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  • Writer's pictureDaniel Goelzer

CAQ Reports on Ten Years of Increasing Audit Committee Transparency

On November 30, the Center for Audit Quality (CAQ) and research firm Ideagen Audit Analytics (AA) released 2023 Audit Committee Transparency Barometer (Barometer), the tenth edition of their annual assessment of S&P Composite 1500 proxy statement disclosures concerning the work of the audit committee.  According to the accompanying press release, audit committees “continue the trend of increasing disclosures in key areas of traditional financial oversight, as well as in emerging areas of responsibility” although “room for improvement remains.” 

 

The Barometer reports that the most common audit committee disclosure in 2023 was how non-audit services may impact auditor independence (85 percent of the S&P 500 make this type if disclosure).  The report also notes that there has been a significant increase in disclosure that the audit committee is responsible for ESG oversight (29 percent of the S&P 500 disclosed audit committee ESG responsibility in 2023, compared to 18 percent in 2022).  On the other hand, the Barometer asserts that areas with “room for improved disclosures” include how the audit committee considers the length of the external auditor’s tenure, how the audit committee is involved in selecting the engagement partner, and the audit committee’s view of the appropriateness of the audit fee.  On these three topics, only 11 percent, 16 percent, and 6 percent, respectively, of the S&P 500 made any disclosure in 2023.  (For discussion of the 2022 Barometer, see Audit Committee Transparency Inches Ahead, November-December 2022 Update.)

 

Frequent Audit Committee Disclosures

 

The Barometer tracks audit committee disclosures on twelve topics, two of which include subtopics, and breaks down S&P 1500 disclosures between the S&P 500 (i.e., large-cap companies), the S&P MidCap 400, and the S&P SmallCap 600.  Of the disclosure topics surveyed, the three that are most frequently disclosed did not change between 2022 and 2023.  These top three disclosures are:

 

  • Disclosure related to a discussion of how non-audit services may impact independence.  In 2023, 85 percent of the S&P 500, 82 percent of the S&P MidCap 400, and 75 percent of the SmallCap 600 made this type of disclosure.

 

  • Disclosure of the length of time the auditor has been engaged.  Seventy-three percent of the S&P 500, 60 percent of the S&P MidCap 400, and 55 percent of the SmallCap 600 disclose auditor tenure.

 

  • Disclosure that the audit committee is responsible for cybersecurity risk oversight.  Fifty-nine percent of the S&P 500, 50 percent of the S&P MidCap 400, and 40 percent of the SmallCap 600 disclosed that the audit committee had cybersecurity risk oversight responsibility.  By comparison, in 2016 only 11 percent of the S&P 500 (and 5 percent of Mid-Caps and 4 percent of SmallCaps) discussed audit committee oversight of cybersecurity risk. 

 

Two other topics that have grown in disclosure frequency over the last several years are whether the board includes a cybersecurity expert and whether the audit committee is responsible for ESG oversight.  As to board cybersecurity expertise, in 2023 51 percent of the S&P 500 disclosed having a cybersecurity expert on the board, as did 36 percent of the MidCap 400 and 28 percent of the SmallCap 600.  In 2016, only 7 percent of the S&P 500, 4 percent of Mid-Caps, and 3 percent of SmallCaps disclosed having such an expert. 

 

Disclosure that the audit committee is responsible for ESG oversight has also increased, although at a slower pace than cybersecurity responsibility disclosure, likely because ESG oversight is often assigned to other committees or to the full board.  In 2023, 29 percent of the S&P 500 disclosed that the audit committee is responsible for ESG oversight, as did 17 percent of the S&P MidCap 400, and 12 percent of the S&P Small Cap 600.  In 2022, the first year in which the Barometer tracked this issue, the comparable figures were 18 percent, 10 percent, and 7 percent, respectively.

 

“Room for Improvement” Disclosures

 

The three areas that the Barometer identifies as having room for improvement had relatively low levels of 2023 disclosure and are not increasing significantly over time.  For example:

 

  • Discussion about how the audit committee considers length of auditor tenure.   In 2023, 11 percent of the S&P 500, 6 percent of the S&P MidCap 400, and 3 percent of the SmallCap 600 explained how the audit committee considers tenure.  In 2022, the frequency of this disclosure was only slightly lower.

