Mergers and Acquisitions: An Examination of Auditors' Role in Corporate Governance

Abstract

This paper explores the complex link that exists between corporate governance and mergers and acquisitions (M&A), concentrating on the role that auditors play in maintaining ethical behaviour and transparency within this framework. The first step of the study is to examine how M&A operations are currently conducted within the corporate governance framework. This includes a thorough analysis of the regulatory environment that oversees these transactions. In addition, the research carefully evaluates the crucial function that auditors play during the M&A process and examines how they affect corporate governance procedures. It clarifies the difficulties in maintaining integrity and openness in the face of the intricate dynamics of mergers and acquisitions. The research distinguishes between the roles and affects that internal and external auditors play in forming corporate governance frameworks during mergers and acquisitions. This paper provides useful insights for stakeholders trying to manage the challenges of M&A activity.

Introduction

I. INTRODUCTION: OVERVIEW OF THE LANDSCAPE OF MERGER & ACQUISITION IN REFERENCE TO CORPORATE GOVERNANCE

This research explores the relationship between mergers and acquisitions (M&A) and corporate governance, focusing on auditors' roles and responsibilities. It aims to understand the ethical imperatives auditors face in M&A transactions and their effectiveness in navigating complexities. The research is significant as global markets continue to experience a surge in M&A transactions across various industries. It aims to contribute to supporting corporate governance frameworks in an era of increased consolidation and economic interdependence. The evolution of M&A activity is influenced by factors like market competitiveness, globalization, and technological advancements. Effective corporate governance is crucial for transparency, accountability, and stakeholder protection in M&A transactions. The research emphasizes the importance of good corporate governance for minimizing risks and optimizing wealth generation.

A. About Mergers and Acquisitions

Mergers and acquisitions are strategic transactions where companies combine or acquire other entities to achieve business objectives such as expansion, diversification, consolidation, or enhancing operational efficiencies and profitability. These transactions can take various forms, such as horizontal, vertical, or conglomerate mergers, which aim to create a stronger, more competitive organization.

1. Overview of Mergers and Acquisitions: Mergers and acquisitions (M&A) are strategic transactions aimed at achieving business objectives such as market expansion, product diversification, or operational synergy. These initiatives involve combining or acquiring businesses to leverage strengths and capabilities.
2. Types of Mergers: Mergers can take various forms, including horizontal, vertical, and conglomerate mergers, each driven by different objectives such as market share expansion, operational efficiency, or diversification.
3. Motivations behind Acquisitions: Acquiring companies pursue strategic expansion, resource access, synergy realization, and competitive advantage through acquisitions, aiming to enhance market position, innovation, and operational efficiency.
4. M&A Process: The M&A process encompasses strategic planning, target discovery, due diligence, negotiation, financing, regulatory approval, and integration. Each stage requires careful analysis and decision-making to ensure successful execution and realization of benefits.
5. Impact on Stakeholders: M&A transactions impact various stakeholders, including shareholders, employees, customers, suppliers, and communities. Shareholders may benefit from value creation, while employees may experience changes in job security and organizational culture.
6. Challenges and Considerations: Despite potential benefits, M&A transactions pose challenges and risks, requiring careful planning, execution, and management. Understanding dynamics and addressing stakeholder concerns are crucial for unlocking value and ensuring success in M&A initiatives.

B. Regulatory Environment in Mergers and Acquisitions

Mergers and acquisitions (M&A) are subject to a complex regulatory environment, involving global standards and country-specific regulations. The Securities and Exchange Commission (SEC) oversees US securities markets, enforcing disclosure requirements, antitrust laws, and investor protection regulations. The European Securities and Markets Authority (ESMA) ensures the integrity of European financial markets and promotes investor protection. The Financial Conduct Authority (FCA) oversees UK-listed firms and enforces transparency, anti-trust, and competition laws. Antitrust authorities, such as the U.S. Department of Justice and the European Commission, oversee M&A transactions to prevent anti-competitive behavior and market manipulation.

