Corporate Governance in the Banking Sector in Oman

Abstract

This research aims to examine the influence of internal audit on effective corporate governance in commercial banks listed on Muscat Securities Market (MSM) in Oman. A questionnaire was used to collect data and was distributed to the 100 top senior-level officials and the internal audit department of the commercial banks. The regression model that was used in this study was five dependent variables: internal audit independence; proficiency and due professional care; nature of work; quality assurance and improvement program; and managing the internal audit activity.

The finding of the research establishes a significant positive relationship between internal audit and effective corporate governance. Variables internal audit independence, proficiency, and due professional care, and nature of work were significantly associated with corporate governance. For quality assurance and improvement program and managing the internal audit activity, their influence on corporate governance is not statistically significant.

Introduction

The financial problems experienced by many companies in the world in recent years have led to the need for a set of ethical and professional controls and principles to achieve confidence and credibility in the information contained in the financial statements. The function of the audit plays an important role in all institutions. It provides senior management with the necessary information that helps in making decisions and also provides information on the efficiency and effectiveness of the internal control system applied in these institutions.

It has been widely recognized that the role of the internal auditor has become increasingly more important in terms of creating good corporate governance structures (Allegrini et al., 2006; Carcello et al., 2005; Nagy & Cenker, 2002).

Corporate governance is the process by which organizations are managed and controlled (Gao et al., 2008). Larcker (2007) asserted that corporate governance mechanisms influence the decisions made by managers when there is a separation of ownership and control. Thus, this is in a bid to enhance accountability and efficiency and to ensure the quality of the financial reporting process. Corporate governance is a key issue in the banking sector in general and aims at improving the performance in this important sector. The concept of the relationship between internal control and corporate governance can be defined as the process and structure used to direct and manage the business affairs of the bank towards enhancing prosperity and corporate accounting with the ultimate objective of realizing shareholders long-term value while taking into account the interest of other stakeholders (Capital Market Authority (CMA), 2015).

Consequently, a relationship between corporate governance and internal audit and to what extent this relationship contributes to business performance has been relatively under-researched. Theoretically, an organization with an effective system of internal control is expected to achieve its objective efficiently and effectively, which is regarded as good corporate governance. On the other hand, an Organization with a weak system of internal control will experience bad corporate governance. Also, the lack of internal controls and their deficient operation make companies vulnerable to several risks, such as improper recording of accounting transactions, making unauthorized transactions, fraud, all of these having a significant impact on financial performance and competitiveness (Mihaela & Iulian, 2012). Empirically, the researchers found a positive relationship between internal control and corporate governance. Pratolo (2007) found that effective internal control has a positive relationship with good corporate governance at State-Owned Enterprises in Indonesia (SOEs). Mensah (2003) found empirical evidence in Ghana that effective internal control improves good governance practices and decreases corruption. Based on the same view to these findings, Nila and Viviyanti (2008) also found that internal control has a positive relationship with good corporate governance at State-owned enterprises in West Java Indonesia.

In Oman, in addition to the old code (2002), a new Code of Corporate Governance was issued for Public Listed Companies in July 2015 by Capital Market Authority (CMA). The purpose of corporate governance is to set out processes by which corporates are controlled and directed to create efficient enterprises that contribute to building a strong, transparent, and competitive national economy (CMA, 2015).

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 in Oman. Therefore, this study attempts to minimize the literature gap by examining the relationship between internal control and corporate governance in the context of Oman as a developing country.

Corporate Governance

Corporate governance has received increased attention and scrutiny over the last two decades. Corporate governance is defined as the total operations and controls of an organization (Fama & Jensen, 1983) or as an overall structured system of principles (Dey Committee, 1994). A comprehensive definition proposed by John and Senbet (1998) in their study stated that corporate governance deals with mechanisms by which stakeholders of a corporation exercise control over corporate insiders and management such that their interests are protected. More recently, Roe (2004) defines corporate governance as the relationships that exist at the top of the firm: the board of directors, the senior managers, and the stockholders.

Corporate governance is based on a set of attributes, including ensuring accountability to shareholders or stakeholders (Keasey & Wright, 1997). It is considered to be the top extensively studied topic which serves as a tool for mitigating conflicts of interests between managers and investors. Corporate governance primarily aims to protect the capital owners from the opportunistic activities of management (Abdurrouf, 2011; Jensen & Meckling, 1976; Pandya, 2011). Also, corporate governance offers the directors the right to create effective decisions in favor of the shareholders interests to realize goals (Shleifer & Vishny, 1997). Firms with superior corporate governance enhanced their operating performance (Irina & Nadezhda, 2009).

Corporate governance represents the system by which companies are directed and controlled (Cadbury, 2000, 8). The control aspect of corporate governance includes the notions of compliance, accountability, and transparency (MacMillan et al., 2004).

The Relationship between Internal Auditing and Corporate Governance It has been widely recognized 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 & Cenker, 2002). In todays business environment, internal auditors are now providing management with a far broader range of information concerning the organizations financial, operational, and compliance activities to improve effectiveness, efficiency, and the economy of management performance and activities (Rezaee, 1996). 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 & Laursen, 2007).

Mihaela and Iulian (2012) analyzed the effectiveness of internal control and the Impact of Corporate governance on companies listed on the Bucharest Stock Exchange. An effective internal control leads to a fair presentation of the financial statements and thus increases stakeholders confidence in the financial statements. Besides, Yassin et al. (2012) carried out research that examines the relationship between internal audit and corporate governance in various commercial banks in Lebanon. The statistical analysis showed several significant tests supporting the hypothesis that the internal audit improves the quality of corporate governance.

Kibet (2008) in his study surveyed the role of internal audit in promoting good corporate governance in State-owned Enterprises (SOEs). His survey, however, is aimed to explore the role and the use of internal audit function in promoting good corporate governance in public sector enterprises and also the challenges faced by the internal auditors in SOEs. The study concluded that the internal audit function played a significant role in corporate governance. Siddiqui and Podder (2002) examined the effectiveness of a financial audit of banking companies operating within Bangladesh. For this study, the audited financial statements of 14 sample banking companies have been analyzed. The study identifies seven (7) sample companies that have actually overstated their profits. Also, the research explores the level of independence, objectivity, and competence of the auditors, assigned for auditing banking companies.

From the above discussion, it is clear that internal auditing is probably one of the most dynamic and yet important subjects to come to our attention and become increasingly more important in terms of creating good corporate governance structures.

From the above, it is clear that the regulation of corporate governance is the governments attempt to ensure that the corporation pursues its defined purposes and protects the interests of its owners (Chang et al., 2006).

Conclusion and Future Research:

The primary objective of the research is to investigate the direct relationship between the internal audit and effective corporate governance in the banking sector in Oman. This section provides a discussion of the results concerning the impact of internal audits on corporate governance in the banking sector in Oman. The independent variables were Internal audit independence; proficiency and due professional care; Nature of work; quality assurance and improvement program and managing the Internal Audit Activity. The sample consisted of 100 banks within the duration of three years (2014-2016). Multiple regression analysis was used to examine the relationship between the independent and dependent variables. Based on the results obtained, this study found a positive and significant association between internal audit and effective corporate governance. This result is consistent with previous studies that found a significantly positive relationship between internal audit and corporate governance, such as the studies of Yassin et al. (2012), Kibet (2008), Allegrini et al. (2006), and Carcello et al. (2005).

Task 3

Define the term Corporate Governance (CG) and briefly explain FOUR pillars of CG pertaining to the banking sector in Oman (Word count: 300-400).