A board’s committees can be either constructive or debilitating. Which of these outcomes is achieved appears to be related to the competencies that are brought to bear at committee level, the committee’s terms of reference and the process of referral back to the full board. The most common board committees in New Zealand are the CEO appointment/remuneration committee and the finance and/or audit committee(s).
What do we know of their impact and what do we know of their organisation? The first one, impact, is really easy to answer. common suspect in our search for good governance has become the impact of the independent audit committee. While significant body of research has now been published on the impact, or otherwise, of independent directors the focus of blame has more recently been directed at audit and finance committees.
None of the published studies have found any relationship between the independence of the audit committee and subsequent firm performance. As is typical with much governance research, motivation has been the supposed agency problem that exists between principals (owners) and agents (managers).
In this case the motivation is supposedly one where the role of the audit committee cannot be entrusted to directors or managers who have an employee relationship with the firm but almost anything else goes (shareholders, beneficiaries, trustees, directors, founders, and founding family members who may be construed as being independent).
An extension of the audit committee argument may be found in research that attempts to identify the relationship between their independence and the probability of financial statement misconduct. Again there is no evidence that independence of the audit committee has any effect on the incidence or otherwise of the misconduct of financial reporting.
The second common sub-committee of the board is the appointment/remuneration committee. Contrary to common belief the relationship between CEO pay and performance has also not been established. While there exists positive relationship between size of organisation and compensation package that is yet to be translated into business performance.
Recent press articles have claimed that CEOs in New Zealand typically have packages with less risk than their Australian or US counterparts and, unsurprisingly, they typically receive greater proportion of the at-risk component. Appointment, pay, package and compensation are all subjects of the remuneration and appointments committee.
In summary, these two committees are commonplace in New Zealand, however, their effectiveness or otherwise (as to their impact on business performance) should remain open to debate.
So why have board committees? Committees appear to have emerged from the dominant, and highly effective, US mixed board model of corporate governance. In that model, where the board is drawn from both executives (inside) and outside directors, committees comprising the outside directors make recommendations to the full board: especially on matters concerning audit and CEO compensation. The motivation for this committee structure can be attributed entirely to the supposed agency problem, namely, that the inside directors cannot be ‘trusted’ with these particular responsibilities.
As best practice models have emerged, the role of board committees has become increasingly well accepted. They should be an important and significant source of recommendations to the full board. Board committees may also be established on an ad hoc or temporary basis to examine an issue (acquisition), review an aspect of management (marketing), or to review the performance of business unit (internal analysis).
In these cases the committee could well include direct input from management and, arguably, in time of crisis take on more ‘management’ oriented role than what would ordinarily be expected.
To be sure, there are dangers in this transitory shift from strategic to an operational focus. These dangers include meddling, interference, and undermining the authority of the board: All good reasons why the terms of reference and processes to be followed should be well understood by the board and committee members.
Critics will argue that in such circumstances management and governance cross the imaginary divide between their respective roles. Such criticism fails to recognise that the board ought to ensure that management is continually striving for exemplary performance. No doubt there will be occasional circumstances when those assigned the role of governance need to cross that divide to ensure that outcome is met.
The glaring omission among typical New Zealand board committees is the strategy committee. common defence offered is that the board should debate strategy and organisational purpose. True. However, the scope of competencies required, creative thinking especially, is not likely to be held by all directors. Why not assign board committee with the sole responsibility of recommending strategy to the board? With input from management they may well provide real insight.
By Dr James Lockhart, director of the School of Business, Massey University.
