Corporate Governance, Internal Control and the Role of Internal

Auditors A Survey of Chinese Managers

Author details:
Dr. Jane J. Zhang
School of Accounting, Economics and Statistics
Edinburgh Napier University Business School
Craiglockhart Campus
Edinburgh EH11 1DJ, UK
Tel: 00-44-131-4554448
Fax: 00-44-131-4554460
Email: ja.zhang@napier.ac.uk

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Corporate Governance, Internal Control and the Role of Internal

Auditors A Survey of Chinese Managers

Abstract
This study investigates the role of internal audit in relation to corporate governance
(CG). Despite the fact that the contribution of internal audit has been argued essential
for organisations to achieve their business objectives, very little has been known of
corporate managers perception as to the practical functions of internal audit in the
context of CG. This study attempts to bridge the gap by examining the role of internal
audit in Chinas current CG system via seeking the views of corporate managers. This
study finds that the managers view internal audit as an important part of CG and the
role of internal auditors has been considered much wider beyond traditional financial
control. It reveals that internal audit in China has been greatly influenced by the
recent developments of CG and the internal audit function has changed towards more
involvement in risk management and internal control. The survey results suggest
Chinas CG codes do not provide adequate explanations on internal audit. The results
also indicate that Chinese companies have recognised the major role that internal
audit function plays and have increasingly provided the resources to improve the
quality and expertise of their internal auditors.

Key words: China; Corporate Governance; Internal Audit; Internal Control;

Risk Management.

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I.

Introduction

This study explores and documents the relationship between corporate governance
and internal audit. While prior studies have argued that successful internal audit has a
positive impact on a firms operational performance (Holm and Laursen, 2007; Arena
et al., 2006; Nagy and Cenker, 2002; Bou-Raad, 2000), a relationship between
corporate governance and internal audit and to what extent this relationship
contributes to business performance are relatively under-researched.
Corporate governance is the process on which organisations are managed and
controlled (Gao et al., 2008). It recognises the inherent conflict in objectives between
owner shareholders and managers and thus establishes institutions, policies, and
procedures to protect shareholders interests (McCarthy and Puffer, 2002, p.2).
Though there is no single best corporate governance model, good corporate system
should have effective organisational management and its approach to achieving the
companys objectives (Holm and Laursen, 2007; Ho, 2005). In the UK, the Combined
Code of 2003 on Corporate Governance provides guidance on various issues in
relation to board responsibility, accountability, audit committee and relations with
shareholders (Sheridan et al., 2006). UK corporate governance stresses the importance
of strengthening financial controls and accountability of the boards of directors to
shareholders. All listed companies in the UK are now required as part of the listing
rules to report the way they complied with the Code in their annual reports. The
Combined Code also recommends that non-executive directors should be independent,
underlining the important role that the non-executive directors play in contributing to
and enhancing corporate governance. Many other countries and regions (such as US,
Germany, China, and Hong Kong) have also developed their corporate governance
guidance and legislations.

It has been widely recognised that the role of the internal auditor becomes
increasingly more important in terms of creating good corporate governance
structures (Allegrini et al., 2006; Carcello et al., 2005; Nagy and Cenker, 2002). It is
argued that an effective internal audit function enables the board to perform its
corporate governance duties. For example, Gramling et al. (2004) believe that the
internal audit function is one of the four cornerstones of corporate governance, and

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the internal auditing function of internal auditors has an important role in assisting the
board to monitor the effectiveness of its governance. By helping the board in this way,
internal audit becomes an essential element of the corporate governance process. As
documented by Crawford and Stein (2002), the internal auditors can also help
organisations to meet corporate governance expectations.

With regard to business risk management and the role of internal audit, the European
Confederation of Institutes of Internal Auditing (ECIIA) states that good corporate
governance expects the board to be responsible for 1) setting up strategies to manage
business risks, 2) ensuring the effectiveness of internal controls, and 3) improving
company performances. The board is expected to implement effective risk
management systems, which should be capable of identifying and detecting business
risks. The board must ensure that internal controls are adequate for the level of risk
that could occur. The internal audit function expects to assist the management and the
board with the risk management implementations (ECIIA, 2005). In the UK, directors
are required under the corporate governance code to produce a statement that they
have carried out an annual review of the effectiveness of the internal control system of
their organisation (Holm and Laursen, 2007; Sheridan et al., 2006).

