HomeChapter 6: One-Tier Board Attributes in the US6.4 Facts About Changing One-Tier Board Attributes

6.4 Facts About Changing One-Tier Board Attributes

Based on the previous description of the formal structure of one-tier boards, this paragraph further explores changes in the attributes of boards of directors in publicly held corporations in the US. Guided by reform issues identified by The Corporate Director’s Guidebook of the American Bar Association, developments in the governance structure of Fortune 500 corporations are portrayed for a period between 1987[12] and 1997. Principle data is collected by Spencer Stuart Board Services in the US and obtained from proxy statements and annual Forms 10-K. Additional information is provided by Heidrick and Struggles, Korn/Ferry International, the NACD, The Conference Board and others.

 

6.4.1   The Main Issue: The Independence of Corporate Boards of Directors

It is widely accepted by reformers and commentators that there should be a balanced mix of executive and non-executive directors in the boards of directors of listed corporations. The Business Roundtable emphasizes that “. . . it is important for the board of a large publicly owned corporation to have a substantial degree of independence from management. Accordingly, a substantial majority of the directors of such a corporation should be outside (non-management) directors” (The Business Roundtable, 1997:10). To have boards that communicate an “appearance of independence”, the American Bar Association encourages boards to work with at least a majority of independent directors (ABA, 1994). The American Law Institute (ALI) recommends in the Principles of Corporate Governance that “. . . the board of every large publicly held corporation … should have a majority of directors who are free of any significant relationship . . . with the corporation's senior executives . . . unless a majority of the corporation's voting securities . . . are owned by a single person . . . a family group . . . or a control group . . .” (ALI, 1992:144). The NYSE requires all listed domestic companies to have at least two non-executive directors (NYSE, Listed Company manual, §303.00).

 

Fact 1 -> Board Size: Total Board Size is Shrinking

 

Spencer Stuart (1997) indicates that the size of boards of directors in listed corporations has changed from an average of sixteen directors in 1981 to a total average of thirteen directors in 1997. This figure is based on a sample of one hundred leading corporations. According to Pic (1997:4), the reduction in board size “ . . appears to be the consequence of an aspiration for more professional and efficient boards.” This has resulted in a net reduction of 200 directorships (13,3 percent) in the sample between 1981 and 1997.

Boards with sixteen and more directors have also become more uncommon. Only nine percent of the corporations investigated have boards with sixteen or more directors while more than half of the boards (51 percent) had sixteen or more board members in 1982! The data undoubtedly indicates a trend in the size of US-boards. Instead of “downsizing” the corporate board, the trend may be best described with “rightsizing” the board (NACD/Deloitte and Touche LLP, 1995:9). Spencer Stuart (1997:5) suggests that this development may indicate that there is little room for a further shrinkage in board size in the US. As a practical matter, boards need to have a certain number of directors to operate their board committees.

Korn/Ferry International (1997) indicates that board size continues to vary with the size of corporations and the type of its businesses. Boards of retailers and corporations in advanced technologies are on average composed of ten directors. Banks do have the largest boards with an average of fifteen directors. According to Spencer Stuart (1997), the largest boards also can be found in financial institutions.

 

Fact 2 -> Board Composition: Non-executives Gain Dominance in Boards

 

Directly related to developments in the size of corporate boards, changes in the composition of boards of directors have become more evident during the last decade in the US. Spencer Stuart (1987-1997) indicates that boards of one hundred of the country’s largest corporations are composed of 3.5 non-executives to every executive director in 1996, compared to two non-executive directors to every executive director in 1987. The latest figures indicate that some 87 percent of a total of 1,302 board positions in the one hundred corporations investigated were occupied by non-executive directors in 1996.

 

Fact 3 -> Board Composition: Total Number of Executives is Shrinking

 

This development has resulted in a net reduction of 195 executive board positions between 1987 and 1996 in corporations surveyed (Spencer Stuart, 1987-1997). In contrast, the total number of non-executive directors decreased with five directorships between 1987 and 1996 (Spencer Stuart, 1987-1997). The Heidrick and Struggles Indexes indicate a similar development in the composition of corporate boards. In 1986, 57.5 percent of directorships in the Fortune 1000 boards was occupied by independent directors.

