Almost all boards of U.S. public companies now have three committees that meet immediately before every board meeting and report to the full board — audit, compensation, and nominating-governance. Committees have become the workhorses of the governance process: with their small size and expert support, they can do more in-depth analysis of complex topics than the full board of directors.
However, since the passage of the 2002 Sarbanes-Oxley Act, the duties of the audit committee, especially, have become so large and complex that it cannot seriously assess broader financial issues.
Audit committees continue to perform the traditional functions of appointing the company’s independent auditor and reviewing its financial statements. But audit committees now have a long list of other obligations — including oversight of complaints by whistle blowers and violations of ethics codes; approval of non-audit functions by auditors; and review of the management report and auditor attestation on internal controls. The audit committee also holds private sessions with both external and internal auditors as well as the chief financial officer and the head of compliance/risk.
In other words, audit committees are overburdened by their increased obligations to oversee the details of the reporting and compliance processes. As a result, the audit committee no longer has enough time to seriously consider broader financial topics. If directors are going to have meaningful input into the broad financial issues faced by any public company, they need to form a finance committee with the time and expertise to address the issues.
Approximately 30% of S&P 500 companies have a committee with finance in its name, according to research by Russell Reynolds. That research showed that industrial and consumer companies have the highest percentage of finance-related committees, while technology and financial services companies have the lowest (the latter often have risk committees instead).
What should be the main subjects addressed by an effective finance committee? It should review the company’s pension plans, insurance coverage, cash management, debt issuance, tax strategies and, most importantly, capital allocation.
On capital allocation, finance committees should concentrate on three subjects —following up on significant acquisitions, monitoring of debt levels, and scrutinizing share repurchase programs.
Of course, boards do a detailed review of significant acquisitions before they occur. Most boards will examine carefully the strategic fit, projected cost savings, potential revenue synergies, and justification for the price. By contrast, boards often do not systematically study, several years later, whether significant acquisitions achieve their objectives.
The finance committee provides a good forum to look systematically at how significant acquisitions fare. The committee may find, for example, that the company typically achieves projected reductions in operating costs but not revenue synergies through cross-selling. So, in the future, the board may decide to evaluate acquisitions without assuming that they will earn additional revenue due to synergies.
Read the full post at CFO.
Robert Pozen is a Senior Lecturer at the MIT Sloan School of Management and a Senior Fellow at the Brookings Institution.