Much of the existing corporate governance literature is on the role of audit

committees and independence of non-executive directors. Despite the internal audit
function has become an important mechanism for corporate governance, little
research has been done on the effectiveness of internal audit and control and its
relationship with corporate governance. The primary aim of this study is to examine
the role of internal audit in relation to corporate governance in the context of Chinese
listed companies. The specific objectives of this study are:

To explain Chinas corporate governance system and the Code of Corporate

Governance;

To assess the role of the internal audit functions of top 100 Chinese listed
companies listed on the Shanghai Stock Exchange in China against Chinas
Code of Corporate Governance for listed companies;

To discuss the changing functions of internal audit in relation to corporate

governance.

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To achieve the above objectives, a questionnaire survey of top 100 Chinese listed
companies was carried out, enquiring corporate managers views on corporate
governance and the role of internal auditors. The remainder of the paper is organised
as follows. The next section is the literature review, providing a background of prior
research on corporate governance and the role of internal audit with a view to
identifying the research objectives. Section 3 explains Chinas corporate governance
system and highlights the role of separated supervisory boards within the system.
Section 4 describes the research method. Section 4 presents the results and
discussions. The final section concludes the paper.

I. Literature review

The Institute of Internal Auditors (IIA) defines internal auditing as an independent,

objective assurance and consulting activity designed to add value and improve an
organisations operations (Nagy and Cenker, 2002, p.1). Traditionally the internal
auditors were acting as policemen that check and monitor the companys procedures
and level of compliances with the rules (Skinner and Spira, 2003). Currently internal
auditors can be portrayed as consultants and the internal audit function of companies
considered as helping to achieve corporate objectives and add value. As noted by
Sarens and De Beelde (2006), internal auditors are currently expected to make things
happen rather than waiting to respond to it.

In developed countries, the role of the internal auditor has recently been affected by
the dramatic changes in regulations, mainly from corporate governance standards and
the emphasis of strengthening the internal controls of organisations of these standards
(Holm and Laursen, 2007). Corporate governance involves the obligations of the
board of directors in managing their organisations objectives and those towards the
shareholders and stakeholders (Pass, 2004 & 2006). Corporate governance is expected
to enhance the role of the internal auditor, and at the same time the internal auditor
also provides benefits to the external auditor (Holm and Laursen, 2007).

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As internal auditors are part of the internal control system, one of their important roles
is to give assurance on the risk management systems objectively to the management
of the organisation (Dittenhofer, 2001; Spira and Page, 2003). The IIA stresses that
the internal auditor should provide assurance services to organisations (Spira and
Page, 2003). This assurance involves testing, checking and providing advice on the
internal control systems set up to manage the risks. Despite the role of the internal
auditor has been changing over time (Spira and Page, 2003), Allegrini et al. (2006)
find that the internal auditor is still viewed as an inspector that monitors the company
internally.

It is argued that the internal audit function helps to improve the corporate governance
processes by enhancing internal control systems and risk management procedures set
to achieve those objectives, and an effective internal audit function has the potential to
add value (Goodwin, 2006; Spira and Page, 2003). Crawford and Stein (2002) note
that as corporate governance continues to get developed, this has placed greater
importance on the role of the internal audit function. From a risk management
perspective, internal auditors can act as risk managers to monitor risk management
procedures set up for the business.

Indeed, both risk management and risk identification have recently become great
concern for many businesses (Holm and Laursen, 2007; Laursen, 2007). Traditionally
the audit committee would be only expected, with help from the auditors, to evaluate
an organisations internal control system. Currently, the audit committees review of
the internal control system has been expanded to include the risk assessment of
organisations (Holm and Laursen, 2007). However, Crawford and Stein (2002) find
many organisations still count on the external auditor for the annual review of their
internal controls.

