______________________________________________
MANAGEMENT AUDIT
─
a study of the development and the meanings in Sweden
____________________________________________________________
Jörgen Dahlgren, School of Management, Linköping University, Sweden
and
Sven-Arne Nilsson, School of Economics and Management, Lund University, Sweden
Corresponding author:
Sven-Arne Nilsson, School of Economics and Management, Lund University, SE-220 07
LUND, SWEDEN
[email protected] , phone: +46 40 669 61 56, fax: +46 40 23 10 15
2
Abstract
For reasons of profitability, ownership and control of companies have for long been separated.
Managing and owning are considered to be two distinct competencies, the return on each of
which is likely to be increased by their separation. The separation introduces, however, a risk
for conflict of interest between owners and managers, a conflict which cannot costlessly be
avoided and which eventually reduces the value of the company. The area for corporate
governance is the problem of how shareholders and managers can minimize the loss from the
separation. International comparisons reveal that the approaches used to handle the problem
differ and that there is consequently a potential for learning by making cross-country
comparisons.
Auditing and auditors represents one of the tools that shareholders use to control management
and to minimize the loss. The auditing process traditionally confines itself to the verification
of accounting data and analysis of its compatibility with laws, established regulations and
approved practice. Since centuries, Swedish auditors have, however, had the additional task of
examining the appropriateness of management decisions and action, the so called
management audit, an assignment that has varied in extent and character over time.
The role of the Swedish auditors’ in the governance structure has been recognized as being
different to solutions chosen in other countries. The Swedish solution has, together with a
similar approach in Finland, differed, not only from continental Europe, but also from the rest
of the Scandinavian countries. Lately, Finland has moved to change its rules, whereas the
Swedish approach was re-confirmed in the latest Annual Accounts Act (1995).
This paper aims at contributing to the analysis of corporate governance structures by
describing and analysing the development of Management Auditing in Sweden and its
meanings.
3
Contents
Abstract.......................................................................................................................................2
1
Introduction ........................................................................................................................4
2
Management auditing before government legislation ........................................................5
3
The Companies Act 1895 ...................................................................................................6
4
The Companies Act 1910 ...................................................................................................8
5
The Companies Act 1944 ...................................................................................................9
6
The Companies Act 1975 .................................................................................................10
7 The present .......................................................................................................................13
8
Summary and conclusions ................................................................................................14
References ................................................................................................................................18
The audit report for the Tar Sales Company, 1652 ..............................................................20
4
1
Introduction
If you imagine a case where the managing director of a limited liability company were to, with
immediate binding effects, reach an agreement on the purchase of the production rights based
on a certain patent against partly immediate payment and partly a high yearly license fee, do
then the auditors of the company have a right or obligation to act because of this agreement?
(Sillén, 1952)1
Professor Oskar Sillén’s2 answer to the question he put was that the answer would depend on
in which country the agreement took place. In Sweden, Swedish law certainly required
auditors to include an examination of the agreement, something that differed from the
situation in countries like the UK, the United States, Denmark and Norway and led to the
conclusion that:
Only in Sweden do we find the duties of an auditor so widely extended. (Schmaltz, 1939)
A section, in Richard Vangermeersch’s (2003) research map, on the discussion of
management auditing at the 5th International Congress of Accountants in Berlin 1938, made
us aware of the extent to which the Swedish auditing practice was regarded as problematic.
Based on the Swedish national paper at that congress, Kurt Schmaltz3 (1939, p. 50) found it
worthwhile to indicate difficulties in the Swedish view, and he quoted the Swedish paper
saying:
This is an obvious danger that the auditor in giving advice as to the conduct of the business ties
his hands in advance, and the system tends to encourage the management to seek the opinion
of the auditor before taking serious steps. The danger, therefore, that the auditor develops into
a kind of ‘super-management’ is very present. It is very important that both parties should have
a proper regard to the functions peculiar to them and this part of an auditor’s duties
necessitates the exercise of much tact and judgement. (Karlgren & Karlgren, 1939, translated
in Schmaltz, 1939)
In his review, Schmaltz also noticed that the views expressed by the national paper of Great
Britain were absolutely contrary to those of the Swedish paper, and he quoted the British
paper:
“It is no part of an auditor’s duty to give advice either to directors or to shareholders as to what
they ought to do. An auditor has nothing to do with the prudence or imprudence of making
loans with or without security. It is nothing to him whether the business of a company is being
conducted prudently or imprudently profitably or unprofitably; it is nothing to him whether
dividends are properly or improperly declared, provided he discharges his own duty to the
shareholders. His business is to ascertain and state the true financial position of the company at
the time of the audit, and his duty is confined to that.” (Schmaltz, 1939)
The meaning of Swedish management auditing and the way to practice it may have changed
over time, but it became a statutory obligation for auditors through the Companies Act 1895,
and it is proposed to remain an obligation in the current revision of the Swedish Companies
Act. In Sweden, the topic has earlier been studied only by Oskar Sillén (1944 and 1952).
