The obsolete notion of auditing information

INFORMATION FOR THE BOARD The obsolete notion of auditing information Boards today are fighting a new kind of war — an information integrity war — with antiquated concepts and tools much the same way the Polish cavalry met the German army in World War II. BY MADHAVAN NAYAR AND ERIC G. FLAMHOLTZ H ISTORY IS REPLETE with examplesof technologies that disrupt the exist- ing world order in many fields of endeavor. Eor example, over the cen- turies, cavalry had been the source of strategic advantage in warfare. In 1939, when the German army invaded Poland, they were met by the Polish cavalry. Proud, skilled, and brave horsemen, the Polish cavalry charged the advancing German army, which was armed with tanks with mounted machine guns. The carnage that ensued decimated the Polish cavalry and made clear its obsolescence. The coming of age ot the Digital Age has made the current approaches to information integrity — its accuracy, consistency, and reliability -^ in most organizations obsolete. Boards have depended on information provided primarily by senior management to base its deci- sions and carry out its responsibilities. It has been assumed, for the most part, that such information is dependable and trustwo rthy, and that manage- ment has implemented appropriate controls in the information systems and processes to ensure in- formation integrity. Additionally, boards have relied on the system of internal con- trols, including internal audits, and on the external auditors for the assurance of information integrity. Suspect information Now boards are under siege from share- holders and regulators. The information they give the shareholders and regulators has become suspect and in some instances been proven to be wrong, misleading, or false. Boards have suffered as a re- sult of the fragmented, ad hoc, and inadequate ap- proach to information integrity that is prevalent in most organizations. The internal control systems aimed at assuring information integrity are, more often than not, held together by a patchwork of manual processes, embedded controls, and obscure audit trails. With the advent of the first Industrial Revolu- tion, some 200 years ago, it became necessary to establish a system of controls to monitor and re- port business activity. The resources of the indus- trial age were tangible things that could be mined, processed, bought, sold, managed, and easily un- derstood, and the 'physical' organization and op- eration — customers, suppliers, people, processes, and resources — were visible, identifiable, and ac- cessible. The task of monitoring and reporting was comparatively simple and straightforward. It was possible to establish internal control systems to Madhavan Nayar (left) is company leader of Intogix, a provider of information management software and solutions ( and Eric G. Flamholtz is professor of management, Anderson School of Business, UCLA. He is a member of the board of directors of 99 Cents Only Stores, an NYSE company, where he serves as chair of the strategic planning and compensation committees. S2 DIRECTORS ft BOARDS INFORMATION FOR THE BOARD physically observe and manually verify the veracity of the information presented by management. Tbe global economy is currently in the midst of a second Industrial Revolution, which has spawned the Digital Age. It is built on electronic software and hardware, widespread access to the Internet, and tbe electronic exchange of information for a variety of purposes. It is now possible to process and store immense quantities of data at ever-faster rates. This has allowed the gathering of previously unimaginable amount of detail about every aspect of the business. In this environment, the physical organization and operation — customers, suppliers, people, processes, and resources — are becoming less and less visible, identifiable, and accessible. Instead, they are represented by tbe information in corporate data warehouses, ERP systems, and various other applications. Consequently, tbe business bas to be defined, analyzed, and assessed through an "infor- mation proxy," the representation of the physical en- vironment in the information environment. Thus, information is rapidly becoming a surrogate for the real, tangible world — a virtual world unto itself This poses new and unique challenges and re- quirements. This means that decisions must be based upon information ratber than observable tangible phenomena. It also means that if and when errors in information occur their significance is magnified. The current paradigm of information integrity is based upon the obsolete no- tion ofauditing information. In a digital world tbis is increasingly futile and cost- ly. What is required is a system of real- time information controls that assesses the processes of creating information. Some of these tools already exist, while others require development. ability by reducing operational costs in many dif- ferent ways: elimination of manual labor, prompt detection of errors, faster resolution of errors, and lower refunds and write-offs. Profitability is also increased by protecting an organization's revenue through prompt detection and prevention of rev- enue leakage and the capture of unbilled revenue. • Regulatory Compliance: Autoimted information controls, because they are consistent, standardized, and verifiable, simplify and speed up inlernal and external audits. They also ensure that the informa- tion provided to the regulators is accurate and reli- able. • Protection of Reputation: Some information er- rors can be catastrophic because they can result in damaging headlines in the media, severe penalties from the regulators, or significant erosion of the market value of the business. Automated informa- tion controls help detect catastrophic information integrity failures. The board should be encouraging senior man- agement to develop and deploy new tools for the continuous validation of electronic information. Otherwise, the information integrity war is des- tined for the fate of the Polish cavalry if we do not develop a new approach. • The authors can he contacted at and Benefits to the enterprise Effective real-time (automated) infor- mation controls can eliminate informa- tion errors, ensure information integ- rity, and yield many important benefits to the enterprise: • Operational Efficiency: Operational efficiency is increased through automa- tion of manual verification, standard- ization of information controls, and elimination of unnecessary delays in processes. Operational efficiency trans- lates to better resource use, reduced cycle time, and increased customer sat- isfaction. • Increased ProfitctbiVity: Automated information controls increase profit- The information explosion The fastest increasing quantity on this plan- et is the amount of information we are gen- erating. Information is accumulating faster than any material or artifact in this world, faster than any byproduct of our activities. The rate of growth in information may even be faster than any biological growth at the same scale- Recently two economists at UC Berkeley calculated our total global information pro- duction for one year. In their study "How Much Information?" researchers Hal Varian and Peter Lyman measured the totai produc- tion of all information channels in the world for two different years, 2000 and 2003, Their totals include the information found on all analog media such as paper, film, and tape, as well as in all digital media such as hard disks and chips, and through all bandwidth such as TV, radio, and telecommunications. Their tally focused on unique information, rather than iust bits, since a duplicate of a song (or photo or database) does not contain any real additional information. Therefore they counted a newly recorded song as new information, but not all the copies of that song, even though those additional copies would require storage space and transmis- sion bandwidth. Varian and Lyman estimate that the total production of new information in 2000 reached 1.5 exabytes, which they explain as about 37,000 times as much information as is in the entire holdings of the Library of Congress. For one year! Three years laterthe annual total yielded 3.5 exabytes. That yields a 66 percent rate of growth in information per year. This rate hardly seems astronomical compared to say the 600 percent increase in iPods shipped last year. But that kind of iPod burst is not sustainable over decades, while the growth of information has been steadily increasing for at least a century. — Msdhavan Nayar and Eric Ramholtz FOURTH QUARTER 2007 S3

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