Home > Risk > Transparency and disclosures: how far is too far?

Transparency and disclosures: how far is too far?

Michael Brozzetti is a speaker and consultant on a variety of governance and audit topics. He recently conducted a survey on LinkedIn; the question was “Do you think public companies should disclose their Chief Internal Auditor compensation package?”

Now, I must admit this question would never have occurred to me for a couple of reasons:

  1. It’s not required by any law or regulation, in any country, as far as I know
  2. I can’t see why it would be material to an investor, so why do it?
  3. The top internal auditor is rarely, if ever, among the highest paid executives

But, it occurred to Michael and the results are shocking – at least to me. 67% (162 voted) said that public companies should disclose the compensation package for the chief audit executive (CAE)!

A review of the comments might shed some light:

  • “The only reason not to report the auditor’s salary and compensation package is if you are paying for the result. How independent or objective can he be when he reports to the very people who set his salary.”
  • “I voted YES because another question has arisen in my mind: When you don’t have it clear: are there any chances that you ‘buy’ your auditor’s work results, directly from him? (I think the verb is ‘to bribe’) and the answer was – also – YES!”
  • “I think publicly traded companies should disclose the compensation package. The public has a right to know if the company is “buying” the auditor’s work results. Since no one would admit when this is going on, it should be required to be disclosed. Transparency should always be a priority.”
  • “Transparency is the name of the game today. Don’t draw attention to yourself by hiding what everyone will find out in the first place, so your company doesn’t end up in last place?”

I will agree that the independence of the internal audit function is very important. However, is it fair to say that if the CAE’s compensation is high that this is an indication that he or she is being bribed? I suggest that the best CAEs provide great value and that is why they are well paid.

Will an investor be able to make a judgment of the internal auditor’s independence and objectivity if given details of the CAE’s compensation package? I really don’t think so. It would be better to support a statement, included in the Audit Committee report in the annual 10-K filing with the SEC, that the internal audit function reports directly to the Audit Committee, is adequately resourced, and is independent from management.

But, the comments go further. They support disclosure for the sake of transparency. And they support transparency on, as far as I can tell, general principles: disclosure is good for you.

But is transparency and disclosure that goes beyond legal and regulatory requirements always healthy? Should companies report everything that is remotely interesting?

I like the standard that companies should disclose anything that is required by law/regulation or might reasonably be considered material to an investor and their decisions/actions. Companies should also give thought to disclosing information that might be ‘expected’ of them by the society they operate in, where it might positively influence their reputation. For example, I would put some of the corporate social responsibility reporting into this voluntary disclosure bucket.

But there are downsides to voluntary disclosures that need to be considered as well:

  • They might give competitors information they could use to their advantage
  • They might give potential customers and trading partners an unnecessary edge
  • The information might help the company’s opponents in current or anticipated lawsuits
  • They might expose the company to unnecessary risk, should a disclosure later turn out to be inaccurate
  • Every additional disclosure has a cost: the resources required to develop and validate the information
  • The disclosure sets the expectation that it will be continued in future filings
  • Too much information can confuse. Just look at the average 10-K; how many investors read it all?

In my view, companies should always hesitate and ensure there is a good business reason before making any voluntary disclosure. While investors and regulators may have the power to obtain the CAE’s compensation package, I don’t see why anybody would disclose it every year.

Transparency when it makes sense. But not for transparency’s sake.

  1. Jim DeLoach
    May 24, 2011 at 5:22 PM

    Hi, Norman. I agree completely with you. The test for disclosure under the securities laws is whether the information in question is material enough to investors such that they need it to make informed decisions about the company. It is difficult for me to imagine any investors expecting or needing this information. I can’t conceive of a situation where a company would be advised to disclose this data voluntarily. I find inappropriate the assertion that the more an internal auditor is paid, the more likely the compensation package can “buy” audit results. That assertion ignores the expanding skillsets required of a CAE, his or her accountability to the board, and the various ways a compensation package can be designed.