Given this and the ongoing processes of globalisation and harmonisation within companies in
1
2
3
All quotations which are not originally in English have for the purpose of increasing readability been
translated into English.
Professor in Accounting at the Stockholm School of Economics and leading chartered public accountant.
German business economist, Dr. rer. pol.
5
general and accounting in particular, we therefore found it interesting and relevant to study
Swedish management auditing further, and this paper aims at contributing to the analysis of
corporate governance structures by describing and analysing the historic development of
Swedish management auditing in a European perspective, with a focus on the different
meanings of the concept.
The paper starts with a description of management auditing before the first government
legislation. In the following sections, the development of the Companies Act for Swedish
limited liability companies4 is described, structured in six periods. The periods chosen are
based on major changes in the legal regulations. We are fully aware that an argument can be
made for choosing another logic behind the period structure e.g. related to changes in the
society at large. At present we do, however, lack any empirical data that would permit such an
alternative. Consequently we have to assume that major changes in legal requirements also
reflect important changes in the society at large.
2
Management auditing before government legislation
Early examples of management audits in Sweden are of general interest and potentially
relevant as a background to the later legislation. One problem with the historical examples is
of course that even if an examination of the management of a company was performed, this
does not mean it can be considered as an example of a management audits, nor that it was
necessarily performed by auditors.
In his study of management auditing in Swedish companies, Oskar Sillén (1952, p. 6ff),
stressed that management auditing was not a fad invented by the legislators of his time, but an
institution that had gradually developed through practice during previous centuries.
One of the early Swedish limited liability companies was the Tar Sales Company, which got
its concession in 1648. It had three directors appointed by the “participants”. A commission of
eight “assistants” was further appointed to exert control, and to assist the directors in more
difficult cases. The first report by the assistants was issued in 1652 (see appendix 1).
Especially important is that the assistants, on behalf of the “participants”, also discharged the
directors from liability. According to Sillén, other Swedish companies during the 17th and 18th
centuries had the same type of arrangement. The Swedish words revisor (auditor) and revision
(auditing or audit) were used already in the 17th century but the meaning was generally only
examination of the accounts, even if comments were made on the actions or measures by the
management. Some of these auditors’ comments were rather informal and drastic:
/one wonders if the steward/ has been here at Sura5 so long that he has got acid in his head
since he is so careless.
To further impress upon the steward, the auditor added a reference to the book of Jeremiah:
4
5
Sweden, like the UK, only has one type of limited liability company, aktiebolag, compared to e.g. Germany
and France who have two types, AG and GmbH, and SA and SARL respectively. Both in Sweden and the
UK, a distinction is, however, made between public and private limited liability companies.
Surahammar AB, a company that produced acid.
6
“Behold, I am against thee, O thou most proud, saith the Lord GOD of hosts: for thy day is
come, the time that I will visit thee.
And the most proud shall stumble and fall, and none shall raise him up: and I will kindle a fire
in his cities, and it shall devour all round about him.” (Jeremiah, ch 50, verses 31-32)
to which the steward responded, quoting the same book but a different chapter and verse:
“And the LORD hath given me knowledge of it, and I know it: then thou shewedst me their
doings.
But I was like a lamb or an ox that is brought to the slaughter; and I knew not that they had
devised devices against me, saying, Let us destroy the tree with the fruit thereof, and let us cut
him off from the land of the living, that his name may be no more remembered.” (Jeremiah, ch
11, verses 18-19)
According to the articles of association for the Götha Canal-Bolag, receiving its concession in
1810 and in charge with both the building and the management of the canal going from the
east coast to the west coast of Sweden, the auditors should report to the general assembly how
they at their examination had found the management and the accounts. According to the
report by the auditors in 1813, they had completed the examination of the management and
accounts, and they recommended the directors to be discharged from their liability for the
management during the previous year. In the renewed articles of 1833, it was prescribed that
the management by the “directorate” should be examined by three auditors. There were
further requirement that the auditors each year should travel along the entire canal and
carefully inspect how it was kept and maintained, make inquiries about collection methods
and find out the observance of them.
Sillén concluded his review as follows:
1. In associations comparable with companies, deputies for the owners were appointed
already in the 17th century with an obligation to examine whether the management could
be discharged from the liability for their management during the last year.
2. Such deputies were in the beginning known as assistants, delegates, deputies or
equivalent, but at least from the beginning of the 19th century they were called auditors.
3. Already at the beginning of the 19th century the examination by these persons should
encompass not only the accounts but also the board’s management.
4. The opinion at that time was that these deputies should to a certain extent also be advisers
to the board, and they could and should provide constructive criticism.
3
The Companies Act 1895
Sweden got its first legislation on share-issuing, limited liability companies in 1848. This
does not, however, mean that such companies did not exist before that time. The act was
based on the concessionary system. At the parliamentary session of 1844-45, a ban was
7
proposed against the founding of companies without a royal concession, but the act did not
include any clause to that effect. Thus it was possible to start share-issuing companies without
a concession, and a number of such companies were founded.