In 1988, this percentage increased to a total 71.7 percent. This development in board composition may demonstrate an increasing emphasis on the appointment of independent non-executive directors to corporate boards in the US. As such, this development may suggest evidence that listed corporations are increasingly adhering to pressures from reformers and regulators to compose their boards of directors more independently of management. Related to the first proposition of this study, this development may also suggest that the separation of decision management from decision control is facilitated by an increasing number of positions held by non-executive directors in boards of listed corporations in the US.

 

6.4.2    The Second Issue: Board Leadership and the Separation of Chairman and CEO Roles

 

While there seems to be a common consent among those involved in the debate on boardroom reform that boards should be composed of a majority of non-executive directors, the separation of the roles of chairman of the board and the CEO is clearly a more controversial matter (Lipton and Lorsch, 1992). As part of the promotional system of directors and as a means of board effectiveness, CEO-duality is widely supported by executives in the US. Bagley and Koppes (1997:158) indicate that “ . . . promotion to the CEO and chair is often viewed as a reward for excellent service and a vote of confidence by the board.” In an early statement, The Business Roundtable explicated that the integration of chair and CEO roles benefits the corporate board. Accordingly, “the general experience of the Roundtable members has been that the board functions well where the CEO also serves as chairman and where there is no sharp organizational line drawn between the board and operating management” (The Business Roundtable, 1978:2112). The Business Roundtable emphasizes in a more recent report:

“Most members of The Business Roundtable believe their corporations are generally well served by a structure in which the CEO also serves as chairman of the board. They believe that the CEO should set the agenda and the priorities for the board and for management and should serve as the bridge between management and the board, ensuring that management and the board are acting with a common purpose.”

Source: The Business Roundtable (1997:12).

Bagley and Koppes (1997) refer to a 1992 Korn/Ferry International study to address that many executives still strongly oppose the idea of splitting the chair and CEO roles. The Korn/Ferry International study found that 41 percent of CEOs believes that the separation of the roles of CEO and chair roles impedes “management effectiveness.” A recent survey of Korn/Ferry International among 1,125 directors also indicates that only two percent would consider a non-executive chairman who is neither at present employed nor has been a former employee of the corporation. A minority of six percent of the 878 investigated Fortune industrial and service corporations has appointed a non-executive chairman (Korn/Ferry International, 1997).

 

Fact 4 -> Board Leadership: There is Only a Very Modest Support To Split CEO and Chair Roles

 

Interestingly, a recent NACD/Deloitte and Touche LLP 1995[13] survey may suggest that more corporations are considering to separate the roles of the CEO and the chair of the board. NACD/Deloitte and Touche LLP (1995) found that a majority of CEOs believes that boards of directors should be required to split the chairman and CEO roles (see box 6.3 for more details on the study findings)[14].

Box 6.3

The Separation of Chairman and CEO Roles

 

“One of the most striking findings in the 1992 survey was the relatively high number of CEOs (23 percent) who said they believed boards of directors should be required to separate chairman and CEO roles. In 1995, role separation appears to be winning not only acceptance, but adherence in a growing number of companies.

 

The 1992 survey did not probe actual practice, but other studies appearing around the same time did. According to separate research by Institutional Shareholder Services in Bethesda, Maryland and by the Institute for Research on Boards of Directors, Inc. in Sarasota, Florida, levels in 1992 were about 20 percent. Comparing these figures with 1995 survey results, it appears that the chairman-CEO role split has nearly doubled in three short years. Well over one-third of respondents (38 percent) say they currently separate the roles, and of those not doing so, nearly half (45 percent) say they would consider doing so. Conversely, fewer than one in five (17 percent, down from 1992’s 23 percent) said a top role split should be required by law.”

 

 

Source: NACD/Deloitte and Touche LLP (1995:18).