 

  • Discussion of how the audit committee is involved in selection of the audit engagement partner.  In 2023, 16 percent of the S&P 500, 9 percent of the S&P MidCap 400, and 5 percent of the SmallCap 600 disclosed specifics of the audit committee’s involvement in engagement partner selection.  As in the case of tenure consideration, the 2022 disclosure rates for this issue were almost the same as in 2023.

 

The Barometer asserts that more transparency on these two issues would benefit investors and other users of corporate disclosure:

 

“[I]t can be helpful for stakeholders to understand how the audit committee considered both positive and negative factors associated with the auditor’s tenure.  Similarly, stakeholders will likely be interested in the audit committee’s process and key considerations in selecting a new audit engagement partner   * * *.   Auditor tenure and the audit partner leading the engagement impact audit quality. Disclosing how the audit committee carefully considered such matters provides useful information to stakeholders and demonstrates the audit committee’s commitment to promoting audit quality.”

 

As to audit fees, the third “room for improvement” disclosure, companies currently provide even less information.  Only 6 percent of the S&P 500 made a disclosure related to the connection between audit fees and audit quality.  For the MidCap 400 and the SmallCap 600, the disclosure percentages were 3 percent and 1 percent, respectively.  This type of disclosure has declined over time.  In 2014, the first year in which the Barometer tracked this disclosure, 13 percent of the S&P 500, 4 percent of the MidCap 400, and 1 percent of the SmallCap 600 discussed the audit fee/audit quality nexus.  The Barometer explains why it recommends that more audit committees provide insight on this issue: 

 

“Audit fees can be an indicator of audit quality for stakeholders because abnormally low fees may indicate that not enough time or resources are spent on the audit engagement, which could contribute to low audit quality. On the other hand, abnormally high audit fees could indicate inefficiencies, which may also be a red flag for stakeholders.     *   Describing the audit committee’s views on the audit fee’s appropriateness can help stakeholders understand what contributes to the audit fee and can provide stakeholders further insights into how the audit committee considers audit quality throughout its engagement with the external auditor.”

 

Explanations of changes in the fees paid to the external auditor have also become less common over the past decade.  In 2023, 25 percent of the S&P 500, 25 percent of the MidCap 400, and 28 percent of the SmallCap 600 provided and explanation of fee changes.  In 2014, the comparable percentages were 28 percent, 30 percent, and 24 percent, respectively.  On this issue, the Barometer states:

 

“For audit committees to enhance their disclosures, they should provide more robust disclosures about how the audit committee considers the appropriateness of the audit fee, including key factors affecting changes to the audit fee year over year. For example, it may be helpful for stakeholders to understand efficiencies achieved, such as the auditor’s use of new technologies, or changes in the scope, such as a major transaction during the year, that could lead to changes in the audit fee.”

 

Disclosure Examples and Audit Committee Questions

 

An appendix to the Barometer includes examples of effective disclosure from specific audit committee reports for each type of disclosure tracked in the annual analysis.  Another appendix contains a detailed pro forma description of an audit committee and its responsibilities, along with a model audit committee report.  A final appendix, “Questions to Consider When Preparing Audit Committee Disclosures,” lists questions to aid in drafting disclosure concerning the work of the audit committee.  These questions are arranged under the twelve disclosure issues tracked in the Barometer report.

 

Comment:  The 2023 Barometer report points out that investors and other stakeholders use audit committee reports and other proxy statement disclosures about the committee’s work to understand how the audit committee is exercising oversight.  The CAQ believes that the “challenges of the current environment,” which include “economic uncertainty, geopolitical crises, and new ways of working” make it an appropriate time for audit committees “to revisit their disclosures to ensure that they are up to date and tailored to the specific events and circumstances that the audit committee currently faces.” 

 

Audit committees should consider expanding their audit committee reports, particularly in the areas that the Barometer flags for improvement.  The kinds of disclosures the Barometer identifies as common among S&P 1500 companies are not controversial and would rarely involve disclosing confidential information or exposing the audit committee to increased litigation risk.  As the Barometer states, “Every year, each audit committee has a unique story to tell, and detailed disclosures in the proxy statement relay the extent of engagement of the audit committee, which contributes to audit quality.” 

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