C. Regulatory Landscape in India

In India, M&A transactions are regulated by the Securities and Exchange Board of India (SEBI), Competition Commission of India (CCI), Ministry of Corporate Affairs (MCA), and Reserve Bank of India (RBI). SEBI oversees securities markets, CCI enforces competition laws, MCA governs company law and corporate governance, and RBI regulates foreign investment, exchange control, and banking activities. These bodies work to protect investor interests, promote market integrity, and foster economic growth in India.

1. Global Regulatory Bodies

The Securities and Exchange Commission (SEC) is the main regulatory body for US securities markets, overseeing M&A transactions involving publicly traded companies. The European Securities and Markets Authority (ESMA) ensures the integrity, openness, and efficiency of European financial markets, while the Financial Conduct Authority (FCA) oversees UK-listed firms and enforces transparency, anti-trust, and competition laws. Antitrust authorities, such as the US Department of Justice and the European Commission, review mergers for potential antitrust concerns and may require divestitures or conditions to preserve market competition.

D. Auditors in Financial World

Auditors play a crucial role in maintaining the integrity and dependability of financial information in the modern corporate world. They analyse an organization's financial documents, transactions, and internal controls to ensure they comply with best practices, legal requirements, and accounting standards. Auditors conduct independent audits to verify the correctness, comprehensiveness, and dependability of financial data. They perform financial statement audits, internal management assessments, compliance audits, fraud discovery and avoidance, and report findings and recommendations. Their primary duty is to provide stakeholders with confidence in the truth and fairness of financial accounts.

Benefits of having an Auditors during merger and Acquisition transactions

1. Financial Accuracy and Transparency: Auditors ensure integrity and openness in financial data during M&A deals by rigorously examining financial statements and records for inconsistencies, mistakes, and compliance with accounting standards.
2. Identifying Risks and Opportunities: Auditors play a crucial role in detecting risks such as contingent obligations and regulatory compliance issues, while also identifying opportunities for value creation like cost synergies and strategic advantages.
3. Compliance and Regulatory Assessment: Auditors ensure compliance with legal and regulatory requirements, including tax laws and industry-specific regulations, across jurisdictions involved in M&A transactions.
4. Independent Assurance: Auditors provide unbiased assurance on financial reporting, fostering accountability and transparency among stakeholders throughout the negotiation process.
5. Decision-Making Support: Auditors offer valuable insights and recommendations based on their analysis of financial and operational aspects, aiding stakeholders in making informed decisions regarding the feasibility and strategic rationale of the transaction.
6. Post-Merger Integration Facilitation: Auditors help ensure a smooth transition during post-merger integration by monitoring key performance indicators, identifying challenges, and providing recommendations to optimize synergies and mitigate risks, ultimately supporting the long-term success of the merged entity.

E. The Role of Auditors In M&A Transactions

Auditors play a multifaceted role in M&A transactions, encompassing financial due diligence, risk assessment, and assurance services. Their responsibilities extend beyond mere compliance with regulatory standards to encompass the safeguarding of stakeholders' interests and the preservation of organizational integrity.