 

Some 38 percent of the respondents also indicate that their board has separated the roles. Although the general opinion suggest that there is only a very modest support to split CEO and chair roles, the 1995 NACD/Deloitte and Touche LLP survey may indicate a development towards more independent board leadership in US. This development may suggest that the first signs can be observed that an increasing number of corporations are recognizing the need to separate decision management from decision control through changes in the formal leadership structure of their boards. Although the legal community has addressed the separation of chair and CEO roles, so far it has not resulted in any legislative reform or amendments of models and codes of conduct. In very general terms, the ABA identifies the separation of chair and CEO roles as a means to strengthen the role of independent directors (ABA, 1994).

 
6.4.3.   The Third Issue: Board Leadership and the Designation of Lead Directors

Closely related to the issue of CEO-duality is the relatively new development of directors to appointment “lead directors” to their boards. The Corporate Director’s Guidebook refers to the designation of a non-executive director selected by independent directors as a lead director if the CEO also serves as chair of the board (ABA, 1994). The role of the lead director is to provide the CEO with advice on the selection of board committee members and to provide advice on the organization of board meetings. The lead director also monitors the adequacy of management information, sets the board agenda and organizes procedures to evaluate the performance of the CEO (Lipton and Lorsch, 1992). According to The Business Roundtable (1997:12-13), a lead director “. . . is sometimes designed with specific duties, such as consultation with the CEO on board agendas and chairing the executive sessions of the board. In other cases, the lead director has no special duties in ordinary situations, but assumes a leadership role in the event of the death or incapacity of the CEO or in other situations where it is not possible or appropriate for the CEO to take the lead.”

 

Fact 5 -> Board Leadership: More Lead Directors Assigned to Corporate Boards

 

Spencer Stuart (1995-1996) indicates an increasing number of lead directors appointments in the US. Out of a total of one hundred large corporations, ten corporations had lead directors assigned to their boards in 1995. The number of lead directors has increased to a total of 36 corporations in 1996. A survey of Korn/Ferry International among 1,125 directors also indicates an increasing number of lead director appointments to boards of Fortune corporations. A total of 24 percent of 878 Fortune industrial and service corporations has a lead director in 1997 compared to 22 percent in 1994 (Korn/Ferry International, 1997). The NACD/Deloitte and Touche LLP 1995 survey on corporate governance indicates that 43 percent of participating CEOs consider the appointment of lead directorship to their boards. According to the survey, a majority of 53 percent of participating CEOs also prefer lead directors to separating the chairman and CEO roles.

 

This relatively new development may suggest that an increasing number of listed corporations seek to counter balance the power of the CEO when he or she also holds the position of chairman of the board. As such, it may indicate that while directors favor a leadership structure that is based on CEO-duality, they also do recognize the need to separate decision management from decision control through the appointment of non-executive lead directors to boards of directors in listed corporations in the US.

 
6.4.4    The Fourth Issue: The Independence of Oversight Board Committees

Much of the public scrutiny of corporate governance issues concentrates on the composition and function of board committees (Varallo and Dreisbach, 1996a). The Corporate Director’s Guidebook recognizes that the formation of committees with independent directors lies at the core of many boardroom proposals (ABA, 1994). Although operating committees are recognized in the contemporary corporate governance discussion, reformers mainly concentrate on the formation of oversight board committees (audit, compensation and nominating committees) in boards of listed corporations. Comprised entirely of independent non-executives, these oversight committees are predominantly accepted by reformers as valuable devices to improve the independence of corporate boards. The Business Roundtable recommends that listed corporations should have an audit committee, a compensation/personnel committee and a nominating committee with membership limited to non-executive directors (The Business Roundtable, 1997).

 

Fact 6 -> Board Committees: The Formation of Audit Committees Has Become More Common

 

The discussion on the formation of audit committees goes back to the 1930s. The formation of audit committees was actively supported and recommended by the SEC in response to a Supreme Court decision in the McKesson-Robbins case on fraudulent financial reporting in 1938: “The company was found to have been deceiving investors by issuing fraudulent financial statements - statements given an apparent clean bill of health by the outside auditing firm, even though they showed large amounts of assets that did not exist and grossly overstated profits . . . One of the recommended practices that emerged from the SEC’s investigation of the McKesson-Robbins scandal was the establishment of an audit committee, a concept that was unusual at that time . . .” (The Conference Board, 1979:6). Through several “Accounting Series Releases” (ASR) and “Exchange Act Releases”, the SEC continuously recommended corporations to establish audit committees.