The act was short, only 15 articles. The company was to have a board. The dividends were not
permitted to be higher than to leave a surplus as a specific proportion, the size of which was to
be laid down in the articles of the company, to the share capital. Apart from this limitation on
dividends, an annual balance sheet was not required, nor were there any requirements
regarding auditing.
The first comprehensive legislation on companies was introduced in Sweden in 1895 (SFS
1895:65). The concessionary system was abandoned, but every limited liability company had
to be registered. At the annual general meeting, the board was to present a management report
and a balance-sheet as well as an auditors' report, and the issue of granting discharge for the
board should also be discussed and decided. Neither an income statement, nor any detailed
requirements for the balance-sheet were mentioned.
The management of the company by the board and the accounts of the company should be
examined by one or several auditors6. The reason for the examination to also include the
management by the board was given in the governmental study preceding the act:
The way in which auditing of companies in our country is performed has often been criticized,
and it is hard to deny that the control, that is intended with the auditing, only too often is
carried out in too hasty a way, for it to be to be a satisfactory guarantee to the shareholders as
well as to the creditors of the company7. To correct this unsatisfactory state of things, […] the
committee has considered that it should suggest rules to extend the power and authority of the
auditors […]. In this regard, the suggestion is: to give to the auditors, during the whole term of
their office, unlimited access to all of the company’s books, accounts and other documents,
that can give information on the operation of the company ─ a right that requires an obligation
for the auditors to continually and attentively follow the operations; that the auditors are
authorized to call the shareholders to an extra general meeting, whenever the circumstances
give reason for that, and thus above all if they find that the management in one or another way
make an intervention by the shareholders necessary immediately […]. Since the auditing
institute in this way gets the character of a continually functioning, responsible supervisory
board, there is well-grounded reason for the expectation that the auditing shall in the future
imply a more effective control than has often been the case so far. (Komitébetänkande 1890, p.
126)
In the Supreme Court treatment of the bill (Prop. 1895:6, p. 144), it was added that the
purpose of the rules regarding auditing of the management of the company, seemed to be to
include in the auditing an element corresponding to the continuously functioning supervisory
board in the legislation of some foreign countries. No countries were mentioned explicitly, but
it is well known that Sweden at that time had close relations with Germany and was
influenced by i.a. German legislation. In Germany, the first company law, the Allgemeines
Deutsches Handelsgesetzbuch (ADHGB), had been passed in 1861. Here the internal
organization was to be built around Generalversammlung (general meeting), Vorstand
(management board) and Aufsichtsrat (supervisory board). The supervisory board was to be
responsible for monitoring management and auditing of the accounts. The intentions behind
6
7
Professional auditors became compulsory for larger companies in the act of 1944 and for all companies in the
act of 1975.
”During this veritable Gründer period … a number of new limited liability companies were founded where
there was no firm tradition to build on, and it became therefore increasingly common that audits in such
companies became a mere formality and therefore the audit institute fell into disrepute” (Sillén, 1952)
8
the regulation was to better protect the shareholders through a continuous supervision and
control and in 1870 the supervisory board became compulsory. Its members had a right to
access documents and accounts and were, apart from auditing the accounts, also responsible
for reviewing the proposal for profit distribution and reported to the general meeting of
shareholders. The auditors, on the other hand, were not to be involved in any examination of
how the company was managed:
Immer aber ist im Auge zu behalten, daß sie /die Revisoren/ nicht in die Verwaltung hieneinzureden
hatten. (Lehmann, 1898)
4
The Companies Act 1910
After only a few years, voices were raised for changes in the Act of 1895. The concern was
increased protection for the public against unsound companies, greater security for the
shareholders in the event that the board abused its powers and its inside knowledge of the
financial position of the company, and protection for the minority against unfair treatment on
the part of the majority (Skarstedt, 1942, p. vi; SOU 1971:15, p. 82). While in the Act of 1848
the impact of the French Code de commerce was manifest, the Act of 1910 was heavily
influenced by German law (SOU 1971:15, p. 83).
Thus, a new Companies Act was enacted in 1910, but the relevant rules on auditing and
auditors do not seem to have changed at all. Still, the management of the company by the
board and the accounts of the company should be examined by one or several auditors, and
the auditor should be allowed to scrutinize all books, accounts and other documents. The
board was not allowed to deny the auditor access to information regarding the management.
The auditors should for each fiscal year submit a signed report on their scrutiny.
In the Swedish paper at the congress in Berlin, Nils Karlgren and Oskar Karlgren (1939, p.
251ff) explained at length the management auditing concept. In addition to studying the
minutes of the board’s meetings, the auditors should examine e.g. the policies for buying and
selling goods and, in producing companies, the operations in the factories. The auditors
further had to carefully study the Selbstkostenberechnungen, not only for the examination of
the valuation of the inventory, but also for the examination of the costing as a reliable basis
for the company’s pricing policy for its products.
