Board Committee Roles and

Responsibilities
Chapter V

Chapter Objectives:
Provide an overview of the functions of board committees.
Understand the roles and responsibilities of board committees.
Be aware of the objectives of establishing board committees.
Become familiar with the duties, responsibilities, and composition of the
audit, compensation, nominating, governance, and special committees.
Understand the process and emerging practices for the election of corporate
directors.

Key Terms
Audit committee
Compensation committee
Enterprise risk management
Governance committee
Nominating committee
Special committee
Strategic board
Succession planning
Tone at the top
Whistleblower

Relevance of Board Committees

The establishment of board committees can bring more focus
to the boards oversight function by giving proper authority
and responsibilities and by demanding accountability for
these committees. Listing standards of national stock
exchanges require that listed companies form at least three
board committees that must include audit, compensation, and
nominating committees. Public companies often, in addition to
these three mandatory committees, have governance and
other committees such as finance, IT, and disclosure.
Average number of directors

9-15

Audit Committee
Lawmakers (SOX), regulators (SEC rules), and listing standards
of national stock exchanges (NYSE, Nasdaq, AMEX) generally
require public committees to have an audit committee, which
must be composed of independent directors with no personal,
financial, or family ties to management.
Standards Relating to Listed Company Audit Committees
outline these requirements, which relate to:
1)
2)
3)
4)
5)

Audit committee members to be independent

Audit committee members to select and oversee the issuers
independent account
Procedural process for handling complaints regarding the
issuers accounting practice
The authority of the audit committee to engage advisors
Funding for the independent auditor and any outside
advisors engaged by the audit committee.

Definition of the Audit Committee

- A committee (or equivalent body) established by and amongst
the board of directors of an issuer for the purpose of overseeing
the accounting and financial reporting processes of the issuer
and audits of the financial statements of the issuer; and if no
such committee exists with respect to an issuer, the entire board
of directors of the issuer.
(Section 205(a) of SOX)

- A committee composed of independent, nonexecutive directors

charged with oversight functions of ensuring responsible
corporate governance, a reliable financial reporting process,
an effective internal control structure, a credible audit function,
an informed whistleblower complaint process, and an appropriate
code of business ethics with the purpose of creating long-term
shareholder value while protecting the interests of other
stakeholders. (In the context of the agency theory)

Audit Committee
Relationships with Others
Audit Committee

Board of Directors

Audit Committee

Management

Audit Committee

External Auditors

Audit Committee

Internal Auditor

Works with other committees, assists board by bringing specialization and expertise
in the areas of financial reporting, internal controls, risk management, and audit
activities.

Asks appropriate questions pertaining to the companys corporate governance

structure, internal controls, financial reporting, audit activities, risk
assessment, codes of ethics, and whistleblower programs. Management should
provide sufficient information.
Directly responsible for hiring, compensating, and firing external auditors, as
well as overseeing their work. External auditors are held ultimately accountable
to the audit committee and should submit their reports of the audit on ICFR and
the audit of financial reporting to management via the audit committee.
Should be responsible for hiring, overseeing, compensating, and firing the head
of the internal audit department (CAE), and internal auditors should report their
audit findings directly to the audit committee, being ultimately accountable to
that committee.

Historical Perspective on Audit Committee

1938

McKesson & Robbins fraud

1939

NYSE recommends the establishment of audit committees

1940

SEC recommends that companies form audit committeesAccounting Series Release (ASR) No. 19

1967

AICPA Executive Committee Statement on Audit Committees of Board of Directors recommends the
establishment of audit committees

1970

Penn Central bankruptcy

1972

ASR Nos. 123 and 126

1973

NYSE White Paper opines that audit committees are a necessity

1974

ASR No. 165

1976

Committees chaired by Senator Lee Metcalf and Congressman John Moss complete their investigations into
the accounting profession AICPA forms Commission on Auditors Responsibilities (Cohen Commission)

1977

Metcalf Committee Staff Report, The Accounting Establishment, is issued.

1978

Foreign Corrupt Practices Act (FCPA)

1985

AICPA Cohen Commission issues Commission on Auditors Responsibilities: Report, Conclusions, and
Recommendations. AICPA forms a special committee to consider the adoption of an audit committee
requirement. NYSE requires companies with common stock issues registered on NYSE to have an audit
committee

1987

Congressman John D. Dingell convenes the first of a series of hearings into the effectiveness of
independent auditors

1988

National Commission on Fraudulent Financial Reporting (NCFRR/the Treadway Commission)

1989

SECs five commissioners, by a narrow vote, decide not to require all public companies to have audit
committees,
but encourage their formation. Statement on Auditing Standards (SAS) No. 61, Communication with the
Audit Committees.