Fraser and Henry (2007) investigate how companies control risk and set internal
control and risk management procedures. Although companies expect internal
auditors to monitor the effectiveness of internal control systems, they question the
level of expertise of internal auditors and the degree of independence. Fraser and
Henry (2007) recommend that the risk management role and the internal audit role
should be separated, in order to maintain objective and independent internal audit
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functions. And as the audit committee is participating more in the review of risk
management procedures, they recommend that companies should set up separate risk
committees which solely deal with risk management issues. This will allow audit
committees to concentrate more on the work done by the internal audit function and
monitoring the effectiveness of the system of internal controls (Fraser and Henry,
2007).

Research suggests that boards are increasingly relying on the internal auditors to
monitor the risk management processes (Fraser and Henry, 2007). And as a result,
internal auditors can end up getting involved with activities which can damage their
objectivity and independence. Fraser and Henry (2007) find that when the internal
auditors get involved with these business operations, they usually lack experience and
expertise to get the job done properly.

Mihret and Yismaw (2007) state that internal audit effectiveness can become to exist
with the help of four interlinked components - internal audit quality, management
support, organizational setting, and attributes of the auditees. They argue that the
internal audit function needs to be able to produce quality audits. If the audits results
are useful to management then they have to support the internal audit function, for
example, by providing more resources to improve the effectiveness of the audit. The
(positive) link between the resources provided to the internal audit department by an
organisation and the perceived role of internal audit, of course, requires empirical
evidence. Vinten (1999) believes that internal audit effectiveness is achieved when
there is independence, sufficient resources and support from management. The author
argues that the objectives of internal auditors should be supported when they carry out
and perform their duties. He stresses the importance of independence from
management and the avoidance of any conflict of interest that may arise. Al-Twaijry
et al. (2004) consider that the overall internal audit quality and effectiveness are
affected by the objectivity and competence of the internal auditor.

The literature has also discussed the necessity of having a good relationship between
the audit committee and internal auditors for the effectiveness of a good internal
mechanism of control (KPMG, 2002; Nagy and Cenker, 2002). The audit committee
oversees the responsibilities of internal auditors and ensures that auditors fulfil their
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duties. Internal auditing is one of the critical resources of the audit committee in
meeting its responsibilities (Rezaee and Farmer, 1994; Montondon, 1995). Zain and
Subramaniam (2007) argue that the audit committee of an organisation can only be
effective if its internal audit is strong and well-resourced. Apostolou and Strawser
(1990) identify that in fulfilling the expanded oversight responsibilities, the audit
committee must rely on internal auditors for much of its information and reporting
concerning corporate activities. On the other hand, the audit committee can also
improve the effectiveness of the internal audit function by reviewing its activities
(Zain et al., 2006; Sarens and De Beelde, 2006). The more the audit committee
reviews the scope of the internal audit function the more likely chance of finding
inadequacies and improving on them (Zain et al., 2006). It is important for the audit
committee to be competent and independent so that it can enhance the internal audit
functions effectiveness. Zain et al. (2006) suggest that if the audit committee
exercises its control and makes the key decisions, this reduces the influence of
managements decisions. In this way the audit committee enhances the independence
of the internal audit function. However, the independence of the internal auditor is an
issue that is very much unresolved.

However, previous empirical studies on the relationship between internal auditors and
corporate governance have shown some different pictures. For example, in a survey
concerning the relationship between audit committee and internal auditors, Kalbers
(1992) shows that 31% of the responses stated that internal auditors did not have
meetings in private with the audit committee in a whole year. However, McHugh and
Raghunandan (1994) show that 65% of the interviewed companies had meetings of
internal auditors with the audit committee. Scarbrough et al. (1998) reveal that that
24% of the interviewed companies with an internal audit function did not have access
to the audit committee. Surveying 114 chief internal auditors, Raghunandan et al.
(2001) show that audit committees with only independent directors and at least one
director with accounting knowledge, were more likely to have more meetings with the
head of internal audit. The similar finding was also found by Scarbrough et al. (1998).
DeZoort and Salterio (2001) show in a sample of 18 heads of internal audit that good
communication between internal auditors and audit committees could improve
corporate governance quality. Sarens and De Beelde (2006) employ a case study

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approach find that senior managements expectations affect the outcome of the
internal audit.