  2. May 24, 2011 at 6:29 PM

    Norman, as always I appreciate your persepctives. I voted yes, and shared my views in the poll discussion after reviewing and considering several respondent comments regarding “relevant factors:”

    “I agree that authority to hire and fire are also very relevant factors, in addition, to how compensation raises and changes are made. My view is that a full disclosure of the Chief Auditor compensation package, the internal audit charter, and the audit committee charter are essential to provide external stakeholders a complete picture on how an organization values the Internal Audit function and it’s purpose “to evaluate and improve the effectiveness of risk management, control, and governance processes.” Bottom line, people pay for things they value, so if an organization values IA then this should be reflected in the Chief Auditor compensation package. The performance measures for bonus, stock, and other incentives are also very relevant factors in a Chief Auditor’s compensation package, which depending on comp structure may either promote or impair independence and objectivity.”

  3. Keith Ouellette
    May 25, 2011 at 3:01 AM

    Compensation disclosures are going too far. I agree that salaries, stock holdings and deferred compensation packages of the highest paid officers should be disclosed to mitigate the risk of insider trading. If CAE’s fall into that category, then I would agree disclosure is necessary.

    However, the Organization Chart of a public company should include the reporting relationship of the CAE to the Audit Committee and to Senior Management. This should be the disclosure requirement, not just compensation, along with a legal requirement to have the Audit Committee set the CAE’s salaries and potential bonuses up and down the ladder. (normally set by CFO, and not the Audit Committee for smaller public companies)

    The CAE’s compensation package should be tied to savings or frauds identified by the Internal Audit Team as a bonus incentive, which would solidify its independence from line management. The trade-off is the possibility of losing trust and support from the Business Units.

    It is difficult for a CAE to balance its allegiance to both the Audit Committee and Senior Management, most likely the CFO or CRO. It is important to disclose the reporting relationships and the Officer, who sets compensation packages for the CAE and internal audit staff. That alone would expose the inherent conflict and whether the CAE is operating independently of Senior Management.

  4. May 25, 2011 at 6:39 AM

    Another interesting fact this poll revealed was that 87.5% of the respondents identified as female voted yes, whereas only 37% of the respondents identified as male voted yes. I am curious to hear thoughts and comments in this regard.

  5. May 25, 2011 at 6:41 AM

    Hi All,
    I would like to add few more questions:
    1) What is it supposed to mean if CAE is one of the top paid executive? Very good performance or company is bribing?
    2) What is it supposed to mean if the identified fraud cases are realtively high? Lack of performance of the audit departement or very high performance?
    3) Would investors like to invest in a company that has higly compansated CEA and high fraud identified.
    4) Can you imagine a company that has no bias between audit department and business lines related to findings?
    5) How the salaries of CAE of public companies may be compared the ones in supervisory goverment bodies that are auditing public CAE?
    I think disclosing few numbers does not mean much and may be misleading. This kind of information may be available not to public that has no shares in the company but to ones that are holding the shares for at least a year.

  6. transparencyjoe
    May 25, 2011 at 11:06 AM

    Would transparency and disclosures have helped Goldman Sachs dump all the toxic assets to their clients? I don’t think so. The problem is that incentive structures of the banks promote the lack of transparency. Lack of transparency also help large oil companies to make record profits at $4 gas prices. IMF is another prime example. What kind of animals do they hire to run IMF? Why is it always the French? Again, the lack of transparency benefits the Europeans.

  7. May 25, 2011 at 10:56 PM

    I think the question comes to the point where and how much goverment intervention needed. Investors usually do not have the ability to assess the level of risk in detail even in transparent conditions. Also, I think it is not just fair to leave investor and a company face to face. There must be a govermental body to supervise and regulate the market when necassary. Otherwise, few bad examples will ruin whole global economy.

  8. Chittaranjan
    May 26, 2011 at 2:56 AM

    Hello Norman, Just as Micahel, I somehow get to agree with most of your view points. Should I then make a disclosure that I run the risk of being ‘biased’ when I opine on your points of views?🙂

    Overall, I agree with your views. So far as disclosures are concerned, I believe the same has to be on NEED basis. The information has to serve someone’s legitimate need. The question is who needs info on CAE’s compensation? A reasonable assumption could be that had it been identified as a legitimate need of investors, bodies like SEC could have made it mandatory. Unwarranted and too much of disclosures often vitiate the very purpose of disclosure of key information. In my opinion, over disclosure (like CAE salary) could be a case of design to ‘avoid liability not to inform anybody’ or ‘get undue mileage for being seemingly a transparent company’.

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