In 1972, the SEC urged “registrants” to form audit committees comprised of non-executive directors (ASR, No. 123). In 1974, all publicly held corporations were required to state the number of audit committee meetings and were required to indicate the function of the audit committee (ASR, No. 165). The SEC has also allowed constituencies like the accounting profession and the respective security markets and stock exchanges (secondary regulatory agencies) to decide whether audit committees are required (Cobb, 1993). The SEC[15] strengthened the role of audit committees by encouraging stock exchanges to include audit committees as a condition for listing in 1978. This has resulted in the alteration of the listing requirements of three major stock exchanges in the US (Todd DeZoort, 1997; Maassen, 1998b).

In 1939, the New York Stock Exchange recommended the formation of audit committees. More recently, the NYSE requires domestic corporations with common stock listed on the exchange to establish audit committees since June 30, 1978 (NYSE, Listed Company Manual, §303.00). Both NASDAQ and AMEX followed the NYSE requirements regarding the composition of audit committees (Cobb, 1993). In 1987, the National Association of Securities Dealers (NASDAQ) required listed corporations on the National Market System to establish audit committees. The American Stock Exchange (AMEX) followed in 1992[16]. The SEC reporting requirements and the exchanges’ listing requirements have strongly contributed to the popularity of audit committees in the US. In addition to these forces, Jeremy Bacon of The Conference Board (1979) indicates that scandals and public distrust of business, changing legalistic environments in which directors operate and pressures from the accounting profession have contributed to the rise of audit committees in the US.

The high profile reports of the ‘National Commission on Fraudulent Reporting’ (Treadway Commission) have also encouraged corporate boards of directors to form audit committees (McMullen and Raghunandan, 1996). Funded by the Institute of Internal Auditors (IIA), the American Institute of Certified Public Accountants (AICPA), the Financial Executives Institute, the American Accounting Association and the National Association of Accountants, the “Treadway Report” of October 1987 was issued to help prevent and detect fraudulent corporate financial reporting (Bull and Sharp, 1989). The Treadway Commission published eleven recommendations for audit committees (see box 6.4).

Treadway did, to some degree, set new standards for audit committees in the US. In response to the Treadway report, the AICPA issued several ‘Statements on Auditing Standards’ (SAS) to emphasize the role of auditors and audit committees in corporate governance in April 1988. The AICPA established with “SAS 61 – Communicate with Audit Committees”, and other Statements on Auditing Standards a new standard for auditors that recommends external auditors to communicate formally with audit committees (Braiotta, 1994; Todd DeZoort, 1997). The 1987 Treadway report was followed by the a report of “The Committee of Sponsoring Organizations” (COSO) of the Treadway Commission.

The report, “Internal Control-Integrated Framework”, also greatly contributed to the popularity of audit committees in the US after its publication in September 1992. The report sought to reflect a broad consensus of opinion on the definition of internal control methods that provide standards to measure the effectiveness of the internal control systems of corporations (Kelley, 1993). Despite increasing pressures on corporate boards to establish audit committees, audit committees are not required by state corporation laws. State law of Connecticut forms an exception for domestic corporations with at least one hundred record holders (Harrison, 1987; Varallo and Dreisbach, 1996b). Another law, The Foreign Corrupt Practices Act (FCPA) of 1977, addresses accounting and internal control standards for publicly held corporations. Its purpose is to prohibit US corporations and their affiliates (directors, officers, etc.) from bribing foreign governmental officials. The law also provides “ . . . the establishment and maintenance of a system of internal accounting control and record-keeping requirements with respect to all publicly held corporations” (Braiotta, 1994:29). As such, the FCPA applies increased pressure on corporate boards and audit committees members to comply with “enforceable guidelines” (Todd DeZoort, 1997:211).

Box 6.4

The Treadway Report - 11 Recommendations For Audit Committees

A company’s audit committee should annually review the management program to monitor compliance with the code of corporate conduct.

Management and the audit committee should ensure that the internal auditors’ involvement in the audit of the entire financial reporting process is appropriate and properly co-ordinated with the independent public accountant.