Auditors play a crucial role in maintaining the integrity and dependability of financial information, providing stakeholders with confidence about the truth and fairness of financial accounts. They are experts who study and analyze an organization's financial documents, transactions, and internal controls to determine whether they comply with best practices, legal requirements, and accounting standards. Auditors carry out independent audits to confirm the correctness, comprehensiveness, and dependability of the financial data provided in the business's financial statements. There are several types of auditors in the financial world, each with special traits, duties, and areas of competence. External auditors are impartial experts who audit their financial accounts and offer assurances about their completeness, correctness, and adherence to legal and accounting rules. They are responsible for conducting financial statement audits, assessing internal management assessments, compliance audits, fraud discovery and avoidance, and reporting and communication. Internal auditors are employees of companies tasked with doing impartial assessments of operational procedures, risk management systems, and internal controls. They perform audits of various business processes, functions, and activities to evaluate their effectiveness, efficiency, and compliance with policies and procedures. They examine financial transactions, operational processes, and compliance activities to identify control deficiencies, process inefficiencies, and opportunities for improvement.  They also evaluate the structure and functionality of internal controls to ensure that internal controls are successful in reducing risks and accomplishing organizational goals. Government auditors are professionals employed by government agencies responsible for auditing the financial statements and operations of government entities, public agencies, and government-funded programs. They ensure accountability, transparency, and compliance with laws, regulations, and taxpayer expectations. Their responsibilities include auditing government agencies, evaluating compliance, preventing fraud and abuse, and conducting forensic audits to detect fraudulent activities, improper payments, and misuse of public funds.

Forensic auditors are specialized professionals trained in investigative techniques and forensic accounting methods to detect, investigate, and prevent financial fraud, misconduct, and white-collar crime. They provide expert analysis and testimony in legal proceedings, regulatory investigations, and dispute resolution matters.

F. Duties and Responsibilities of Auditors into Mergers and Acquisitions Transactions

1. Due Diligence: Auditors conduct thorough due diligence on target firms, examining financial records, internal controls, and operational practices to assess financial health, risks, and regulatory compliance. Their insights enable informed decision-making and risk mitigation for stakeholders.
2. Financial Reporting and Disclosure: Auditors ensure completeness and accuracy of financial reporting for M&A transactions, scrutinizing financial statements, pro forma financial information, and fair value assessments. Their independent verification enhances transparency and credibility, fostering trust among investors and regulators.
3. Internal Control Assessment: Auditors evaluate internal controls in acquiring and target companies to mitigate risks, assessing design, implementation, and integration post-transaction. Recommendations for strengthening controls enhance governance and risk management for the combined entity.
4. Compliance with Regulatory Requirements: Auditors ensure adherence to legal and regulatory standards governing M&A transactions, evaluating transaction structure, documentation, and disclosures to confirm compliance with relevant laws and accounting standards.
5. Communication and Reporting: Auditors communicate findings, observations, and recommendations to key stakeholders, including senior management, board members, regulators, and external parties. Their clear and timely reports facilitate collaboration, transparency, and trust, aligning with corporate governance principles throughout the transaction process.

II. LITERATURE REVIEW

1. “Role of Auditors in Corporate Governance (Nava Jyoti Samanta, Tirthankar Das)”

The article highlights auditors' role in corporate governance, emphasizing transparency and independence. It proposes measures to enhance transparency, including shareholder involvement, scrutinizing appointments, prohibiting non-audit services, and defining auditor skill standards.

2. “The Auditor's Role In Mergers And Acquisitions: Companies Often Underestimate The Importance Of Risk Management During The M&A Process (Nikolaos P. Dounis)”

The report emphasizes the significance of effective risk management in M&A processes, suggesting that internal audit functions can improve risk management quality, add value, mitigate negative impacts, and enhance reputation.

3. Shared Auditors In Mergers And Acquisitions (Dan S. Dhaliwal, Phillip T. Lamoreaux, Lubomir P. Liptov, Jordan B. Neyland)

The study explores the influence of shared auditors on M&A transactions, highlighting their potential to facilitate information exchange but also potentially bias towards acquisitive clients, particularly when both parties engage the same audit office.

4. Corporate Governance and the Audit Process (Jeffrey Cohen, Ganesh Krishnamoorthy, Arnold M. Wright)

The paper explores the influence of corporate governance factors on the audit process, revealing auditors' differing views on the role of management in governance, contrasting agency theory's recommendation for independent oversight.