There is little research of managers perceptions on the role of internal auditors and
the relationship between the audit committee and internal audit in China, the largest
developing economy. China has reformed their enterprises in the 1990s and
introduced corporate governance. The understanding of the managers views from
Chinese companies on the relationship between corporate governance and internal
audit will help enhance our knowledge in relation to this crucial issue. Also, this
research has some practical implications for the implementation of corporate
governance, particularly in the context of developing countries.

III. Corporate Governance in China

There are two broad models of corporate governance: the market-based governance
model appeared in the US and the UK (called the Anglo-Saxon model), and the
control-based model commonly found in Japan, emerging economies and in
continental Europe. The market-based model reflects the characteristics of an
independent board, dispersed ownership, transparent disclosure, active takeover
markets and well-developed legal infrastructure, while the control-based model
emphasizes an insider board, a concentrated ownership structure, limited disclosure
and reliance on family finance or the banking system (Zhang et al., 2008). The
corporate governance system adopted by Chinese listed firms can be best described as a
control-based model, in which the controlling shareholders (mostly the state) closely
control over the listed firms through concentrated ownership and management friendly
boards (Liu, 2006). The dominance of state shareholders in Chinese listed companies
has led to problematic corporate governance practices, significant related-party
transactions and, at times, marginalization of individual shareholders interests (Chen
et al., 2007).

Corporate governance in China has also received much attention (e.g., Gao et al., 2008,
Zhang et al., 2008, Chen et al., 2007). The system of corporate governance in China
features some characteristics of control-based model, which differs significantly from
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the institutional settings in the Anglo-Saxon world. An outstanding feature of the

Chinese governance system is the dual board structure which separates management
and supervision. Under Chinas governance system, there are two boards: boards of
directors (or called management board) and supervisory boards which represent owners
and other stakeholders (e.g., the government, trade union) interests. The function of
both boards is to supervise the management. Under the management board, there are a
number of committees being responsible for various controls and monitoring activities.
It has been emphasised of the involvement of independent directors in the committees.
For example, the Chinese Corporate Governance Code (CCGC) stipulates that the
board of directors of a listed company may establish a corporate strategy committee, an
audit committee, a nomination committee, a remuneration and appraisal committee,
and other special committees in accordance with the resolutions of the shareholders
meetings. All committees shall be composed solely of directors. The audit committee,
the nomination committee and the remuneration and appraisal committee shall be
chaired by an independent director, and independent directors shall constitute the
majority of the committees. At least one independent director from the audit committee
shall be an accounting professional.

According to the CCGC, the supervisory board shall be accountable to all

shareholders. The supervisory board shall supervise the corporate finance, the
legitimacy of directors, managers and other senior management personnels
performance of duties, and shall protect the companys and the shareholders legal
rights and interests (CCGC, Article 59). As in many cases where the state is the
largest shareholder of the listed companies, the government officials are often
represented in the supervisory board. The supervisory board has direct influence and
control on the audit committees. However under the existing governance rules, it is
unclear as regards to what extent audit committees are supervised by the supervisory
board. In the Anglo-Saxon corporate governance models, the audit committee is
directly responsible for and reporting to the board of directors.
Under the CCGC, the supervisory board may independently hire intermediary
institutions to provide professional opinions. It requires a listed company to adopt
measures to ensure supervisors right to learn about companys matters and to provide