Historical Perspective on Audit Committee

1989

The National Association of Securities Dealers (NASD) approves a requirement that National
Market System
companies (a subset of the over-the-counter market) must have audit committees.
Statement on Internal Auditing Standards No. 7 (SAIS No. 7) Communication with the Board
of Directors

1991

Federal Deposit Insurance Corporation Improvement Act

1992

Committee of Sponsoring Organizations of the Treadway Commission (COSO) issues Internal ControlIntegrated Framework

1993

Public Oversight Board of the AICPAs SEC Practices Section releases In the Public Interest

1994

Kirk Panel (Public Oversight Board of the AICPAs SEC Practices Section) releases Strengthening the
Professionalism of the Independent Auditor

1995

Public Oversight Board of the AICPAs SEC Practices Section releases Allies in Protecting Shareholder
Interests

1998

SEC Chairman Arthur Levitt delivers speech at the NYU Center for Business and Law in which he calls for
the
NYSE and Nasdaq to form a blue ribbon committee to study the role of the audit committee

1999

Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate
Audit Committees. SAS No. 90, Audit Committee Communications. SEC Release No. 34-42266: Audit
Committee Disclosure. NYSE and Nasdaq adopt new listing requirements, mandating the existence,
composition, director qualifications,
and duties of an audit committee

2000

POBs Panel on Audit Effectiveness releases Report and Recommendations

2001

Arthur Levitt, SEC Chairman, issues letter to audit committee chairmen

2002

Sarbanes-Oxley Act

2003

SEC Release Nos. 33-8177 and 34-47235: Disclosure Required by Sections 406 and 407 of the SarbanesOxley
Act of 2002. SEC Release Nos. 33-8220 and 34-47654: Standards Relating to Listed Company Audit
Committees. SEC approved amendments to NYSE and the Nasdaq corporate governance listing
standards.

Audit Committee Principles

Audit Committee Formation
Audit committee independence
Audit committee members qualifications
Audit committee authority
Audit committee funding
Audit committee oversight function
Audit committee accountability
Audit committee charter
Audit committee agenda
Audit committee orientation, training, and continued
education.

Audit Committee
Composition
Audit committee composition is discussed in terms of size,
independence, qualifications, attributes, and resources:
Audit Committee Size - The size of the committee usually
ranges from three to six members, whereas the SEC rule and
listing standards for public companies require at least three
independent members and should be composed for at least three
months.
Audit Committee Independence - The audit committee should
be composed of independent, nonexecutive, outside directors.
The emerging corporate governance guidelines on audit
committee independence should assist public companies in
avoiding potential conflicts of interest due to committee
members excessive contractual or consulting ties to the
company or its management.

Audit Committee
Composition
Member Qualifications - At least one member of the audit
committee should be designated as a financial expert. The
companys board of directors should apply the SECs
definition and consider audit committee members experience
and knowledge in determining which members qualify as
financial experts and, if none qualify, recruit at least one
member who meets the required qualifications.
Audit Committee Authority/Resources - SOX, recognizing
the increased responsibilities assigned to audit committees,
authorizes them to engage independent counsel and other
outside advisors as they determined necessary and requires
the company to provide appropriate funding for such advisors.

Audit Committee Responsibilities

Audit committee oversight responsibilities can be grouped
into the following categories:
Corporate

governance
Internal controls
Financial reporting
Audit activities
Code of ethics conduct
Whistleblower program
Enterprise risk management
Financial statement fraud

Audit Committee
Meetings
A combination of formal audit committee meetings with the
presence of senior executives and executive meetings with
just internal and/or external auditors should improve the
effectiveness of audit committee oversight functions.
The audit committee should meet at least four times a year to
review the companys quarterly financial reports and as
needed to address other important issues.

The quality and quantity of meetings can have a significant

impact on the effectiveness of fulfilling its oversight
responsibilities.

Audit Committee Agenda

The audit committee should have a well-defined, written
agenda for all of its meetings.
The agenda should cover:
(1) the minutes of the previous meeting;
(2) a review of current financial statements,
(3) a review of the current management, independent auditor
reports on ICFR including identified material weaknesses in
internal control, and the management responses to
reported material weaknesses;
(4) a review of the established whistleblower programs and
the appropriate responses to those complaints;
(5) a review of the companys enterprise risk management to
ensure objectives are defined, risks are assessed, and
procedures are designed to minimize risks;
(6) a review of internal auditors, external auditors, audit plans,
scope, and findings.

Audit Committee Reporting

Audit committee reports to shareholders include, among other
things, a description of audit committee responsibilities, its
activities and accomplishments, and its self-assessment of
how well it has discharged its assigned responsibilities.
Question: What are the main paragraphs in audit committee
reporting?