At the congress, Sillén (1952, p. 17) replied to a question about the fact that auditing of
companies in Sweden also encompassed the management of the company and not only the
accounts. The question was whether one could find persons who considered themselves able
to examine not only the accounts of a large entity, but also the management of it. Sillén’s
reply was:
Only in rare cases can it be necessary to do a detailed examination […]....it should be an
examination using ‘common sense’ in order to be able to in time discover the risks of unwise
allocations of capital. […]. the auditors have to use reasonable care and skill. One does not
require them to be ‘Übermenschen’.[…] (Sillén, 1952, p. 17)
A further clarification on the meaning of management audit in the Companies Act of 1910 is
given in a committee’s discussion behind its proposal for a Companies Act (SOU 1941:9, p.
448). In the Danish and Norwegian Companies Acts, the auditors’ duty was to examine the
9
accounts and the annual report, while the Swedish and Finnish Companies Acts also required
an examination of the board’s management. The fears, especially in Denmark, that such an
examination could give rise to a situation where the auditors gave more attention to reviewing
the management than to analysing the accounts had, neither in Sweden nor in Finland, proved
to be justified. All practical experience in Sweden was said to contradict the suspicion that the
auditors’ right to review management would give rise to an improper extension of the basic
auditing activity and an inappropriate influence for the auditors. It was also pointed out that,
contrary to the laws in Denmark and Norway, the Swedish Companies Act contained a
decharge institute. The significance of that institute was that it required that the auditors in the
auditors’ report recorded any management decision or activity which was detrimental to the
company. Consequently, they had to examine the management as well.
5
The Companies Act 1944
According to the Government Bill of 1933 (Prop. 1933:205) that initiated the analyses
underlying the Companies Act of 1944, the economic development during the period after the
1910 Act had not been foreseen by the legislators. Experience, it said, and in particular
“recent events”8, had demonstrated the necessity of a more efficient auditing, and a
memorandum had been drawn up in the autumn of 1932. Until the 1930‘s Sweden had been
spared the disastrous failures that had struck other countries, e.g. the French Mississippi
Company, the English South Sea Company, and the German Gründer period after the FrancoGerman war of 1870–1871. The moment of truth came for Sweden when Ivar Kreuger‘s
financial empire collapsed and the Swedish parent company went bankrupt in 1932. The
accounts in this group had largely been fraudulent, and the experiences from the Kreuger
crash were pivotal in the preparatory work on a new Act.
The committee report of 1941 (SOU 1941:9, pp. 3f) described the background from another
perspective. The need for reform had become obvious not only in Sweden and the other
Nordic countries. (During the preparatory work there were deliberations with delegates from
Denmark, Finland, and Norway, and the Icelandic government followed the progress of these
deliberations.) Examples were taken from e.g. England, Denmark, and Germany. The general
economic development had significantly changed the circumstances of business, in particular
as far as company groups were concerned. Profound changes in economic, social, and
political opinion influenced the companies in various ways. Interests other than those that had
earlier been specially protected, now had to be considered. The committee was guided by the
doctrine that the object of a company was not limited to that of a mechanism producing
private profit – companies also had an important function in the service of the whole economy
and subsistence of the nation.
The memorandum contained proposals that in listed companies one of the auditors would
have to be appointed by royal consent, that companies with financial links should have the
same auditor and formal requirements for auditors. The memorandum was circulated to a
number of authorities and organizations. Most of the submitted responses recommended,
however, that the issue of a more efficient auditing should not be made an object for separate
analysis, but that it was necessary to undertake a complete revision of the Companies Act.
Some of the organizations also pointed out the interdependence between the issue of auditing
and other organizational considerations. It was among other things suggested that one ought
8
The term ”recent events” was a reference to the collapse of the Kreuger industrial and financial empire.
10
to consider the German governance model with an administrative board and a supervisory
board. This latter proposal was included in the directives for the ensuing committee assigned
with the task of reviewing the Companies Act. The minister wrote that one, inter alia, ought
to “consider the desirability of a system roughly corresponding to that of Germany.”
In the new act, there was no division of the board into two levels, but the role of the managing
director was regulated. In large companies, a professional auditor was mandatory, and the
rights of a minority group of share-holders to appoint an auditor were extended. Specific
regulations were introduced on the duties of the auditors and the content of the auditors’
report. The idea that in large companies one auditor ought to be appointed by royal consent
was not included in the final proposal. The auditors’ role as part of the governance structure
was thought to be threatened if an external auditor in the examination of the management
would be given access to privileged information. Such a solution would be a reason for
concern and tensions. Other reasons cited for not pursuing the idea of an externally appointed
auditor were lack of legitimate organizational competence and that the state must not be seen
as a guarantor for a company. The appointment of auditors remained in the hands of the
shareholders’ general meeting.