-

The boards of directors of all public companies should be required by Securities and Exchange Commis-sion rules to establish audit committees composed solely of independent directors.

-

Audit committees should be informed, vigilant and effective overseers of the financial reporting process and the company’s internal controls.

 

All public companies should develop a written charter of the audit committee’s duties and responsi-bilities. The board should approve the charter, review it periodically and modify it as necessary.

-

Audit committees should have adequate resources and authority to discharge their responsibilities.

-

The audit committee should review management’s evaluation of factors related to the independence of the company’s public accountant. Both the audit committee and management should assist public accountants in preserving their independence.

 

 

Before the beginning of each year, the committee should review management’s plans for engaging the company’s independent public accountant to perform management advisory services during the coming year, considering both the types of services that may be rendered and the projected fees.

-

All public companies should be required by SEC rules to include in their annual report to stockholders a letter signed by the chairman of the audit committee describing the committee’s responsibilities and activities during the year.

-

Management should advice the audit committee when it seeks a second opinion on a significant accounting issue.

-

Audit committees should oversee the quarterly reporting process.

Source: Treadway Report (1987), summarized by Bull and Sharp (1989).


A relatively new development is the introduction of the Federal Deposit Insurance Corporation Improvement Act’ (FDICIA) that regulates audit committee requirements for banks and savings institutions with over USD 500 million in assets in the US (see box 6.5).

 

Box 6.5

The FDICIA Rules on Audit Committees

 

“ (1) Independent Audit Committee.-

Establishment. – Each insured depository institution (to which this section applies) shall have an independent audit committee entirely made up of outside directors who are independent of management of the institution, and who satisfy any specific requirements the Corporation may establish.

Duties. – An independent audit committee’s duties shall include reviewing with management and the independent public accountant the basis for the reports issued under subsections (b)(2), (c), and (d).

Criteria applicable to committees of large insured depository institutions. – In the case of each insured depository institution which the Corporation determines to be a large institution, the audit committee required by subparagraph (A) shall

(i) Include members with banking or related financial management expertise;

(ii) Have access to the committee’s own outside council; and

(iii) Not include any large customers of the institution.”

 

Source: Braiotta (1994).

 

6.4.5    The Fifth Issue: The Composition and Independence of Audit Committees

The Model Business Corporation Act does not specify any qualifications for directors who work in board committees. Formally, board committees can be comprised of executive directors or, if desirable, committees can be comprised of non-executive directors. In the case of audit committees, the Corporate Director’s Guidebook strongly advocates for an independent committee consisting of three to five independent directors. Under the rules of the NYSE, audit committees need to be solely comprised of directors who are independent of management: “Each domestic company . . . shall establish . . . an Audit Committee comprised solely of directors independent of management and free from any relationship that, in the opinion of its Boards of Directors, would interfere with the exercise of independent judgement as a committee member. Directors who are affiliates of the company or offices, or employees of the company or its subsidiaries would not be qualified for Audit Committee Membership” (NYSE, Listed Company Manual, §303.00).

 

Fact 7 -> Board Committees: Audit Committees Have Become More Independently Composed

 

The Heidrick and Struggles 1986-1988 indexes indicate an increasing number of non-executive directors in audit committees in Fortune 1000 corporations. The Korn/Ferry International 1997 study of proxy statements of 878 corporations even indicates that all corporations have established audit committees in 1996. These committees were on average composed of four non-executive directors (Korn/Ferry International, 1997). This development indicates that audit committees have become common in the US. It also indicates that directors increasingly understand the need to operate with audit committees that are comprised of directors who operate independently of management. As such, related to the first proposition of this research, the increasing popularity of independent audit committees may suggest that directors are using this committee as a vehicle to formally separate boards’ decision management role from its decision control role.

Vicknair et al. (1993) and Braiotta (1994) suggest that it is important to standardize the rules on the independence of audit committees. Vicknair et al. (1993) examined the proxy statements of one hundred NYSE-corporations on the background of audit committee members between 1980 and 1987 (see table 6.1). The research indicates that a total of 26 percent of the corporations had a majority of audit committee members who can be classified as grey area directors[17].

