Shareholders appoint auditors as per the provisions of Section 159(1)-(6) of the Companies Act. The auditors are supposed to monitor the performance of the management on behalf of the shareholders. They act as watchdogs to ensure that the financial statements prepared by the management reflect the true and fair view of the financial performance and position of the firm.
Since auditors act on behalf of shareholders they become agents while shareholders are the principal. The auditors may prejudice the interest of the shareholders thus causing agency problems in the following ways:
- Colluding with the management in performance of their duties whereby their independence is compromised.
- Demanding a very high audit fee (which reduces the profits of the firm) although there is insignificant audit work due to the strong internal control system existing in the firm.
- Issuing unqualified reports which might be misleading the shareholders and the public and which may lead to investment losses if investors rely on such misleading report to make investment and commercial decisions.
- Failure to apply professional care and due diligence in performance of their audit work.
Solutions to the conflict
1. Firing: The auditors may be removed from office by the shareholders at the AGM.
2. Legal action: Shareholders can institute legal proceedings against the auditors who issue misleading reports leading to investment losses
3. Disciplinary Action – ICPAK. Professional bodies have disciplinary procedures and measures against their members who are involved in un-ethical practices. such disciplinary actions may involve:
- Suspension of the auditor
- Withdrawal of practicing certificate
- Fines and penalties
4. Use of audit committees and audit reviews.
5. HEAD OFFICE AND SUBSIDIARY/BRANCH
MNC has diverse operations set up in different geographical locations.
The HQ acts as the principal and the subsidiary as an agent thus creating an agency relationship.
The subsidiary management may pursue its own goals at the expense of overall corporate goals. This will lead to sub-optimisation and conflict of interest with the headquarter.
This conflict can be resolved in the following ways:
a) Frequent transfer of managers
b) Adopt global strategic planning to ensure commonality of vision
c) Having a voluntary code of ethical practices to guide the branch managers
An elaborate performance reporting system providing a 2-way feedback mechanism.
Performance contracts with managers with commensurate compensation package for the same.