As far as the extent of the auditors’ examination was concerned, a limitation to examining
only the financial statements and the accounts was thought to be logical only in legal systems
─like the German─where there was a special body which was in charge of the examination of
the management. The conclusion by the committee was:
For reasons given, the rules from the existing act have been included in the proposal, and that
consequently the management ─ according to the proposal not only by the board but also by
the managing director ─ together with the accounts of the company shall be examined by the
auditors. It is in the nature of things that this examination of the management does not mean
that the auditors encroach upon the authority over management. The examination shall
essentially focus on the discovery and prevention of illegal or otherwise indefensible
management actions. It does not fall to the auditors to extend their criticism further than what
might be motivated by possible decharge refusals or claims for damages or other neglected
duties and violations by the management - preventing illegal or otherwise indefensible
management actions. […] (SOU 1941:9, pp. 448f)
In conclusion, the 1944 Companies Act, basically carried the 1910 definition of auditing
forward. Since no supervisory board was added to the governance structure of limited liability
companies, the auditors’ role remained more or less unchanged. Because of the decharge
institute, management audits were still to be an integral part of the auditors’ tasks. Although
the importance of the difference in this respect compared to Denmark and Norway was played
down, the government thought it unwise not to have a legal requirement for management
audit.
6
The Companies Act 1975
The turbulent years of the 60s and the beginnings of the 70s also came to affect business and
the business climate. The riots and social unrest in both Europe and the US brought about a
critical examination of the society and particularly the business sector. These were the years
of criticism against the operations of multi-national companies and the birth of the general
issue of company responsibility. Business firms were criticized for polluting, exploiting third
world countries and pursuing commercial goals at the expense of consumers.
11
One consequence of this development was the Social Accounting model where companies
were requested to not only account for the financial effects of their operations, but also for
other effects on the surrounding society. During this period, accounting was discussed and
models were developed both in Europe, North America and Australia. It is a reflection of the
tenor of the times that we in both the Company Report, from the Accounting Standards
Steering Committee of the ICAEW9, and in the Stamp Report, from CICA10, find definitions
of users of accounting that include a with array of groups. The latter report mentions
shareholders, long-term creditors, short-term creditors, analysts and advisors serving the
above, employees, non-executive directors, customers, suppliers, labour unions, the public
etc. The financial results for a company were thought to be of interest to the general society.
In accounting, this period further saw a renewed interest in the 20 year old Enterprise
theory11, where a company was conceived of as an integral part of the division of labour in
society, affecting and affected by a number of stakeholder groups which all held a legitimate
right to be considered. The corresponding income concept of value-added income, was now
used to describe what different groups got out of their financial relationship with a company
since the bottom line was seen as a result of the combined effort of a number of participants.
During the 1950s preparatory work had been under way in the other Nordic countries for
revisions of their companies acts; there was thus reason to envisage a standardized Nordic
legislation on companies. In the 1960s parallel committees were at work in Denmark, Finland,
Norway, and Sweden, and representatives from Iceland took part in the deliberations.12 Thus
it seemed natural that the main objective for the Swedish committee was to propose, in
cooperation with the committees of the other countries, that – wherever possible – Nordic
company legislation should be standardized. The guidelines included awareness of EEC
legislation, but since Sweden‘s relations with the Common Market were undecided, the
committee confined itself to reviewing the new German and French company legislations.
With rising claims against companies during the end of the 60s and the beginning of the 70s, a
sudden interest in auditing arose as a method of controlling the operations of, particularly,
large companies. Alternatives were proposed where the auditors ought to, on behalf of other
groups than shareholders, evaluate the social responsibility of the companies. The sentiments
were very much in favour of a greater transparency of commercial operations, leading to a
possibility of greater control.
The committee showed that it had been listening to the demands in society. In its report the
committee presented a new proposal for governance structure in limited liability companies.
As before there should be the general meeting of shareholders, the board and the managing
director. To this was added a new element, the supervisory board, a concept very similar to
the Aufsichtsrat of the German limited liability companies. The main task for a supervisory
board was to give information on the company’s activities and supervise the management
board and the managing director. The Supervisory Board was to be a contact between the
general meeting and the board and MD. One of its duties would be to give an opinion on the
accounts presented to the general meeting. The supervisory board should not only consist of
shareholders, but also representatives for other interested parties e.g. the employees and their
9
The Institute of Chartered Accountants in England and Wales
The Canadian Institute of Chartered Accountants
11 Suojanen, W (1954). Accounting Theory and the Large Corporation. Accounting Review, July
12 SOU 1971:15, pp. 75 ff
10
12
unions. The idea of the Supervisory Board, although facultative, went to show how ideas on
governance structure were linked to the political discussion in society.
The committee’s proposal on auditing was that it should encompass “… an examination of
company books and other accounting material, examination of financial statements and an
audit of the board’s and the MD’s management”. This represented, however, no change
compared to the existing 1944 rules. What was new, however, was the idea of an extended
management audit. The latter, showing an affinity with models introduced in the public
sector13, should include “reviewing and evaluating important decisions from a commercial
and economic perspective, possibly also from a social or societal perspective.” The result of
this part of the audit could be included in the auditors’ report.
In the final analysis the committee concluded that a formalization of this, as it was considered,
valuable review, would meet with some difficulties. Auditors might in this area become
involved in the decision process and consequently have their objectivity compromised. It
could also be that such a task would be outside the competence of the auditors and that they
could inflict damage on the company by the evaluative judgments in the auditors’ report. A
final point was that no other country had such rules.