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necessary assistance to supervisors for their normal performance of duties. No one

shall interfere with or obstruct supervisors work.
It is rather ambiguous in terms of the reporting system of the supervisory board under
Chinas governance framework. The CCGC states that the supervisory board may
report directly to Chinas securities regulatory authorities and other related authorities
as well as reporting to the board of directors and the shareholders meetings when the
supervisory board learns of any violation of laws, regulations or the companys
articles of association by directors, managers or other senior management personnel.
Under Chinas system, members of the supervisory boards shall have professional
knowledge or work experience in such areas as law and accounting. The members and
the structure of the supervisory board shall ensure its capability to independently and
efficiently conduct its supervision of directors, managers and other senior
management personnel and to supervise and examine the companys financial matters.
Chinas Code of Corporate Governance rules that: the main duties of the audit
committee are (1) to recommend the engagement or replacement of the companys
external auditing institutions; (2) to review the internal audit system and its execution;
(3) to oversee the interaction between the companys internal and external auditing
institutions; (4) to inspect the companys financial information and its disclosure; and
(5) to monitor the companys internal control system. Under the Chinese system,
internal control and internal audit are part of the remit of the audit committee. There
was no mention of the role of the supervisory board involving with internal audit and
control. This clearly raises some doubts about the effectiveness of the supervisory
board in supervising corporate finance.

Under Chinas governance system, a listed company shall disclose information

regarding its corporate governance in accordance with laws, regulations and other
relevant rules, including but not limited to:
1) the members and structure of the board of directors and the supervisory board;
2) the performance and evaluation of the board of directors and the supervisory
board;
3) the performance and evaluation of the independent directors, including their
attendance at board of directors meetings, their issuance of independent
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opinions and their opinions regarding related party transactions and

appointment and removal of directors and senior management personnel;
4) the composition and work of the specialized committees of the board of
directors;
5) the actual state of corporate governance of the company, the gap between the
companys corporate governance and the Code, and the reasons for the gap;
and
6) specific plans and measures to improve corporate governance.

IV. Research method

Research methods on corporate governance are usually based on surveys, content

analyses and case studies (e.g., Alleyne et al., 2006; Zakaria et al., 2006; Paape et al.,
2003; Reid and Ashelby, 2002). For example, Alleyne et al. (2006) send
questionnaires to 26 local publicly listed firms, investigating the role and function of
audit committees in public companies in Barbados. Razaee and Olibe (2003) apply
content analysis of the annual accounts, examining the audit committee reports in
corporate governance statements.

As the research in this area is very descriptive in nature, a survey questionnaire is

considered to be the best approach to collect the data (Alleyne, et al., 2006; Paape et
al., 2003). The research method of this study is therefore constructed questionnaires
which were sent to 100 top Chinese listed companies. The survey was created to
target only the senior level officials of the top 100 firms listed on Chinas Shanghai
stock Exchange.

The total companies in the initial sample were 100, but eight of them were unable to
receive the survey questionnaire, due to address delivery problems. Overall, the
response rate for the questionnaire was reasonably high, with a total successful
response rate of 25% (23 out of 92) after adjusting for delivery failures. The response
rate is higher compared to 17% of the previous survey by Paape et al., (2003) in the
case of UK companies.
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The questionnaires written in Chinese were sent to the top 100 firms via China-based
email, which was considered to be the most appropriate cost effective way of
distributing the online survey. However, follow-up were carried out by telephone
once no response to the e-mail survey in order to identifying right persons for resending e-mails. A covering letter was attached to it specifying the research topic and
the purpose, as well as guaranteeing the confidentiality of the respondents answers.
The online survey was loaded by clicking on the link given in the cover letter, sent by
email to the sample companies. The online survey was firstly tested using a pilot
questionnaire sent to five listed companies and five academics with experience in
questionnaire design and survey (Goodwin and Yeo, 2001). Seven responses (two
from companies and five from academics) were received. The responses from the
pilot questionnaire indicate that the original questionnaire was too long. The improved
questionnaire is only made of 15 questions, which requires no more than 5 minutes to
complete.

The questionnaire was designed to seek management perceptions on corporate

governance and the role of internal audit. The questionnaire covers some important
issues relating to enhancement of the corporate governance system, such as the
internal audit function, the audit committees, and resource and expertise of internal
auditors. Additional sources of information were obtained from companies websites
as the majority of the top 100 Chinese listed companies have an informative section
on their website (mostly in Chinese) dedicated for corporate governance matters. The
research questions are mainly concerned with the companies extent of compliance
with corporate governance rules in relation to the internal audit function.

