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6. Board committees

Boardroom Best Practice

In this chapter

Executive Summary

  • Delegation of activities to committees does not excuse the board from collective responsibility for the committees’ actions; all directors should have the right to attend all committee meetings.
  • The majority of audit committee members should be independent and all should have an understanding of financial matters.
  • It is important to establish where the responsibility lies for the oversight of each type of risk in the business, but risk management must always remain an executive responsibility — it is the job of the appropriate board committee to monitor that it’s being done effectively.
  • The nomination committee’s remit should be expanded to include governance matters generally.
  • The remuneration committee should ensure remuneration policy is aligned to strategic goals, ensure that decisions are based on performance evaluation, avoid rewards for failure and communicate clearly the adopted principals of working methods.
  • Engaging directors through participation in a strategy day is preferable to delegating all responsibility for strategy to a board committee.
  • All committee advisors such as auditors and remuneration consultants should be the subject of regular competitive tender.
  • The board should keep the committee structure under review, ensuring that specific industry requirements are met.

6.1 Committee membership

As the role and remit of the board has expanded, so has the practice of delegating specific activities to committees. Of course, responsibility for any actions taken, even if recommended or evaluated by the committee, remains with the board as a whole.

This has the advantage of freeing up the board’s time for more forward-looking and strategic discussion. It provides an opportunity for groups of directors to focus on specific areas, be they audit, remuneration, risk etc. It also allows them to devote sufficient time to a proper consideration of the issues before bringing their recommendations to the full board.

The board should be careful about increasing the number of committees, given the limited availability and time of board members. There is a growing trend in some countries for all independent directors to be members of all committees, especially where outside directors number fewer than, say, six. Whilst this is an appealing idea, it can defeat the object of sharing the burden and benefiting from the synergy and focus that a subset of directors provides.

This returns us to the discussion of the optimum size of the board, which should be framed so that at least the three principal committees — audit, remuneration and nomination — can be properly staffed by independent directors.

Moreover, the concept of “everybody doing everything” wastes the opportunity for the best qualified to concentrate on their areas of interest and expertise.

That said, it should be a principle that any board director should be entitled to attend any committee meeting (without being compensated) so long as this does not reduce the efficiency of the committee’s work.

6.2 Reporting back

It is essential that committee deliberations are reported back to the board regularly and in full. This is the responsibility of the committee chairman. A full report should include a summary of the debate on contentious issues, the options discussed and the reasons behind any recommendations. Thus, the report-back is not simply a report, it provides an opening for further review if necessary — the board must always have the opportunity to discuss in full any issues raised by the committee.

Sometimes the committee chairman’s report is oral, followed some days or weeks later by the written minutes of the committee meeting. The report should be full enough for an understanding of the principal issues by all the board.

The chairman should always allow time for questions from non-committee members and encourage a measure of discussion and enquiry.

As a general principle, the agenda and minutes of every committee should be sent to all members of the board for information. However, there will be exceptions, especially when it comes to certain sensitive issues relating to remuneration and succession.

6.3 Audit committee

Until recently, the audit committee was often seen as the senior board committee where most public scrutiny was concentrated. Worldwide regulatory initiatives have concentrated on the role of audit committees and the approval and presentation of accounts, with the result that the remit and authority of the audit committee is more uniform and clearer than in the past. The committee’s priority is to ensure that the nature of the relationships between the auditor and the company around the preparation of the accounts is rigorous, objective and not in any way compromised.

The principal tasks of the audit committee are as follows:

  • to monitor the preparation and accuracy of the accounts and satisfy itself that the functions are adequately staffed to produce the necessary management and statutory accounts
  • to monitor the financial controls and discipline of the company in all its aspects and, if necessary, to interrogate the operations and those responsible
  • to maintain and evaluate the risk register, including any extant litigation. If a risk committee exists, then knowledge of the register is shared between committees and ultimately the board
  • to set the programme for the internal audit and review its findings
  • to manage and review the periodic reports from the external auditors
  • to review the performance and work of both the internal and external auditors
  • to recommend any changes to the external auditors and oversee the retendering process.

Many jurisdictions require members of an audit committee to have an understanding of financial affairs (“financial literacy”). In Germany, members of the audit committee must also have relevant sector experience. We believe that the chairman of the committee should be a person with a formal financial qualification and directly relevant experience, for example an auditor or a former or current financial director. There is usually a requirement that either a majority or all members of the audit committee be independent.

