The Information Asymmetry, Corporate Failures in Contemporary Issue in Essay

The Information Asymmetry, Corporate Failures in Contemporary Issue in Accounting - Essay Example The internal auditor plays a critical role in reducing agency costs by ensuring and assuring that financial reports prepared by the firm are consistent with regulations and standards as expected by the investors (Ahlawat & Lowe 2004, p. 147). There is often a business relationship between the client and the external audit. The firm contracts the auditor to audit and attest to the firm’s accuracy of the financial statements. Corporate failures and major financial scandals like Enron and WorldCom have resulted from poor accounting system where there were information asymmetry between shareholders, investors as well as other outside parties, and the insider parties mainly the management executives and the internal auditors. There is also a business relationship between the auditor and the shareholders who rely on the financial statements prepared by the auditor. Internal audit function works closely with the management in examining internal controls, detecting fraud and advising them in the appropriate remedial measures in case of fraud detection in the system (Sengupta 1998, p. 462). In the vase of internal audit function and audit committees, these auditors are employed by the firm and are therefore paid by their firms, the interaction between the internal auditors and managers as well as the employees can be potential sources of conflict of interest, which may result in the auditors not being fundamentally objective and also compromising their independence. Internal auditors and the dominant senior managers can work together to ensure that their individual interests override those of the firm. In such cases, the financial reports issued to the investors and shareholders may look consistent with accounting standards and principles while being far from the true position of the company. Role of information in the firms’ corporate governance Information plays an important role in facilitating firms’ corporate governance. One of the important is sues of corporate governance is the construction of mechanisms that help in aligning objectives of executives with those of the firm’s shareholders (Hermalin & Weisbach 2008). The firms’ board of directors often find themselves heavily tasked with the role of monitoring and advising executives. These boards comprise of internal directors who are the firm’s senior executives and outside directors. Outside directors are essential in bringing independence to the function while the internal directors help in bringing information about the firm’s activities. These directors being insiders or senior executives in the management can hide information where they detect that such information will be utilized in disciplining or taking away the executives private benefits. Information plays an important role in the selection and construction of corporate governance mechanisms that help in aligning actions of managers and senior executives with shareholders’ in terests. Information also helps in reducing contracting costs and in the making of strategic decisions. Information asymmetry The internal audit function and the management generally have more information about the firm’s performance than the firm’s shareholders. This information asymmetry can be detrimental to the firm’