Legal Liability of Audit

Committees
SEC rules provide the following safe harbors in addressing the
concerns about the increased liability of an audit committee
member designated as a financial expert:
1. An audit committee financial expert is not deemed to
be an expert for the purpose of liability under Section 11
of the Securities Act of 1933.
2. The designation of a member as a financial expert does
not impose liability, obligation, or duties above and beyond
those of other members of the audit committee or the board
of directors, nor does the designation affect the liability,
obligations, or duties of other members of the committee or
board

Compensation Committee
The compensation committee is usually formed to determine the
compensation and benefits of directors and executives.
Structure: The committee should be composed of all independent
directors who rotate periodically.
Responsibilities: committees have a set of responsibilities which
they need to follow stricktly.
Proxy Statement Disclosure: The committee is directly
responsible for ensuring that all aspects of executive
compensation are fully and fairly disclosed in in the annual proxy
statement.
Committee responsibilities:
1. Evaluation of directors.
2. Design and implementation of director compensation
plans.
3. Evaluation of senior executives.
4. Design and implementation of executive compensation
plans.

Compensation Committee
(Cont)
Performance metrics typically used by the compensation
committee include:
a. Earnings per share (EPS)
b. Cash flow
c. Total shareholder return (TSR)
d. Return metrics
e. Economic profit or economic value added (EVA)
f. Revenue
g. Operational metrics
h. Qualitative factors
SEC
rules
require
proper
disclosure
of
executive
compensation without imposing or even assessing the nature
and extent of the companys executive compensation thats
why all everything the compensation committee does should
be properly disclosed.

Corporate Governance
Committee
The corporate governance committee should be composed of
both executive and nonexecutive directors and be responsible
for developing and monitoring the companys governance
principles, including the roles and responsibilities of directors
and officers.
The corporate governance committee should be in charge of
establishing the agenda for the companys board of directors
to determine what the board should discuss with management
and to what extent.
The corporate governance committee should provide
sufficient information to the board to enable it to effectively
review the companys performance.
The information should consist of both financial and
nonfinancial measures of its performance, its comparison
with the industrys best practices, and the companys budget.

Nominating Committee
The nominating committee is usually responsible for
evaluating and nominating a new director to the board, and it
also facilitates the election of the new director by
shareholders.
The nominating committee is responsible for
(1) reviewing the performance of current directors;
(2) assessing the need for new directors;
(3) identifying and evaluating the skills, background, diversity,
and knowledge of candidates;
(4) having an objective nominating process for qualified
candidates;
(5) assisting in the election of qualified new directors.

Other Board Standing Committees

Public companies may form other standing or special
committees to deal with issues requiring particular expertise.
Examples:
1. Finance committee to oversee financial activities
2. Outside directors committee to maintain board
independence
3. Executive committee to approve managements decision,
plans , and actions on a behalf of entire board.

Conclusion
Listing

standards require listed companies to form at least three

board committees, including the audit, compensation, and
nominating/governance committees.
Board committees are usually formed as a means of improving the
effectiveness of the board in areas where more focused, specialized,
and technically oriented committees are deemed necessary.
Audit committees act as guardians of investor interests by assuming
oversight responsibilities in the areas of corporate governance,
financial reporting, audit activities, and compliance with applicable
regulations.
The audit committee is one of the major standing committees of the
companys board of directors and, as such, works with other board
committees, company management, and external and internal
auditors to effectively fulfill the boards fiduciary duties to all
stakeholders.
External and internal auditors are ultimately held accountable to the
audit committee and should submit their reports to the audit
committee.
The determinants of an effective audit committee include diligence,
independence,
communication,
responsibility,
accountability,
resources, working relationships, evaluation, functions, and legal
liability.

Conclusion
The

composition of
the audit committee, including size,
independence, qualifications, and resources, can have a significant
impact on its effectiveness.
At least one of the members of the audit committee should be
designated as a financial expert.
Audit committee responsibilities may be grouped into the following
categories: corporate governance, internal controls, financial
reporting, audit activities, code of ethics conduct, whistleblower
programs, enterprise risk management, and financial statement fraud.
Audit committee reports to shareholders include, among other
things, a description of audit committee responsibilities, its activities
and accomplishments, and its self-assessment of how well it has
discharged its assigned responsibilities.
Responsibilities of the compensation committee can be generalized
into three categories: (1) evaluating the performance of directors and
senior executives, (2) designing and implementing compensation
plans for directors and executives, and (3) disclosing the activities of
the compensation committee.

Conclusion
Listing standards of national stock exchanges and best practices
require a formal annual evaluation process for the board of directors,
each major committee of the board, and each member of the board
committees.
The compensation report should fully disclose the companys
compensation policies.
The corporate governance committee should be composed of both
executive and nonexecutive directors.
The corporate governance committee should be in charge of
establishing the agenda for the companys board of directors to
determine what the board should discuss with management
and to what extent.
The corporate governance committee should provide sufficient
information to the board to enable it to effectively review the
companys performance. The information should consist of both
financial and nonfinancial measures of its performance, its
comparison with the industrys best practices, and the companys
budget.
The nominating committee is responsible for the proper composition
of the board, including director independence, skills, diversity, and
commitment.