Most audit committees concern themselves with the financial risks present in the business or which threaten it. All risks are the responsibility of the executive to identify and mitigate and insofar as these arise from the general operations of the company. Oversight of this process is the task of the whole board.

A measure of realism is appropriate here. There are financial, operating and environmental risks that everyone can identify and agree upon. There are possible existential risks, the “known unknowns”. But there are also risks that are unanticipated, the “unknown unknowns”. Every organisation may be confronted by the wholly unexpected. This is not a failure in itself. It will only become a failure if the corporate response is muddled or unsure.

Risk management in such cases is after the fact. Those responsible should ensure that procedures for dealing with the unexpected are in place, with clear roles and responsibilities identified. The issue of crisis management is examined in section 8.1.

The frequency of audit committee meetings is in general dictated by the publication of company results, both at interim and final stage. However there is a growing trend for audit committees to meet more frequently than this and quarterly meetings are increasingly common. All committee members must be prepared to meet when needs require.

Audit and risk committees — to combine or separate?

It is important to establish where the responsibility lies for oversight of each type of risk, but risk management will always be an executive responsibility — it is the job of the appropriate board committee to monitor that it is being done effectively.

A risk committee is often required in companies where the principal risk is financial, such as in the financial sector (particularly banking). In the case of industrial companies, the equivalent of a risk committee can be found in the health/safety/environment/security committee.

Where there are separate audit and risk committees, the boundaries of responsibility between the two must be absolutely clear. In such cases, it may well be appropriate for the same person to chair both committees and for there to be some joint members.

6.4 Remuneration committee

The remuneration committee has, at least for the present, replaced the audit committee as the principal target for public scrutiny. It is increasingly under the spotlight, attracting close attention from investors, politicians, media and other stakeholders.

The remit of the remuneration committee is simple: to set remuneration levels for executive directors and to approve the remuneration policies of the company. However, as we have seen, no committee can operate in a vacuum, especially not a remuneration committee.

Accordingly, a well-functioning remuneration committee will:

  • Understand its remit clearly
  • Align all aspects of remuneration policy to the achievement of the company’s strategic goals and demonstrate how every decision about remuneration is consistent with this policy
  • Base its decisions on individual performance evaluation and set appropriate and defensible targets
  • Avoid rewards for failure at all costs
  • Communicate clearly and effectively about its working methods and aims, the reward criteria, pay-out periods, etc.
  • Construct simpler packages: many arrangements are over-complex if not impenetrable. Transparency alone is not a solution
  • Present the CEO/senior management remuneration policy to shareholders at the annual meeting. In some jurisdictions the policy must be put to shareholders for a vote
  • Be clear as to the principles guiding any exercise of committee discretion.

How the remuneration committee communicates its decisions can have a significant impact on the company. Close attention should be paid to the reputational damage that can result from unpopular decisions about CEO and executive remuneration.

We cannot stress too strongly the need for the committee to communicate clearly its decisions, and the reasons for them, to all stakeholders. This will serve to avoid many of the problems that currently beset remuneration initiatives.

It is a welcome fact that regulators’ current initiatives in this area are concerned with ensuring that remuneration schemes are as simple and comprehensible as possible. Transparency is not the same as clarity.

It was once sufficient for committees to focus on the most senior executive remuneration and to declare this as “aligned with shareholder interest”. The bar is now set higher and the enlightened committee will promote a policy that ensures that remuneration levels support the business strategy and other policy objectives while reflecting the corporate culture.

Issues such as pay relativities within an organisation (whether pay is uniform for the same role and does not vary by gender or ethnicity) and whether rates of pay, at all levels, are defensible both to the shareholder and the wider public audience are now finding expression in the better remuneration policies being published.

Notable in this debate is the focus on the CEO/average employee remuneration multiple — currently at a record high. While this is an oversimplified description of what can be a complex calculation, there can be no doubt that executive remuneration has been rising steeply for a generation or two. As attention turns increasingly to remuneration levels it seems we are reaching a tipping point: the challenge will be no longer “keeping up”, but managing down. These are very real issues for today’s remuneration committee.

All this must be framed against the remuneration committee’s principal objective — to foster the growth and success of the company in the longer term. All they do must seek to promote long-term success rather than short-term reward.

The properly advised remuneration committee would normally be attended by the human resources director and/or the head of remuneration. It is common for remuneration committees to appoint remuneration advisors to keep them abreast of best practice and investor sentiment. Two observations follow: first, these advisors should be the committee’s own, not the company’s; second, they should be subject to a competitive tender process with at least the same frequency as are the auditors.

