Sustainable corporate governance and new auditing issues: a preliminary empirical evidence on key audit matters

• DOI: https://doi.org/10.1108/CG-09-2020-0427
• Published date: 06 September 2021
• Date: 06 September 2021
• Pages: 194-211
• Subject Matter: Strategy,Corporate governance
• Author: Pietro Fera,Michele Pizzo,Rosa Vinciguerra,Giorgio Ricciardi

Sustainable corporate governance and

new auditing issues: a preliminary

empirical evidence on key audit matters

Pietro Fera, Michele Pizzo, Rosa Vinciguerra and Giorgio Ricciardi

Abstract

Purpose –This paper aims to investigate the relationship between the quality of internal corporate

governancemechanisms and the audit issues disclosed by external auditorsin their report, assuming the

beneficialeffect related to the adoption of a sustainablecorporate governancesystem.

Design/methodology/approach –This paper investigatesthe impact of the International Auditing and

AssuranceStandards Board’s ISA 701 in the Europeancontext as a new auditing principlesupporting the

key audit matters (KAMs) in reporting and disclosing auditing activities. The analysis is carried out

through a quantitative methodology using a sample composed of non-financial companies listed on the

ItalianStock Exchange.

Findings –Empirical findings highlight that firms having a high quality and sustainable corporate

governance system tend to havefewer KAMs arising from the audit process and then disclosed in the

audit report. To ensurethe reliability of the empirical analysis, the authors controlledfor a set of variables

that could affect the audit function and for the mediating role of the overall business complexity (as

proxiedby the firm size).

Originality/value –This studyis of interest to academics, practitionersand regulators, as it highlights the

role of a higher quality internal corporate governance on the perceived corporate riskiness and

complexity. It contributes to the recent debate on sustainable corporate governance, corporate

sustainabilityand auditing streams.

Keywords Corporate sustainability, Auditing, Key audit matters, Sustainable corporate governance

Paper type Research paper

1. Introduction

Among several studies analyzing corporate governance systems’ primary role, recent

papers document how it can be considered crucial to business sustainability. Scholars

highlight that the quality of corporate governance strongly depends on corporate

sustainability, which aims to achieve sustainability in all corporate practices (Hahn and

Scheermesser, 2006;Mudiyanselage, 2018;Schrippe and Ribeiro, 2019). Sustainable

corporate governance may impact both internal and external corporate functions, as the

audit one, which has been severely criticizedin recent years.

The 2008–2009 financial crisis revealed all the flaws connected to the audit function. Enron,

Worldcom, Ahold and Parmalat’s defaults have shown that something was out-of-line with

corporate governance, financial reporting and above all with auditing, at the end of the

twentieth century (Knechel, 2007). Besides, the considerable losses reported from 2007 to

2009 by several banks raised questions on how auditors could have provided spotless

audit reports to their clients for those periods (Sikka, 2009). So that, in the past two

decades, we have witnessed a watershed period for the auditing profession (Knechel,

2007;Sikka, 2009).

Pietro Fera, Michele Pizzo,

Rosa Vinciguerra and

Giorgio Ricciardi are all

based at the Department of

Economics, University of

Campania, Luigi Vanvitelli,

Capua, Italy.

Received 23 September 2020

Revised 11 February 2021

29 March 2021

23 June 2021

26 July 2021

Accepted 15 August 2021

PAGE 194 jCORPORATE GOVERNANCE jVOL. 22 NO. 1 2022, pp. 194-211, ©EmeraldPublishing Limited, ISSN 1472-0701 DOI 10.1108/CG-09-2020-0427

In this regard, Boolaky and Quick (2016) considered the audit report the primary tool for

communicating with firms’ stakeholders. In the aftermath of the global financial and

economic crisis, the European Commission launched its Green Paper on audit policy

(European Commission, 2010), where auditors’ communication to stakeholders represents

one of its fundamental topics.

The auditor’s report is the final output of the whole audit process. It briefly describes the

audited financial statements, the management and auditor’s responsibilities, the audit

process and ends with the auditor’sopinion (ISA 700). However, despite its importance, it is

usually very concise and standardized.

Accordingly, some Authors criticize the audit report for being uninformative due to its over-

standardized nature (Be

´dard et al.,2016;Gutierrez et al., 2018). Others assert that, in most

countries, the auditors’ opinions were mainly consistent with each other and not related to

the company-specific information (Gutierrez et al., 2018). Consistently, many stakeholders

have questioned the effectiveness of auditor reporting because of the lack of company-

specific information in the audit report(Be

´dard et al.,2016).

In response to this criticism, standard setters and regulators have already implemented or

are in the process of implementing, a developed model of audit reporting (Humphrey et al.,

2009). Focusing on the European scenario, the European Council adopted the reform of the

audit market (Regulation EU no. 537/2014of the European Parliament and the Council of the

European Union, 2014). Concurrently, the International Auditing and Assurance Standards

Board (IAASB) established the Key Audit Matters (KAMs)section in the audit report, aiming

to provide stakeholders with more information about the audit process and the

accompanying financial statements. Specifically, the IAASBissued a new standard, the ISA

701: Communicating KAMs in the Independent Auditor’s Report (International Auditing and

Assurance Standards Board [IAASB], 2015), that offers an as simple as effective definition:

KAMs are those matters that, in the auditor’s professional judgment, were of most

significance in the audit of the financial statements;KAMs are a selection of matters

communicated with those chargedwith governance (ISA 701, p. 8).

The IAASB contextually highlights the need for an interaction between the auditor and its client’s

corporate governance to address the KAMs issues adequately. It is not the first time that the

IAASB, recognizing the fundamental role of the characteristics and structure of the corporate

governance on different firms’ dimensions, deems the internal corporate governance crucial in

setting an auditing standard (e.g. ISA 260; ISA 315; ISA 700). For the above reasons, the

presence of high-quality and sustainable corporate governance, capable of effectively assisting

the auditor in the performance of its functions, can help pursue the new ISA 701 aim.

Enabling the development of reliable and sustainable corporategovernance systems, many

regulators adopted self-regulatory codes, defining the main characteristics and the ideal

features of a proper governance model that focuses on the role and the structure of the

board of directors, as well as the functioning of internal committees (Tukker et al.,2008).

Indeed, the previous literature suggests that higher quality and sustainable corporate

governance system enhances the degree of market transparency and ensures better

protection for the whole set of stakeholders (Kang and Shivdasani, 1995;Mallin, 2002;

Black et al.,2006).

Relying on the beneficial effect related to the adoption of a sustainable corporate

governance system, many studies show both the interaction between the auditor and

the client (Bamber and Iyer, 2007;Hellman, 2011) and the impact of the quality of

corporate governance on the audit process (Cohen et al.,2002;Sharma et al., 2008).

Indeed, specific corporate governance characteristics impact the audit function and

play a key role in determining the audit opinion. In addition, focusing on the new audit

report requirements (ISA 701), there is preliminary evidence concerning the

relationship between the internal corporate governance structure and the KAM

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