V. Results and Discussion

The survey results are presented in Table 1. It can be seen that of the 23 responses,
over 86% believed that compliance with corporate governance code in China is
difficult. This is very much in line with the expectation as Chinas code on corporate
governance is by and large principles copied/adopted from the Western corporate
governance system, which were rarely tested for their suitability to Chinas business
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environment. Although China has two boards within its governance structure, the
difference of the roles and functions between the two boards is unclear. The response
to the following question confirms to this ambiguity of the functions of two boards.
With regard to the question of corporate governance code in China clearly divides
the roles of supervisory boards from the board of directors, over 78% of the
respondents did not agree.

Table 1 Survey results - corporate governance and internal audit in Chin

Percentage of responses
Strongly
agree

Agree

Neutral

Disagree

Strongly
disagree

Compliance with corporate governance

code in China is difficult

34.78

52.17

4.35

4.35

4.35

Corporate governance code in China

clearly divides the roles of supervisory
boards from the board of directors

8.70

8.70

4.35

43.48

34.78

Corporate governance code in China are

weak in describing the role of the
internal audit

13.04

34.78

21.74

30.43

0.00

Corporate governance rules in China

have strongly affected the function of
the internal audit
Internal auditors should report directly
to the audit committee
Internal auditors should report directly
to supervisory boards

43.48

43.48

8.70

4.35

0.00

13.04

47.83

0.00

34.78

4.35

17.39

21.74

0.00

52.17

8.70

internal auditors can act as risk

managers to monitor risk management
procedures set up for the business

21.74

26.09

34.78

17.39

0.00

Internal auditors have the experience

and expertise to address corporate risk
management problems within the
organisation
Internal auditors in your company are
capable of carrying out internal control
function under current corporate
governance rules

34.78

52.17

4.35

4.35

4.35

30.43

56.52

0.00

8.70

4.35

Internal auditors have received adequate

training within the past three years for
them to carried out their duties

39.13

43.48

4.35

8.70

4.35

Internal audit department in your

company is well-resourced
Your internal audit departments have
actively contributed to shareholder value

26.09

34.78

17.39

13.04

8.70

34.78

56.52

0.00

8.70

0.00

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Value-added activities bring greater

pressures for the internal audit function

52.17

43.48

0.00

4.35

0.00

The role of the internal audit will be

changed in the next five years towards
more independence
Should internal audit department be
separated from accounting (finance)
department?

4.35

13.04

13.04

52.17

17.39

13.04

26.09

34.78

26.09

0.00

One of the questions asked in the questionnaire was whether corporate governance
rules have strongly affected the functions of the internal audit. Consistent with the
literature (e.g., Spira and Page, 2003), the majority of responses (87%) agreed with
this. Despite the influence of corporate governance on internal audit, more than 47%
believed that corporate governance codes in China are weak in describing the role of
the internal audit and almost 22% gave a neutral response. The response is generally
expected based on the prior literature on corporate governance. The weak prescription
of internal audit within Chinas corporate governance system has recently been
recognised by the authorities and new internal audit standards are currently proposed
by Chinese government.

In terms of the relationship between internal audit and audit committee, a mix picture
was given. While the majority considered internal auditors should report to the audit
committee within the board of directors, nearly 40% believed internal auditors should
report to the supervisory board, instead of the management board. Reporting directly
to the supervisory board will enable internal auditors to act more independently; but it
is unclear in the literature and theories whether independence is the aim of internal
audit functions. The responses from the survey reflect this controversy. Concerning
the changing role of internal auditors towards more independence, the majority of
respondents showed disagreement. Less that 20% respondents believed the role of
internal audit would be changed in the next five years towards more independence,
suggesting that internal audit was very much considered by corporate managers as
part of internal management and control process.