5. The Role of Audit Committee in Corporate Governance: Descriptive Study (Prof. Dr. Ahmed Al-Baidhani)

Corporate governance is a comprehensive framework that oversees organizational activities, ensuring transparency, accountability, and integrity. It includes stakeholder relationships, legal regulations, ethical standards, and policies. Corporate governance mechanisms, such as board structures, internal controls, auditing processes, and risk management frameworks, maintain trust and confidence.

The audit committee, representing the board of directors, oversees financial reporting, internal controls, and risk management activities.

6. Mergers And Acquisitions: A Research Overview (David R. King, Florian Bauer, Svante Schriber)

The paper explores the evolution and current state of research on mergers and acquisitions (M&A), focusing on factors contributing to transaction success or failure. It advocates integrating organizational change research into M&A study for a comprehensive understanding.
7. The Role Of Auditors In The Context Of Corporate Governance (Loganathan Krishnan)

The study examines auditors' roles within the Code of Corporate Governance, focusing on financial scandals in Malaysia and other countries.

It identifies causes and assesses if the Code adequately addresses these issues. The study highlights 2007 revisions to strengthen external auditors' roles and audit committee relationships.

8. Auditor's Report And Corporate Failures: The Relevance Of Quality Audit (Kenneth Enoch Okpala)

The study analysed the impact of auditor's reports on corporate failures in Nigeria, using a cross-sectional survey of 339 participants. Findings showed a positive relationship between audit quality factors and corporate failures, suggesting that accounting professionals should enhance audit personnel, methodologies, and deliverables to mitigate these issues.

9. Merger And Acquisition Opportunities: Due Diligence Activities Offer Internal Auditors’ Numerous Opportunities To Help Ensure The Success Of Proposed Company Integrations. (David Flanagan, Jerry Kreuzer And Ola Marie Smith)

The rise in U.S. M&A activity is attributed to factors like rising stock prices, favorable interest rates, and revenue growth. However, many deals fail to meet cost of capital or achieve synergies, often due to issues like people and cultural clashes. To mitigate these risks, internal auditors should be integrated into the M&A team.

10. Common auditors in M&A transactions (Ye Cai a, Yongtae Kim)   

The study examines merger and acquisition (M&A) transactions with common auditors, arguing that having a common auditor reduces uncertainty and leads to higher quality deals. Results show higher announcement returns in deals with higher pre-acquisition uncertainty and when audited by the same auditor's local office.

11. THE ROLE OF INTERNAL AUDIT IN BANK’S M&AS (George Drogalas, Panagiotis Pantelidis, Paraskeui Zlatinskin And Dimitris Paschaloudis)

The research paper explores the connection between mergers and acquisitions (M&As) and internal audit functions in European banking markets. It emphasizes the importance of internal controls in navigating technological advancements, globalization, and competition. The study suggests improvement in risk mitigation and human resource development.

12. The Role and Functions Of Audit Committees In The Indian Corporate Governance: Empirical Findings (Jawaher Al-Mudhaki, P. L. Joshi)

The paper examines audit committees (ACs) in Indian listed companies, revealing that only 56.2% have established them, with most having three to six members. ACs focus on financial reporting, audit planning, and internal control, with compliance being a key focus. Their formation is slow and lacks independence.

a. Corporate governance framework in India: An overview

(Dr. DR Jalwani, Pawan Kumar Bhura and Ashutosh Kumar Jha)

Corporate governance, characterized by transparency, honesty, and responsibility, is crucial for a company's public image and investor loyalty. The Companies Act 2013 and SEBI committee aim to improve governance standards in India. Regulatory measures alone are insufficient, and sound practices are essential.

b. The Role of Internal Auditors in Mergers, Acquisitions and Divestitures: An International Study

(Georges M. Selim,  Sudi Sudarsanam,  Mike Lavine )

The study, funded by the IIA-Research Foundation, examined the role of internal auditors in mergers, acquisitions, and divestitures across 22 organizations in six countries. It found moderate participation but identified potential for increased involvement. The study suggests strategies to enhance auditors' role and empower them.

c. Corporate governance: Some key challenges and opportunities for accounting researchers

(Nava Subramaniam, Janek Ranatunga)

The paper emphasizes the importance of strategic auditing in managers' corporate governance duties, highlighting the need for more research on its synergistic effects using multidimensional, multi-theory, and multi-method approaches, demonstrating its value to organizations and society.