The degree to which the committee has discretion over awards has been the subject of much debate, and committees have been criticised for resetting targets and making individual exceptions, particularly when these exert an upward momentum on remuneration. We believe that remuneration packages should be capable of going down as well as up, depending on performance. Committees should therefore be happy to exercise discretion in the interests of a dynamic and effective remuneration policy.

Frequency of meetings is dictated more and more by regulatory requirements. The need to set targets and frame the report to shareholders generally requires at least two to three meetings a year. This might increase when the corporate remuneration policy has to be reframed. All committee members must be prepared to meet whenever circumstances demand it.

6.5 Nomination committee

The principal role of the nomination committee is non-executive and executive director succession, but in recent years its scope has expanded to the point where now, in many companies, it is the repository of knowledge and guidance on all matters relevant to corporate governance.

The nomination committee’s principal tasks are fourfold:

First, managing board composition. This will involve succession planning, recruitment, skill-profiling and responding to current regulatory pressures. It is the committee’s responsibility to define the ideal composition of the board to ensure a mix of relevant expertise and experience, as well as diversity. This responsibility includes the membership of board committees.

Second, overseeing executive director succession and ensuring that the whole board is informed of the candidates, their strengths and weaknesses.

Third, the nomination committee is often the forum for the evaluation of board performance. This includes administration of the annual performance review, consequent training initiatives, and the induction of directors, giving guidance to the company secretary whose day-to-day responsibility this usually is.

Fourth, the committee takes general responsibility for corporate governance, including oversight of potential conflicts of interest, the preparation of the governance report and, of course, the resolution of any issues that arise. It is responsible for the public reporting of the company’s governance initiatives and policies.

Whilst the remit of the nomination committee differs from country to country, to have too narrow a remit would be an opportunity missed. The better nomination committees take responsibility for leading the corporate debate on matters of governance generally.

Given this expanded remit, nomination committees should consider appointing succession advisors in just the same way that remuneration committees can call on the advice of remuneration specialists.

Some companies are combining the work of the two people-related committees — nomination and remuneration — since their work is interconnected. It is too early to call this a trend, but there is a close connection between the increased scrutiny on remuneration and the people who benefit from it. Considering these two topics together might be a way forward.

Whilst meetings were originally on a needs-only basis, sometimes once or twice a year, the growing agenda and the committee’s involvement in governance matters generally means that two meetings each year is now a minimum. All committee members must be prepared to meet when necessary.

6.6 Strategy committee

The board has a responsibility for approving corporate strategy and overseeing its proper implementation. Whatever is deemed important in terms of corporate strategy can be delegated to a committee. There, due to the focus and concentration of expertise, detailed examination can take place and an effective summary be provided to the board.

Giving oversight of strategy preparation to a committee goes some way towards avoiding the problem that many non-executive directors express, namely that they are insufficiently engaged in the strategy process.

The creation of a strategy committee should not exclude other best practices, notably an annual strategy day at which all directors are present and engaged with management.

In some jurisdictions, a strategy and investment committee focuses on work that elsewhere is shared between the board and the audit committee. The role is one of oversight and challenge as the investment proposals within the strategy obviously derive from the executive.

6.7 Other committees

Certain industries require specialised committees but, as we have stressed above, the number of committees needs to be compatible with the size of the board and the time available to directors.

In some sectors, health and safety issues are increasingly recognised as so mission-critical that a dedicated committee is essential both for practical oversight and to stress the significance of the issue to the organisation.

Another area that is often recognised as appropriate for committee review is the broad area of corporate social responsibility, sustainability and social impact.

The importance of reputation to business success, in both B2B and B2C industries, and the potential catastrophic impact of existential risk, are major preoccupations in boardrooms. Some see a solution in the committee structure, by monitoring and considering the “unthinkable” and then to bring their thinking to the board.

Similarly, increased business dependence on IT and the internet in all its forms, and the threats to business integrity manifested by poor cybersecurity, can benefit from the scrutiny of a board committee.

So, the best companies see the committee system as providing a flexible yet focused response to issues of the day, one that permits concentrated attention and harnesses the contribution of specific expertise among outside directors.

Ad hoc committees of the board may be set up to deal with special events, the most familiar being an approach to acquire the company or even a major investment by the company.

Exceptionally, a chairman might decide to form an ad hoc committee and invite to run it a director who is less confident of their contribution, giving this person the chance to take ownership of the topic. This can be an effective way of integrating such a person on to the board and developing their ability to play a full part.