In the referral process, both the idea of a Supervisory Board and an extended management
audit met with wide resistance among the organizations that the committee’s proposal was
circulated to. The Supervisory Board was a new element and it was argued that it was not
needed and/or that the borders of responsibility between different governance organs would
be unclear. Since the idea did not even get support from the labour unions, who might have
gained representation through it, the government did not include it in its bill.14
As far as the extended management audit was concerned, not even the committee itself
ventured such a proposal. The government played down some of the risks that the committee
had used as arguments for not advancing any proposal, but concluded that it would not
propose an extended management audit. The reasons given were more technical than
intellectual. The idea was thought to be sound, but it would meet with practical difficulties to
implement it in law. Given its support to the idea, the government instead relied on the future
development of accepted auditing practice. The minister wrote that:
“It is reasonable to believe that the development without any special regulation in law will lead
to an extended management audit.” (Prop. 1975:103 s 243)
If the development that the minister expected would come true, this would of course mean
that, since auditors were obliged to follow accepted auditing practice, extended management
audit would be a reality.
The minister’s expectation would, however, come to nought. The auditing profession never
embraced the new ideas of an extended management audit and in their statement on auditing
practice in 1978, they reiterated the risks already mentioned in the committee’s report. They
13
In the public sector, the traditional financial audit had been supplemented by a model for performance audit,
the latter focusing on efficiency and effectiveness
14 A contributing factor to the attitude of the unions was that employees had been allowed representation on the
board through a separate law in 1972 and therefore the need for additional representation was not felt as
strongly as before.
13
also added that, although the auditors’ task was to work with the stakeholders, different
groups had different interests and consequently that the risk for conflict between stakeholders
worked to limit the extent of the audit. The role of the auditor should be limited to the
auditor’s “natural” (sic) competence and they stated the somewhat nebulous principle that
auditing should not be extended any further than what could be motivated by its benefits. In
short, despite embracing the idea of the importance of the auditor, the professional
organization, FAR, in fact advocated a continuation of the model from 1944, thereby
deflecting the development foreseen by the minister.
7
The present
The parallel work on Companies Acts in the Nordic Countries during the 60s and the
beginning of the 70s, led to national laws that were harmonized in relation to each other. New
laws were passed in all countries in the mid 70s. As always, the developments after that
created, however, increasing diversity and in 1988 the Nordic Council suggested that a review
of existing laws and practices should be initiated. Other developments also contributed to the
need for a revision e.g. new financial instruments and solutions (convertibles, stock options,
own shares), the question of differentiated voting rights, owners’ financial responsibility,
financial scandals in Sweden (Fermenta, Gusum) etc. A final reason was the then ongoing
general discussion of an integration between EFTA and EEC countries, particularly the
financial accounting directives. All this led to the appointment of the Company Law
Committee in 1990.
Following the ideas of harmonisation, the committee carefully studied law and practice in
other countries, not only Scandinavian, but also the major European countries such as
Germany, France and Great Britain. By the time the committee presented its final
conclusions, limited liability companies had been divided into public and private since the
beginning of 1995, where stricter rules were thought necessary for the public companies. One
main problem was thought to be unclear roles between members of the governance structure,
in particular the relationship between the board and the MD.
In an interim report the committee stated that the Swedish rules governing auditing and
auditors were in principle the same as in other continental countries in Europe and that they,
by and large, functioned satisfactorily. The appropriateness of the auditors’ possible role as
consultants was not thought to be an issue although information on whether the auditors had
acted as consultants was made a compulsory part of the management report. Further, in line
with the EC directives, the auditors should now attest that the financial statements that a
company presented, gave a true and fair view of the company’s financial performance and
position. The most noticeable change proposed by the committee in relation to auditing and
auditors, was that auditors should be responsible for reporting to a public prosecutor
conditions which were considered to be a crime and illegal. This requirement, although
opposed by the auditing profession, was later included in the law passed by the Parliament.
As far as the scope for auditing was concerned, the committee reiterated the prevailing
practice. Auditors should examine the company’s financial statements and accounting books
and the board’s and the MD’s management of the company. The examination of the latter
should in all essentials focus upon “discovering and preventing illegal or in other respects
unwarrantable acts of management”. It should not, however, fall to the auditors to criticize the
economic appropriateness of management decisions if they could not lead to a situation where
14
discharge was not going to be granted. The examination should generally be based on good
auditing practice and was therefore thought to be of varying extent in different companies.
Much of the auditing activities were further specified by the requirement for the auditors’
report (e.g. to control that the financial statements were according to the Companies Act). The
general conclusion by the committee was that:
“[…] the regulations on the auditor’s tasks included in the Companies Act are by and large
formulated in a satisfactorily manner.”
There were, according to the committee, convincing reasons for not further regulating the
auditing process by rules of law.
In a comparison between German and Swedish law, the committee noted that unlike German
rules, the Swedish auditor was not an outside controller, but part of the governance structure.
These circumstances would not per se prevent the auditor to include an account of important
threats to or risks concerning the survival of the company in the auditors’ report. This was,
however, not to be recommended, since it would force the auditors to make economic
evaluations of the company, something that they were not obliged to do according to Swedish
law.