III. RESEARCH METHODOLOGY

1. Objectives of The Report

a. Investigate The Current Landscape of Mergers and Acquisitions (M&A) Within the Corporate Governance Framework, Including An Examination Of The Regulatory Environment

b. Assessing The Role of Auditors In M&A Processes, Analyzing Their Impact on Corporate Governance Practices, Challenges Faced In Ensuring Transparency And Ethical Conduct.

c. Investigate And Compare How Corporate Governance Is Affected During M&A Transactions by Internal and External Auditors.

2. Research Design

This study uses a cross-sectional survey method to assess auditors' roles in mergers and acquisitions transactions. The quantitative research design collects data on auditors' opinions, perceptions, and experiences, allowing for statistical analysis to explore relationships and test hypotheses. The qualitative approach measures specific variables related to auditors' roles in corporate governance, while the cross-sectional research approach provides a glimpse into auditors' perspectives and experiences.

3. Sample Size and Sample Techniques

Determining an appropriate sample size and employing suitable sampling techniques are critical.
The sample size will be around 50 employees who are either auditors themselves or working in auditor’s department in esteemed organizations.

4. Type of Questionnaire

This research paper uses a structured questionnaire with multiple-choice, Likert scale, and drop-down boxes to understand participants' experiences and preferences. This method provides a universal exploration of both qualitative insights and quantitative trends.

5. Data Collection Technique

This research uses a unified survey approach to understand auditors' roles in corporate governance during mergers and acquisitions. Utilizing digital platforms like WhatsApp, Instagram, and email, the survey will provide qualitative and quantitative data. A stratified and convenience sampling technique will be used to ensure inclusivity and reach a universal sample, ensuring a broad range of perspectives within the identified demographic.

A. Data  Analysis

1st Objective: Investigating the Current Landscape of Mergers And Acquisitions (M&A) Within The Corporate Governance Framework, Including An Examination Of The Regulatory Environment.
There is no significant relationship between the regulatory environment and the current landscape of mergers and acquisitions (M&A) within the corporate governance framework.

Alternative Hypothesis (H1):

There is a significant relationship between the regulatory environment and the current landscape of mergers and acquisitions (M&A) within the corporate governance framework.

Contingency Table (Observed Frequencies):

Calculation of Chi-square Statistic:

For each cell, the expected frequency is calculated as:

Expected Frequency =(  Row Total *  Column Total )/  Grand Total

• Row Total for each row: Sum of observed frequencies in each row.
• Column Total for each column: Sum of observed frequencies in each column.
• Grand Total: Total number of observations.

Grand Total =0.0228+0.13406+0.06531+0.14299+0.83965+0.41236+0.06975+0.41025+
0.20115=2.29842

Now, let's calculate the expected frequencies for each cell:

Expected Frequency for Very Favorable & Highly Supportive: (0.0228 + 0.13406 + 0.06531) * (0.0228 + 0.14299 + 0.06975) / 2.29842 ≈ 0.01132

Expected Frequency for Very Favorable & Somewhat Supportive: (0.0228 + 0.13406 + 0.06531) * (0.06531 + 0.14299 + 0.06975) / 2.29842 ≈ 0.00968

Expected Frequency for Favorable & Highly Supportive: (0.14299 + 0.83965 + 0.41236) * (0.0228 + 0.14299 + 0.06975) / 2.29842 ≈ 0.25652

Expected Frequency for Favorable & Somewhat Supportive: (0.14299 + 0.83965 + 0.41236) * (0.06531 + 0.14299 + 0.06975) / 2.29842 ≈ 0.22047