 

Table 6.1

The Percentage of Directors in Each Grey Area Category in

100 NYSE-Corporations (1989-1987 Proxy Statement Data)

Interlocking directorships

12.0%

Other related party transactions

11.5%

Affiliated with corporations’ bank

3.1%

Lawyers receiving fee income

2.9%

Retirees of the corporation

2.4%

Consultants to the corporation

0.5%

Relatives of management

0.5%

Full sample is 428[18] directors in audit committees

Source: Vicknair et al. (1993:56).

According to Vicknair et al. (1993), grey area directors are not employed by corporations on whose boards they serve. Yet, these directors are affiliated with the corporation or its management or their background suggests that they enjoy a direct or indirect financial interest in the corporation. A total of some 32 percent of 418 audit committee members in the sample are classified as grey area directors. Table 6.1 indicates the grey area categories in the Vicknair et al. (1993) study.

Vicknair et al. (1993:57) conclude: “Given the evidence . . . we feel that it is premature for accountants and others interested in improving corporate governance to relax their concern over audit committee independence [. . . ] the pervasiveness of ‘Grey’ area directors . . . suggests the existence of a more serious potential independence problem.” Also noted by Vicknair et al. (1993), this problem seems to be less persistent in a study of The Conference Board in 1988. The Conference Board study indicates a decreasing number of former employees in audit committees (from 19 percent in 1978 to 13 percent in 1987). Bankers’ representatives dropped from 23 percent in 1978 to 10 percent in 1987. Jeremy Bacon of The Conference Board concludes: “In fact, figures for most of the potentially non-independent directors listed in the table have decreased since the last report.

Since many survey companies are not listed on the NYSE, the high compliance with the Exchange’s guidelines . . . is evidence that many non-Exchange companies believe in independent committees and voluntarily abide by strict membership standards” (The Conference Board, 1988:7-8). Table 6.2 presents the grey area categories in The Conference Board study.

 

Table 6.2

Grey Area Categories in The Conference Board Study

Relationship of director to corporation

Number of corporations with at least one such director on the audit committee

1987 study results

in percentages

1978 study results

in percentages

Former employee

93

13

19

Attorney

80

12

10

Banker

68

10

23

Investment banker

48

7

9

Employee

44

6

3

Major customer

33

5

9

Major supplier

5

1

2

 

692 corporations

 

 

Note: the relationships in this table are based on the NYSE policy statement on audit committees. Attorneys are affiliated with corporation’s outside counsel. Bankers are representing banks customarily serving the corporation and investment bankers provide service to the corporation.

Source: The Conference Board (1988:7).

6.4.6    The Sixth Issue: The Function of Audit Committees

 

Samet and Sherman (1984) indicate that while the SEC, exchanges, legislators, auditors and others strongly have encouraged the use of audit committees, the objectives and duties of audit committees are still diverse. The authors indicate that the ambiguities with respect to the function of audit committees may be due to three factors:

  • the relatively recent development of the audit committee as part of the corporate structure;
  • the lack of a single central authority in the US that has established the functions and duties of the audit committee, and;
  • the fact that the functions of audit committees vary according to the context in which audit committees exist.

Source: Samet and Sherman (1984:47-48).

 

Cobb (1993) and Maassen (1998b) refer to at least four key functions of audit committees identified in the Anglo-Saxon corporate governance literature (see table 6.3). (1) The first function concentrates on the internal control and financial reporting procedures of the firm. According to McMullen (1996:88): “Effective audit committees enhance the credibility of annual audited financial statements and thus assist the board of directors which is charged with safeguarding and advancing the interests of shareholders . . .” (2) Another function of the audit committee aims at reducing illegal activity and preventing fraudulent financial reporting. Beasley (1994) indicates that the audit committee can play an important role in preventing and detecting management fraud because audit committee members may be often the first non-management personnel to identify a potential irregularity. (3) To strengthen the position and the independence of the external auditor, the audit committee is also a means to create a link and a channel of communication between the auditor and the board of directors. The audit committee can reduce the liability of external auditors, can assist external auditors in reviewing the activities of the internal auditors of the corporation and can assist the board of directors in reviewing the nomination and performance of external auditors. (4) Finally, an audit committee can assist the board of directors to conform to standards and institutional norms.