In conclusion, the rules that had applied to auditing since the end of the 70s remained more or
less unchanged. Apart from the statement on whether financial statements truly and fairly
reflected the financial performance and situation of the company and the compulsory task of
reporting criminal and illegal decisions and activities, the auditors’ role remained unaltered,
including the question of recommending or rejecting discharge of responsibility for the board
and the managing director. The development in the rest of Europe, although analysed and
referred to, did not lead to increased convergence in governance structures. The historical
difference continues to exist.
8
Summary and conclusions
One of the results of research on corporate governance is that the legal system of a country is
one of the fundamental determinants of how well the protection of investors’ rights functions
in that country. Parts of that legal system are the requirements on audits and auditors. Ideally
the auditors’ role would be defined in relation to other actors in the governance system. Any
proposal for a corporate governance system which does not take this interaction into account,
is incomplete (Demirag et al, 2000).
Several attempts have been made to describe and analyze the differences between accounting
regulations within Europe and relate them to different fundamental approaches (e.g. Gray
1988, Nobes 1998). The model used by Nobes distinguishes between, on one hand, countries
with a strong equity outsider model, where the ownership of shares is dispersed and where the
financial reporting is targeted for the investors, and, on the other hand, countries with a weak
equity outsider model, where ownership is more concentrated and creditors is an important
target group for financial reports. The first group of countries include the US and the UK and
the second France and Germany.
Most countries have a legal requirement that the company should have a board of directors. In
the US and the UK, with the strong equity outsider model, this is a unitary body, whereas
countries like Germany and Austria have a two-tier system, and some other, like France and
15
Finland, allow a two-tier system (Denis & McConnell, 2003). The American and British
system is thus monistic, whereas the German is dualistic. Members of the board in British
companies used to be recruited to a large extent among the directors of the company.
Nowadays, however, the corporate governance code requires a majority of a board’s members
to be non-executives. In the dualistic German system, the General Meeting appoints the
Supervisory Board (Aufsichtsrat), which in turn appoints the Board (Vorstand). The Board is
the principle management organ, and its actions are supervised by the Supervisory Board
which, however, does not intervene in the day-to- day management of the company. No
individual is allowed to be a member of both organs.
The Swedish model is in comparison with the British and the German models somewhat of a
mixture between them. In terms of ownership, Swedish companies are closer to the
continental European situation. Few listed Swedish companies lack a controlling owner or
controlling owners. On the other hand, as has been described in previous sections, the
Swedish Companies Act is not based on the dualistic system and is instead closer to the
British monistic system.
Sweden has historically been heavily influenced by the German tradition, and, in the
discussion on the auditors’ role in general and management audits in particular, we find
explicit references to and comparisons with the German model. Defining the scope of auditing
to include management audit has then been seen as an alternative to the solution with a
supervisory board (Aufsichtsrat):
Since the audit institute in this way acquires a quality of a continuously functioning
supervisory board, one has grounded belief to assume that the audit in the future will lead to a
more efficient control than what has been the case so far. (Komitébetänkande 1890)
It seems reasonably certain that the Swedish model of management audit, originating in the
17th century, was originally introduced to protect the shareholders and help them understand
and evaluate the management of their company. Shareholders, who themselves were not
knowledgeable or did not have the time and resources to inspect the operations of the
company, employed auditors to do the job for them. The product of that audit should be a
recommendation to discharge the management of responsibility for the past period. Included
in the management audit has also come to be an examination of whether the management has
taken any decisions or actions which might legally compromise the shareholders.
A crucial question is of course ‘corporate governance for whom’. During the last decades of
the 20th century, there were attempts towards a convergence on the US shareholder based
model although both the IASC, the ASC and the CICA originally had more stakeholder
oriented approaches. As was described earlier, the discussion before the Companies Act of
1975 included ideas that the auditor ought to be regarded as an instrument for a broader
societal control, benefiting not only the state but also employees, customers, suppliers etc.
Although these discussions never landed in any statutory requirements, the already existing
task for the auditors to pass judgment on the proposed distribution of profit can be considered
as an assignment more motivated by external interests than the protection of shareholders.
