Wednesday November 26, 2014

A Performance in Three Acts

What directors need to know before joining an audit committee.

Joining a new board is not something to take lightly. Indeed, both the company and the candidate will often separately undertake a significant amount of work before either tendering an invitation to join a board, or accepting it. For a director, serving on a board can be intellectually engaging and prestigious. It’s also a way to share the wisdom you’ve accumulated over the course of your career, and help a company grow and prosper. Conversely, it does carry an element of risk. If something goes wrong at the company, directors can find themselves having to devote a significant amount of time and attention to guiding the company as it resolves the issue. Directors can also see their reputations damaged.

Catherine Bromilow

Of course, if you are a candidate with any type of financial reporting experience or internal control/risk management background, you probably are being considered for the audit committee. And despite the fact that a great deal of attention, post Dodd-Frank, is shifting to compensation, the audit committee hasn’t moved off the hot seat. Financial reporting is highly complex and subject to second-guessing by regulators, analysts and shareholders. It’s also information-intense, with audit committees regularly needing to analyze volumes of information over the course of the year. So first, you need to be satisfied that you have the capacity, time-wise, to serve on the audit committee. Understand when and where the committee meets, how long meetings last and how long it typically takes to study the advance materials. Once you are confident there are no conflicts or issues, your next question is whether you should join the committee.

Act One: Study the script
For starters, audit committee candidates should read the company’s most recent 10-K, MD&A, quarterly reports, proxy statement and other financial filings. Are they transparent? Are they clear? Do you get the sense management is using these vehicles to really communicate performance and the challenges it faces? Or do they read more like simple compliance documents? Are there industry-related accounting policies that you aren’t familiar with? At the end of the day, do all the reports allow you to understand how the company operates?

Next, go online. What do the finance sites say about the company? Are there criticisms about its disclosures or allegations that management is overly aggressive in the selection of its accounting policies? Can you discern whether it uses substantially different accounting policies than its competitors? Are short-sellers targeting the stock?

More stories in The Boardroom Guide for New Directors:
Securing Your First Public Company Board Seat: Mission Possible

Directors Registry Now Exceeds 4,000 Listings
A Dodd-Frank Cheat Sheet for New Directors

Candidates who are on other audit committees or are deeply involved in financial reporting—either through recent experience as a CFO or as an audit firm partner— will have more comfort with this stage of diligence. This segment will take longer if this is the first board you’re considering or if your experience with financial reporting is a little dated. By reading and reflecting on the public information available, you’ll get a better sense of where the possible issues are, and will be well prepared for the next phase of the diligence process.

Act Two: Meet the supporting cast
At the end of the day, the audit committee relies heavily on financial management, external auditors and internal audit. The quality of these individuals and the relationships and respect they have with one another is key. You’ll want to meet with the CFO, lead audit partner and internal audit director.

The competence and integrity of financial management is obviously vital. The CFO and his or her team need to be able to understand how to address complex issues and be able to stand up when other executives are pressing hard for certain reporting results. The internal audit function typically has a good perspective of the control environment across the company, and they know whether management takes their recommendations seriously and wants to control processes effectively. External auditors are in a unique position. They understand the company and how it conducts its business, know management and also are able to evaluate how the company’s team and reporting processes measure up against peers.

Talking with the CFO is your opportunity to ask questions about some of the accounting issues you may have identified in your earlier reading. As well as the technical responses, you’ll be able to get a sense of how management functions. Is the CFO defensive when questioned?

Act Three: Attend a dress rehearsal
While meeting the key players will give you a great sense of how the company operates and whether there is support to do the right thing, the reality is that no piece of paper or interview can tell you how well the committee really functions. So if you’re already on the board, take the opportunity to observe a committee meeting. Is there real dialogue or merely management presentation? Is it evident the committee members are prepared for the meeting and engaged? Are they diligently trying to ensure what they are overseeing is appropriate, or are they rubber stamping?

If it’s not possible to observe a meeting, at least speak with the audit committee chair and the lead director to ensure there is a common understanding of how you will fit into the committee and discuss what particular value you’ll bring.

Curtain Call
You now can triangulate your views and perspectives and make an informed decision on whether to be an audit committee member. Obviously, there’s nothing entertaining about making a serious decision to join an audit committee. It’s in all our best interests to have effective audit committees, which require effective directors. But do well with your first audit committee role and you’re sure to get an encore.

Catherine Bromilow is partner at PwC’s Center for Board Governance. Visit

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