According to Harrison (1987:11): “For a board of directors, its committee structure symbolizes its methods of operation, which itself is not readily observable. With the increasing attention focused on board committees by the SEC disclosure requirements, the New York Stock Exchange regulations, the AMEX and ABA recommendations, and the courts, the board’s committee structure is becoming increasingly visible and important for legitimacy maintenance.”

Despite legislators’ and commentators’ disagreement on the precise function of audit committees (Cobb, 1993; Wallage, 1995; Varallo and Dreisbach, 1996b; Todd DeZoort, 1997; Maassen, 1998b), it is generally agreed upon that audit committees of publicly held corporations should perform functions that are indicated by the ALI, The Business Roundtable and the ABA.

 

Table 6.3

Four Functions of Audit Committees in the Anglo-Saxon Literature

Enhance the integrity and the credibility of financial statements and corporate accountability:

oversee the total audit of the financial reporting process, including the internal control system and the use of generally accepted accounting principles (McMullen, 1996);

review financial statements and other financial information distributed externally (KPMG, 1996).

Reduce illegal activity and prevent fraudulent financial reporting:

provide detailed information to the board of directors to signal potential irregularities (Cobb, 1993; Beasley 1994, 1996).

Strengthen the position and the independence of the external auditor:

 

provide a link and a channel of communication between the auditor and the board of directors (The Conference Board, 1988; Cobb, 1993; Vicknair et al., 1993);

reduce the liability of the external auditor (Samet and Sherman, 1984);

review of the recommendations and activities of the internal auditors of the corporation (Samet and Sherman, 1984);

review the nomination and performance of the external auditor (KPMG, 1996; The Business Roundtable, 1997).

Pursue legitimacy to conform to standards and institutional norms:

 

promote corporate legitimacy as “a signal to the outside world” by adapting to methods of operation that adhere to socially acceptable standards (Harisson, 1987; Cobb, 1993);

review the corporation’s code of ethics or code of conduct (The Business Roundtable, 1997);

reduce the liability of boards and directors (Braiotta, 1984).

Sources: Cobb (1993); Maassen (1998b).

 


Based on the ALI’s Principles of Corporate Governance and The Business Roundtable’s 1990 statement, the Corporate Director’s Guidebook suggests the following functions of audit committees:

  • make recommendations to shareholders concerning the engagement or termination of the corporation’s external auditor;
  • review the compensation, proposed terms of engagement and the independence of the external auditor;
  • review the appointment and replacement of internal auditing executives;
  • serve as a channel of communication between the board and the internal and external auditors;
  • review the external audit, the management letter and management’s response to recommendations from the external auditor and internal auditors;
  • review and discuss internal financial controls.

Source: ABA (1994:1265-1266).

 

Fact 8 -> Board Committees: Compensation Committees Become More Common and More Independently Composed

 

As an independent source of advice, the compensation committee can support boards’ policies regarding the remuneration of top executives and the recommendation of board candidates. The Corporate Director’s Guidebook and the ALI indicate - amongst other things - the following duties of compensation committees that are comprised entirely of non-executives:

  • review and recommend to the board, or determine, the annual salary, bonus, stock options, and other benefits, direct and indirect of the senior executives;
  • review new executive compensation programs; review on a periodic basis the operation of the corporation’s executive compensation programs to determine whether they are properly coordinated; establish and periodically review policies for the administration of executive compensation programs; and take steps to modify any executive compensation programs that yield payments and benefits that are not reasonably related to executive performance;
  • establish and periodically review policies in the area of management perquisites;
  • plan for executive development and succession; in that capacity some compensation committees take on a broader role, to actually plan for management development and evaluation of key personnel.

Source: ABA (1994:1269,1271).

