How are board committee charters used?
- At the highest level, each committee needs to have a charter. The charter is typically reviewed by the committee and the board once a year. Public companies need a minimum of three committees:
- Audit
- Compensation
- NomGov
- Banks or companies that do a lot of financing might have other committees such as Finance Committee. Real estate development companies may have a Development Committee. Another growing trend is to have a Cybersecurity Committee. Sometimes there are other special committees for a one-time purpose, or short duration, such as M&A.
- The charter has a minimum set of duties defined either by SEC, by effective law, or by the stock exchange like NASDAQ or New York Stock Exchange. That helps define the mandatory tasks. From the charters, boards develop a workflow and annual calendar that sets the primary agenda items for a full year. That ensures that each committee does its work so that when the proxy is sent each year, each committee can represent that it has performed all the duties in its charter.
- Many boards assign different duties to committees for varying reasons. Usually, committee tasks are a function of who the members are and the work that needs to get done. The NomGov committee typically assigns membership. There may be informal committees. For example, a board can set aside two to three hours to go over a particular product area, or go-to-market areas, and bring in the business leaders who are 2-3 levels below the CEO to give exposure to the board.
What does the Audit Committee do?
- Audit committees must read and review the SEC filings, such as the 10-K and 10-Q, for consistency of the reports across two or three reporting periods. The AC also reviews the financial statements to understand business results, identify changes in the business and potentially detect red flags.
- The audit committee should have independent sessions with the external auditor so that they can speak freely with the audit committee with no management team in the room. Informally, the audit committee chair meets with the audit partner on a quarterly basis to ensure an open communication channel.
- Audit committees also oversee internal audits to ensure the company maintains strong internal controls, particularly over financial reporting.
- The chair of the audit committee needs to have an independent relationship with the CFO, the chief compliance officer or internal audit. Under certain circumstances, there needs to be a conduit of information between those functions and the committee. It requires artistry, not to step on toes, but all those functions need to know that they have unobstructed access to the audit committee – this is critically important.
- The audit committee chair regularly meets with the CFO. This is part of the communication and feedback to management. The audit committee helps in the transition of CFOs to ensure a well-managed process with the board.
- For example, the audit committee felt that our CFO would not scale because the company was getting larger as a result of an acquisition. The AC discussed this observation with the CEO. The initial reaction from the CEO was, “you are wrong.” Two months later, the CEO came back and said, “you’re right.” That’s part of the audit committee’s job to support the CEO.
What does the Compensation Committee do?
- Everybody talks about audit being a difficult committee because the financial results or the consequences of missing guidance can be significant. The consensus is, however, that serving on the Comp Committee is the most difficult assignment because you are dealing with human emotions and pay.
- Make sure that the person with the highest emotional quotient on the board is the chair of the Comp Committee because it requires the highest finesse. Managing emotions around pay structures, balancing demands from ISS, Glass Lewis, shareholders, and the CEO’s pay is demanding.
- Comp Committees must own the relationship with the compensation consultant. Oftentimes, the compensation consultant is selected by the head HR. Remember the HR person works for the CEO and the compensation consultant wants the job. It’s critically important the Comp Committee have an independent relationship with the compensation consultant. The Comp Committee should hire and fire the compensation consultant and have the courage to challenge the compensation consultant.
- Independence between management and the compensation consultant becomes an issue when the compensation consultant wants to keep the client happy by paying the CEO a lot of money.
- Verify that the compensation consultant’s assumptions and calculations are accurate. Validate that the financial results used in calculating the bonus are correct. Question the peer companies used in the comparison. Every company wants to pay the CEO above the 50th percentile. That math artificially inflates CEO pay year over year.
What does the Nominating and Governance Committee do?
- The NomGov Committee is all about governance, nominating board members, restructuring the board, hiring good board members, and creating a diverse board portfolio of individuals, including gender diversity.
- Once the board decides to add a new board member, the NomGov Committee drives the process with a skills matrix to determine the recruiting criteria. The NomGov chair presents to the whole board for discussion. Then, the board decides on the key skills needed and the time frame for recruitment.
- Who has responsibility for recruiting a new CEO? It depends on what the board decides. The board could decide to remove the CEO because it’s not working out. The board then could decide to run the whole process at the board level. Or, the board could decide to run the process through the NomGov Committee. In the end, it’s a board decision because hiring and firing the CEO is one of the most important decisions the board makes.
- Who decides on board committee assignments? Initially, the NomGov Committee suggests the committee assignments based on available skills and workload. Then, you present it to the full board for discussion and consensus.
- Many boards think ahead and plan for succession. When new directors join the board, in three or four years they are ready for a leadership role. That means each committee should become a junior member so that they are a viable candidate to lead.
Which committee is responsible for ESG?
- ESG is a relatively new area for boards. It’s gaining momentum and becoming more significant. Most boards, particularly smaller companies, don’t have a separate committee for ESG. It’s typically with the NomGov Committee who focuses on board composition and diversity.
- There are elements of ESG that have to do with communication with constituents like employees. The HR team takes an active role in this case.