In Sweden, the concept of management audit has been considered in every committee’s work
on a new companies act, and in the middle of the 70s an extended audit was expected to
develop on a voluntary basis. Furthermore, the management audit has in most cases been
16
explicitly related to the German Aufsichtsrat. Two things stand out – firstly, the existence of
the management audit has not been seriously questioned at any of the occasions, not even
during the 1990s, and secondly, in every case the result has been not to adopt a governance
structure with a supervisory board. Despite the lack of hard evidence, one must draw the
conclusion that the decisions not to adopt the German model were based on a belief that the
management audit is more efficient than a Supervisory Board when it comes to overseeing the
activities of the Management. ─The supervisory board in Germany has moreover lately been
criticized for having been more of a formal than real player in the governance structure:
Man muß sich vor Augen führen, daß bis vor wenigen Jahren engagierte Aufsichtsräte meist
nicht erwünscht waren. Ohne den Einfluß aktiver Großaktionäre oder institutioneller
Investoren hatten Aufsichtsratssitzungen meist nur formalen Character.15 (Frankfurter
Allgemeine Zeitung, 2004-03-14)
The evidence on Japan and Germany similarly indicates that boards are quite passive except in
extreme circumstances. (Shleifer & Vishny, 1997)
Some of the differences between the models can be seen in the following table:
Anglo-American
Type of system
Ownership
Monistic
Dispersed
German
Swedish
Dualistic
Concentrated
Mixture
Large
owners
+
dispersed
Auditor’s role
Internal (auditors are External (auditors are Mixture
(auditors
not required to report required to report required to report
illegal actions)
illegal actions)
certain illegal actions
but discharge is only
an internal issue)
Control over Board General assembly
General assembly
General assembly
and Management
through independent through supervisory through Auditors’
directors on the board board (Aufsichtsrat)
Management
Audit
and non-executives on
the board
As far as the Swedish model with management audits is concerned, one can observe that it has
withstood all previous attempts to convert it into a regular dualistic system. However, a
committee has recently developed a proposal for a new Code for Corporate Control (Svensk
Kod för Bolagsstyrning, 2004). This proposal contains some features which have direct
implications for the corporate control model. One such area is a nominating committee. The
nominating committee shall propose both members for the board and auditors. Further, the
nominating committee is also proposed to be charged with the task of evaluating the activities
of the board, something which can overlap or at least come close to the role of the
management audit. The structure is further complicated by the proposal that the board should,
15
”One must realise that only a few years ago, active supervisory boards were not regarded as desirable.
Without influence from large shareholders or institutional investors, the meetings of the Supervisory Board
were mostly a formality.”
17
through an auditing committee, evaluate the auditors (who through the management audit
evaluate the board). It seems to lead to a situation where the issue of “who controls whom”
becomes somewhat blurred.
Auditing committees are by the way already part of a proposal for a revised EC directive on
auditing. The present chairman of FAR (the Swedish Institute of Authorized Public
Accountants) noted:
If this proposal survives, the Swedish (and Finnish) management audit does not, at least not in
companies with an auditing committee. (Brännström, 2004)
He also raised the question of what will happen to the rules in the Companies Act on the
auditors’ obligation to report suspected illegal actions or the examination of taxes. Will these
also be removed? If this were the case, the Swedish auditors would be very much in the same
situation as their UK counterparts.
In accounting, a process of harmonisation and convergence is under way and from January
2005 all European listed companies are required to use the reporting standards developed by
the IASB in their group accounts. Since many of these standards have been developed in
cooperation with SEC and FASB in the US, they also represent true international standards. In
corporate governance, on the contrary, the question of whether global convergence eventually
will lead to a uniform one-tier system, as some researchers think, or whether different models
will survive is still undecided. Global competition and global capital markets are thought to be
the main drives behind a possible harmonisation. Strikingly little research has been directed
towards discussing the effectiveness of these various arrangements in Europe, and most of the
studies relate to the UK experiences with the proposals from the Cadbury Committee.
The processes of integration, convergence and harmonisation will certainly continue, and it
seems─given the development of global financial markets, the world wide trading in stock
markets and the development within international accounting─unlikely that a third, Swedish
model of corporate governance will survive. The future development of corporate control
might, however, hold still another alternative. The convergence and harmonisation processes
and the concomitant changes in laws, rules and codes will maybe only be made to apply to the
set of companies which are truly traded on and operate in the international market. Already
today, companies are divided into listed and non-listed companies in terms of the
requirements to disclose financial information, and the EC-regulation on the use of IASB
standards only applies to the group accounts of listed companies. In this perspective there is
room for corporate control models for companies which are not traded on public markets and
where the ownership still might be concentrated. For these companies, management audit
might still represent a viable control instrument in the corporate control structure. The
management audit has, after all, survived the test of some 400 years.
18
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20
Appendix 1
The audit report for the Tar Sales Company, 1652
We, the undersigned, elected by the owners as their associates in the management of the Tar
Company, hereby declare to each of the owners that the directors of the aforementioned
company have annually, from the inception of the company to this date, fully disclosed how they
have discharged their responsibilities to the said company and how its affairs have been
transacted and managed, all of which we have found have been both carried out and recorded in
the company’s accounts in a proper manner in all respects, and, thus, in a satisfactory manner
have carried out all of the affairs having to do with the company’s operations; for these reasons,
on behalf of the owners, we not only accept and approve the present capital and all transactions
that have been entered upon the books up to this day, but we also absolve the directors of the
company and all others concerned with its operations from future suits and complaints of every
kind from the undersigned and all owners. As an added assurance, and in the interest of greater
security, we have hereby affixed our signatures under the authority conferred upon us by the
owners in Paragraph 14 of the company’s articles. Dated in Stockholm the 16th day of September,
Anno 1652 (Sillén, 1952, p. 8f, translated here from Swedish)
Jonas Heinrichsson
Jacob Pfeiff
Jacob Barckman
Joachim Dittmer
Anders Jonsson
Johan Jonsson