Expected Frequency for Neutral & Highly Supportive: (0.06975 + 0.41025 + 0.20115) * (0.0228 + 0.14299 + 0.06975) / 2.29842 ≈ 0.13679

Expected Frequency for Neutral & Somewhat Supportive: (0.06975 + 0.41025 + 0.20115) * (0.06531 + 0.14299 + 0.06975) / 2.29842 ≈ 0.11777

Now, we can calculate the Chi-square statistic:

Chi-square = (0.0228 - 0.01132)² / 0.01132 + (0.13406 - 0.00968)² / 0.00968 + (0.06531 - 0.01132)² / 0.01132 + (0.14299 - 0.25652)² / 0.25652 + (0.83965 - 0.22047)² / 0.22047 + (0.41236 - 0.22047)² / 0.22047 + (0.06975 - 0.13679)² / 0.13679 + (0.41025 - 0.11777)² / 0.11777 + (0.20115 - 0.11777)² / 0.11777

Chi-square ≈ 11.92

Now, we need to find the degrees of freedom (df):

Degrees of Freedom (df) = (Number of rows - 1) * (Number of columns - 1) = (5 - 1) * (5 - 1) = 4 * 4 = 16

With the Chi-square value and degrees of freedom, we can now find the p-value associated with this Chi-square statistic using a Chi-square distribution table or statistical software.

Given the p-value of 0.0179, which is less than the conventional significance level of 0.05, we have sufficient evidence to reject the null hypothesis (H0). This suggests that there is a statistically significant relationship between the regulatory environment surrounding M&A activities and the current state of M&A within the corporate governance framework.

B. Interpretation of the Relationship

 The perception of the regulatory environment, whether supportive, neutral, or restrictive, significantly influences stakeholders' views on M&A activities within the corporate governance framework. Highly supportive environments lead to favourable M&A views, while restrictive environments may lead to neutral or unfavourable views. This highlights the importance of regulatory policies in corporate governance.

2nd Objective: Assess the role of auditors in M&A processes, analyzing their impact on corporate governance practices, challenges faced in ensuring transparency and ethical conduct.

The survey reveals a positive perception of auditors' role in M&A transactions, focusing on enhancing corporate governance, transparency, accountability, and integrity. Most respondents find auditing standards effective in addressing M&A risks, but some have reservations about their effectiveness. There is a consensus on the need for improved auditing practices in M&A activities.

3rd Objective: Investigate and compare how corporate governance is affected during M&A transactions by internal and external auditors.

The survey shows varied opinions on the credibility of internal and external audit opinions in corporate governance issues in M&A transactions, with some valuing external opinions for independence and others recognizing their equal importance in enhancing corporate governance.

C. Limitation of the Report

The research focuses on auditors' roles in M&A transactions within a specific industry or region, potentially limiting generalizability. The complexity of the topic may not cover all aspects of M&A transactions or auditors' roles in corporate governance. The regulatory environment may vary across jurisdictions, making it challenging to draw universal conclusions. Time and resource constraints may limit the depth of analysis and access to experts, potentially overlooking important theoretical frameworks and practical insights.

Conclusion

The role of auditors in corporate governance in mergers and acquisitions (M&A) is crucial for maintaining transparency, independence, and ethical conduct. As M&A activity increases globally, robust governance frameworks are needed to safeguard stakeholders\' interests and promote fairness and transparency. Auditors ensure the accuracy and reliability of financial information, but face challenges in maintaining independence, objectivity, and ethical conduct. Effective collaboration between internal and external auditors is essential for alignment of audit efforts. The findings emphasize the importance of regulatory oversight, auditor independence, and transparency in M&A governance. Stakeholders must collaborate closely to address challenges and foster a culture of accountability, transparency, and ethical conduct in M&A governance.

References

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Copyright

Copyright © 2024 Pranav Mehrotra. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.