[Global Internal Audit Trends] Vol. 13: CAE Dismissal and Key Points for Audit Committee Involvement
Hello, this is HIRO. I am currently based in Silicon Valley, USA, where I am engaged in research and consulting on "Global Internal Audit Best Practices" and "The Use of Generative AI in Internal Audit." In this series, I will deliver the latest information on "global internal audit"—topics that Japanese internal auditors rarely have the opportunity to encounter—in a quick and easy-to-understand manner. In particular, it is said that internal auditing in the United States is more than a decade ahead of Japan in its evolution, and I find that there are many cases that serve as excellent references.
This time, I would like to pick up the #1 blog post from 2024 by Richard Chambers, the former President and CEO of the Institute of Internal Auditors (IIA) whom I respect, and share insights on "CAE (Chief Audit Executive) Dismissal and Audit Committee Involvement." By reading this article, you will be able to understand how to maintain the independence of the internal audit department and what responsibilities the audit committee should bear.
1. The Issue of CAE Dismissal and the Responsibility of the Audit Committee
1.1. The Real Voice of a Dismissed CAE
Recently, an interesting case was introduced in a blog post by Richard Chambers, an internal audit expert I respect. A person who served as a CAE at a company was suddenly told they were being dismissed. According to him, although the relationship with management was "good" on the surface, it was "strictly formal and lacked transparency." Even more surprising is the fact that the audit committee (the Audit Committee in the U.S.) was only informed of his dismissal after the fact. It was only after the CAE himself contacted the chair of the audit committee directly that the chair became aware of the situation.
When I heard this story, I honestly had a strong question: "Why couldn't the audit committee get involved sooner?" It is said that even in the United States, there are cases where the audit committee does not sufficiently involve itself in the appointment or dismissal of the CAE, effectively "leaving it entirely" to the judgment of management. For Japanese internal auditors, who often have an image of U.S. audit committees as having strong authority, it might be shocking that such "bystander" behavior actually occurs.
1.2. The Duties of the Audit Committee and the Importance of Ensuring Independence
In the first place, the audit committee (equivalent to an Audit & Supervisory Committee or similar in Japan) is in a position to fulfill a powerful governance function established to ensure the independence of the internal audit department. In particular, when it comes to the appointment and dismissal of a CAE, they should have the responsibility to "ensure personnel who have opinions sufficiently independent from management and can objectively monitor the organization's risks." However, as shown in the opening case, if the audit committee itself is "indifferent to the dismissal of the CAE" or does not participate in the dismissal process, the original significance of internal audit—the "check and balance of the organization"—could collapse.
When I was supporting companies as a consultant, I encountered a situation where management was plotting to effectively control the CAE. They used methods such as cutting budgets or placing restrictions on audit plans, all while pretending to be "consulting" but effectively narrowing the scope of the CAE's work. In that case, if the audit committee had firmly taken the lead and listened to the CAE's voice, the internal audit function should have been kept healthy. However, because the audit committee was distracted by other priorities and remained a silent observer even after noticing interference with the audit department, the independence of internal audit was ultimately severely compromised. This is a story that also applies to Japanese corporate culture; I believe it is a universal truth that the stronger the intentions of top management, the more easily independence is threatened.
2. Implications for Internal Audit Sites in Japan
2.1. The Importance of Clarifying Reporting Lines
Even in Japanese companies, the internal audit department is often placed under the CFO (Chief Financial Officer) or the head of the administrative department, who are members of management, and has a dual reporting line that reports from there to the audit committee (Audit & Supervisory Committee). However, in reality, it is not uncommon for "reporting to management" to be prioritized, while "reporting to the audit committee" becomes a mere formality.
What is important here is to clearly demonstrate that the audit committee is at the top of the substantive "functional reporting line." Specifically, it is necessary to design a process in which the audit committee takes the initiative in making decisions regarding important matters such as the hiring/dismissal of the CAE, compensation determination, and budget approval. By appealing to both inside and outside the company that the audit committee "properly understands the CAE's employment conditions and scope of duties, and guarantees independence beyond the reach of management," the position of internal audit as an "objective critic" within the organization becomes unshakable.
2.2. Concrete Measures to Protect CAE Independence
Internal audit inevitably has moments where it "clashes" with management. This is because it is in a position to point out problems and urge improvements in terms of risk management and compliance. Therefore, for a CAE to not succumb to pressure from management and to cut into risky themes while coordinating with the audit committee, the following mechanisms are required.
The first is the guarantee of budget and staffing. If the necessity of internal audit is left to management, there is a risk that inconvenient projects will be cut or that sufficient personnel will not be provided. By establishing a process where the audit committee "approves the budget with authority," the CAE is ensured a field in which they can move freely.
The second is regular individual meetings. In Japanese companies, it is effective for the CAE not only to attend regular audit committee meetings but also to increase opportunities for the CAE to speak individually with the chair of the audit committee or independent outside directors. By doing so, a route is created where even things that are difficult to say to management can be consulted directly with the audit committee.
The third is the exercise of the audit committee's "veto power" over dismissal or reassignment. As mentioned earlier, there was a case in the U.S. where the audit committee learned of the CAE's dismissal after the fact. Since something similar could happen in Japan, it is desirable to clearly stipulate in company regulations or job authority regulations that "the dismissal or reassignment of the CAE requires the prior approval of the audit committee."
2.3. Expert Perspective and Real Experience
I myself have felt an atmosphere in the internal audit department of a Japanese company in the past where it was difficult to report risks lurking in the audit field to management. In Japanese organizational culture, "reading the air" is emphasized, and there are many situations where people fear damaging the feelings of those around them by raising issues. However, looking at advanced cases in the United States, the CAE has the courage to say "NO" without hesitation when necessary by building a flat relationship with management while gaining the backing of the audit committee.
To introduce such cases to Japan, it is an absolute requirement that the audit committee functions as an "independent and powerful backing." And as a Japanese internal auditor, I feel that it is necessary to have the resolve to communicate sufficiently with the audit committee and to always carry out necessary reports, "even if the information is inconvenient for management." For the audit committee to demonstrate effective governance rather than becoming a "formality-only body," a strong collaborative relationship between internal audit and the audit committee is indispensable.
This article is posted for free to support the development of the internal audit industry, so your 'likes' and 'follows' would be greatly appreciated and serve as encouragement. See you in the next article!
Source of this article:
Richard F. Chambers, “Where is the Audit Committee When the Head of Internal Audit is Being Fired?”
https://www.richardchambers.com/where-is-the-audit-committee-when-the-head-of-internal-audit-is-being-fired/