The Business Roundtable recognizes the compensation/personnel committee as an independent source for “ensuring that a proper system of long- and short-term compensation is in place to provide performance-oriented incentives to management” (The Business Roundtable, 1997:16). Another important function of the compensation committee is also to fulfill the 1992-SEC requirement to file a “Compensation Committee Report” on executive remuneration programs. In general, corporations registered under the 1934 Act are required to describe “ . . . the performance factors on which the Committee relied in determining the compensation of the CEO, as well as a discussion of the Committee’s general policies with respect to executive compensation” (ABA, 1994:1270).

According to Varallo and Dreisbach (1996a:21), the compensation committee is “likely second only to the Audit Committee in its prevalence . . .” The Heidrick and Struggles indexes indeed confirm the popularity of the compensation committee. A vast majority of boards in Fortune 1000 corporations (95,1 percent) had established such a committee in 1986. A majority of the compensation committees is also composed of non-executive directors. In 1986, some 69 percent was entirely composed of these directors. In 1988, more than three-fourth of the committees were solely composed of non-executive directors. Based on proxy statements, Korn/Ferry International (1997) indicates that 99 percent of 878 Fortune industrial and service corporations have established a compensation committee in 1996. The average compensation committee was composed of four non-executive directors. Executive directors were on average no member of the compensation committee.

 

Fact 9 -> Board Committees: Nominating Committees Become More Common and Independently Composed

 

According to the Corporate Directors’ Guidebook, the nominating committee has two principle functions:

  • recommend to the board the slate of nominees of directors to be elected by the shareholders (and any director to be elected by the board to fill vacancies); and
  • recommend the directors to be selected for membership on the various board committees including the designation of chairs of board committees.

Source: ABA (1994:1272).

These responsibilities are similar to The Business Roundtable's definition of the duties of nominating committees. In addition to the recommendations of the ALI and the ABA, The Business Roundtable identifies the following responsibilities of the nominating committee:

  • develop a policy on the size and composition of the board;
  • review possible candidates for board membership;
  • evaluate the participation and contribution of current board members.

Source: The Business Roundtable (1997).

 

The ABA, ALI and The Business Roundtable all acknowledge a certain degree of CEO involvement in the nomination of directors. According to The Business Roundtable: “While the CEO must be involved, boards should create a process that makes it apparent to the corporation’s stakeholders that selecting director nominees is the board’s responsibility” (The Business Roundtable, 1990:250). Although the ALI states that: “ . . . officers and employees should not be members of the nominating committee, officers and other agents and employees are in no way disqualified from playing an active role in the nominating process. On the contrary, such persons, and in particular the chief executive officer, can be expected to be highly active in recommending to and discussing candidates with the committee and in recruiting candidates for the board.

Indeed, the chief executive officer’s active participation in recruitment is often an important and perhaps essential element in convincing high-quality individuals to become directors, and recommendations as to nominees made by the chief executive officer for directorships to be filled by other senior executives should normally carry very substantial weight. However, this kind of participation can be achieved without making the chief executive officer a member of the committee” (ALI, 1992:161). According to proxy statements, Korn/Ferry International (1997) indicates that 74 percent of 878 Fortune industrial and service corporations have a nominating committee in 1996. The average committee was composed of four non-executive directors. Executive directors were on average no member of the nominating committee.

 

Fact 10 -> Board Committees: More Independent Leadership at Board Committees

 

It is generally accepted by reformers that oversight board committees should be entirely composed of non-executive directors. To strengthen the role of independent directors, it is suggested that members of oversight board committees choose their own committee chairs rather than having CEOs who designate the chairs of board committees (ABA, The Corporate Director’s Guidebook, 1994). According to Heidrick and Struggles (1986), a majority of board committees are chaired by non-executive directors in 1986, with the exception of the executive committee, which is generally headed by a managing director who is usually also the CEO of the corporation. Korn/Ferry International (1997) indicates that all audit, compensation and nominating committees in 878 Fortune industrial and service corporations are chaired by non-executive directors in 1996. As such, these oversight committees are formally composed and chaired independently of management.


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Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands.

Maassen, G.F. (2002). An International Comparison of Corporate Governance Models. A Study on the Formal Independence and Convergence of One-Tier and Two-Tier Corporate Boards of Directors in the United States of America, the United Kingdom and the Netherlands. Amsterdam: Spencer Stuart Executive Search.