time for the new CAE to build that expansive view to the benefit of the organization, which creates a window of vulnerability. And, frankly, if the rotation is only three years, deep knowledge of the business may never be fully attained. As a result, management stakeholders throughout the organization are often frustrated by a lack of corporate business knowledge from internal audit.
Objectivity This is fundamental to internal audit's credibility and value to the organization. A CAE's objectivity must be beyond reproach. Management and the board must be confident the findings and recommendations from internal audit are not influenced by a CAE's personal bias.
This objectivity or perception of objectivity is frequently a challenge for rotational CAEs. They fully expect to move back into the business in a senior management position at the conclusion of their CAE rotation. As the rotation date approaches, they are frequently apprehensive about issuing critical audit reports of areas controlled by senior executives on whom they are dependent for their next assignment. It is evident to me that the objectivity of the CAEs in such situations is often compromised, and CAEs in such circumstances have often privately confided to me as much.
Independence of the Internal Audit Function Like objectivity, independence is fundamental. The audit function must be free from influences and pressure that can color its findings. This is why a dual-reporting system is essential to independence. A key check-and-balance system is created by having internal audit report functionally to the audit committee and administratively to management.
However, that check can be weakened if the audit committee does not play a significant role in vetting and approving rotational CAE candidates. It is not uncommon for a CAE to be selected by the chief financial officer (CFO) from the CFO organization, assigned to the CAE role with the full expectation of returning to the CFO organization, and supervised by the CFO for the period of the rotational assignment. In such cases, the independence of the internal audit function would be seriously questioned by an objective third-party.
The result is a situation where the individual who rotates through the CAE position benefits, but the internal audit function, and hence the organization, suffers. I remain concerned that investor confidence in the capital markets has truly not recovered since the onset of the economic crisis in 2008. There are a number of steps that can be taken to strengthen corporate governance and help restore that confidence. However, expanding the use of rotational CAEs is a step in the wrong direction.
As always, I look forward to your comments.