AF437: Issues in Governance and Ethics Tutorial Solutions Week 3 Chapter 5 Board Committee Roles and Responsibilities 1. What are the key functions of the nominating, audit, governance, and compensation committees? Audit Committee: - Provide oversight over the company’s internal controls, financial reporting preparation, internal and external audit activities, code of ethics conduct, risk management, fraud and whistle blower programme Nominating Committee: - Review performance of current directors - Assess the needs for new directors - Identify and evaluate the skills, background, diversity, and knowledge of candidates - Have an objective nominating process for qualified candidates - Assist in the election of qualified new directors by shareholders Compensation Committee: - Evaluation of directors - Design and implementation of director compensation plan - Evaluation of senior executive - Design and implementation of executive compensation plan - Ensure all aspects of executive compensation are fully and fairly disclosed in the annual proxy statement Governance Committee: - Develop and monitor the company’s governance principles, including roles and responsibilities of directors - Establish agenda for the board to determine what is should discuss with management and to what extent - Provide sufficient information to the board to enable it to effectively review company performance 2. What actions must be taken to make the compensation committee effective? Should the compensation committee consist of independent directors only? Why or why not? - To make the compensation committee effective, the committee should: o be composed of independent directors only (at least 3) who should be rotated after two years o Meet at least four times a year to evaluate half yearly and annual performance of directors and executives o - Design of director and executive compensation plans should be based on published research findings and practical applications in the past. All care should be taken to ensure the compensation packages do not eventually result in earnings management or other unethical behaviour The compensation committee should consist of independent directors only – need to be independent of management 3. What issues should the nominating committee consider in the evaluation process? - Skills, knowledge and experience of current directors and future directors - The independence of directors – the board should consist of at least 2/3 independent directors - Competency and diversity in background – personal characteristics; legal and financial literacy; maturity; confidence; judgement; crisis response; leadership; strategy and vision; industry knowledge; international markets - Integrity of board members - Number of years of membership of directors 4. Describe the relationship that should exist between the audit committee and management. - Audit committee asks management appropriate questions pertaining to the company’s corporate governance structure, codes of ethics, internal controls, financial reporting, audit activities, risk assessment & whistleblower programmes - In return, management ought to provide sufficient information to the audit committee – e.g. significant transactions/events, financial risks and accounting policies 5. Members of the audit committee must be vigilant, effective, and informed. What are some characteristics that contribute to these traits? - Competency and diversity in background – personal characteristics; legal and financial literacy; maturity; confidence; judgement; crisis response; leadership; strategy and vision; industry knowledge; international markets knowledge - Skills, knowledge and experience - Integrity and highly independent - Professional curiosity 6. What are some qualities or actions that can impede the effectiveness of an audit committee? - Insufficient number of meetings (should be at least 4) and inappropriate agenda resulting in poor quality of the meetings – focusing too much on administrative-type matters and too little on material critical accounting or related issues that affect strategic decisions, corporate governance, financial reporting and audit functions - Inappropriate composition of audit committee – there should be at least 3 independent directors with at least one member of the committee with relevant financial expertise - Clash of personalities on the committee – inability to reach decisions - Weak members/ no professional curiosity – inability to ask tough questions and make tough decision – must have the courage to ask tough questions and bring the finance team to task - Loss of integrity and independence – committee members should not be in any situation where there is conflict of interest including related party transactions - Legal liability – safe harbor provided for financial expert member of the committee – avoids probing deeper into issues because of the safe harbor provided 7. What are the positives and negatives of the CEO and executive management’s attendance at audit committee meetings? Positives: - Signals the commitment of senior executives to effective audit committee oversight functions as well as underscore the importance of those meetings - Enhances information sharing between the company management and audit committee – resulting in improved understanding of matters and decision making Negatives: - Presence of CEO and senior executives at meetings may prevent open and candid dialogue between the independent auditor and the audit committee - May undermine the authority of the committee chair particularly where the CEO has a dominant personality 8. Discuss the common-sense executive compensation program. Explain the key features of an effective succession planning process. The common-sense executive compensation programme focuses senior executives on long-term corporate value growth which should benefit all stakeholders of the company. In this approach/programme, directors and executive compensation is designed to promote creation of long-term corporate value, thus directors and executives should be rewarded based on the long-term corporate values they create. The compensation should have both a current (cash) and long-term (stocks) component. Key features of effective succession planning: i. Identifying the critical positions in the organization that require replacing – e.g. leadership roles, expert roles ii. Identify the potential successors – those capable of progressing into the identified critical role iii. Create the talent pool - high potential successors are developing the skills and competencies required for the higher position iv. Populating the succession plan – with the critical positions now known, and high potential successors now identified, now start analyzing the data and begin mapping out succession plans v. Schedule succession planning or talent review meetings – meetings in which the succession plan is reviewed and discussed. These are an essential component of the succession planning approach 9. Explain the views of executive compensation. Which one do you agree with? Why? Express your views on reasons for higher compensation for CEOs Views of executive compensation: i. First view - there is reverse relationship between executive compensation and the development of the company. The higher the executive compensation, the more likely the executive will violate the moral constraints and deviate from the value orientation of the business itself, which is unfavourable for the sustainable development of the enterprise. ii. Second view – there is a positive relationship between the executive compensation and the business development. Under the incentive of executive compensation, the management will be loyal to the interests and values of shareholders. Thus executive compensation match with their performance in maximizing company value. It is up to the student which view they agree with so long as valid reasons and evidence are given to support their answer. Views on reasons for higher compensation for CEO is also open for students views – the important thing is to support your views with appropriate research evidence and examples