With regard to the role of internal auditors played in risk management, almost a half
of the responses believed that internal auditors can act as risk managers to monitor
risk management procedures set up for the business, and over 86% considered internal

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auditors have the experience and expertise to address corporate risk management
problems within the organisation. This is in disagreement with the arguments put
forwarded by Fraser and Henry (2007), as they consider the risk management role and
the internal audit role should be separated and internal auditors lack the experience
and skills of risk management. Spira and Page (2003) argue that it is the board of
directors that are responsible for risk management. The internal audit function has the
role of identifying potential business risks and advises the board on how to improve
the risk management systems and internal controls of the organisation. While the
internal audit function should provide information to management on organisations
ability to manage risks, internal auditors should not replace risk managers.

As regards the question of whether internal auditors are capable of carrying out
internal control function under Chinas current corporate governance rules, over 87%
of the responses were confident by selecting agree (30.43%) and strongly agree
(56.52%). This could be a danger to internal auditors as internal control is very much
company-wide and operational-based activities in which internal audit is only part of
the whole process. Over-relying on internal auditors for internal control could result
in diluting the audit committees responsibility of overseeing the effectiveness of
internal control within the corporate governance system.

Mostly, the responses suggested that the role of internal audit has changed, agreeing
with research literature of internal audit adding value to shareholders. As shown in
Table 1, the majority of the responses believed their internal audit department has
actively contributed to adding value to shareholders, and value-added activities bring
greater pressures for the internal audit function (over 91% and 65% respectively). The
internal audit function can add value to corporate governance through their assurance
services and maybe by acting as consultants of the firm. As noted by Nagy and
Cenker (2002), by acting as consultants they are also seen to be influencing the
corporate governance system as they will be sharing their knowledge and advising
management to make amendments and improvements in these corporate governance
processes.

Table 1 also presents the results concerning internal audit department effectiveness. It
shows that most companies (82.6%) that responded seem to be developing and
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training their internal auditors. It also exhibits that most companies had dedicated
enough resources to their internal audit departments. Over 60% of the companies that
have responded to the questionnaire agreed that their internal audit department was
well resourced, while over 20% responded that this was not the case, disagreeing with
the question. The study carried by Pickett (2000) highlights the importance of training
and development of the internal audit staff to the success of organisations. Nearly
40% of the respondents agreed that internal audit department should be separated
from accounting (finance) department, indicating the awareness by managers of the
differences in functions between traditional financial control and internal audit.
However, over one third of the respondents could not determine whether internal
audit and accounting should be divided structurally within an organisation. This raises
an interesting question as to the real differences in functions between accountingbased financial control and operation-based internal audit.

VI. Conclusions

This study attempts to contribute to the corporate governance literature, in relation to

the role of internal audit. In the literature, the internal audit functions are widely
considered essential to organisations and their ability to achieve corporate objectives.
This study confirms this and it reveals that the important role of internal audit in
corporate governance is being acknowledged by the participating Chinese companies
in the survey. The findings of this study indicate that the internal audit functions,
which are influenced by recent corporate governance rules, has been changed and
corporate managers view internal audit more positive in adding values and enhancing
corporate governance. Corporate managers have considered the role of internal
auditors much wider, beyond traditionally defined financial control within the
accounting department.

It also shows that Chinas code of corporate governance does not provide adequate
explanations on internal audit and for many Chinese companies it is difficult to follow
corporate governance rules. However, the results of the survey suggest that Chinese
companies are recognising the major role that internal audit function plays, and are

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increasingly providing more resources to improve the quality and expertise of their
internal audit departments.

This research has a number of limitations. Apart from the inherent weaknesses of the
survey approach and small sample size, the sample restricted to the companies listed
on the SSE could have some impact on the results. The findings would be more
generalisable if companies listed on the Shenzhen Stock Exchange would be included
in the sample. Future research needs to extend the scope of this study by involving
companies listed on both Stock Exchanges and also including the companies whose
shares are listed overseas. Nevertheless, it is hoped that the results of this study
provide an insight into corporate managers perceptions concerning internal audit in
Chinese companies, and build up our understanding of the relationship between
corporate governance and internal audit in the context of the world largest developing
economy.

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