Corporate Governance – Principles, Policies and Practices 3e

1. Corporate Governance – Principles, Policies and Practices 3e Chapter 14 Board Activities – corporate governance in practice

2. Board activities – corporate governance in practice In which we review: • committees of the board • the influence of the audit committee • the role of internal audit in corporate governance • the importance of the external auditor • the significance of the company secretary

3. Board committees Audit committee (duties follow) Remuneration committee - responsible for determining remuneration and conditions of top executives Nominating committee - responsible for proposing names for nomination as additional or replacement directors Compliance committee -responsible for ensuring compliance with corporate governance requirements (sometimes by audit com.) Strategic Risk Committee (sometimes by audit com.) Other board committees - executive, strategic, ad hoc

4. The influence of the audit committee Every director should be aware of significant matters that have arisen during the audit by the independent, external auditor Audit committee comprised of independent directors, provides a bridge between the external auditor and board Corporate governance codes require listed companies to have audit committees.

5. Duties of an audit committee - 1 • Liaison between the external auditor, the internal auditor and the board as a whole. • Advising the board on the appointment. re-appointment, resignation, or replacement of the external auditor. • Ensuring the independence of the external auditor • Reviewing the extent of non-audit work undertaken by the external auditor and the fees involved • Reviewing the audit fees and advising the board accordingly • Considering the scope of and the plans for the audit by the external auditors.

6. Duties of an audit committee - 2 • Agreeing the scope of the work and plans of the internal audit • Supervising the work of the head of the internal audit function, including the setting of policies, procedures, and plans, the budgeting of resources, the remuneration and performance of staff, the monitoring of results, and the effectiveness of the function • Ensure that the activities of the external and internal auditors are coordinated, avoiding both duplication or incomplete coverage • Reviewing the appointment, performance, remuneration, and replacement or dismissal of the head of the internal audit function, ensuring continuing independence of the internal audit function from undue managerial influence.

7. Duties of an audit committee - 3 Reviewing with the external and internal auditors and advising the board on the adequacy of the company’s internal control systems, security of physical assets, and protection of information. • Reviewing with the external and internal auditors and advise the board on the conduct of the external audit, particularly any important findings, (‘management letter’), with management’s response; and report any significant changes to the financial results or to management controls that resulted.

8. Duties of an audit committee - 4 • Reviewing with the external and internal auditors and advising the board on the company’s financial statements (interim and annual) prior to publication, the auditor’s report to the shareholders, any changes to accounting policies, material issues arising in or from the financial statements; and compliance with accounting standards, company law [and if appropriate stock exchange] reporting requirements and corporate governance codes of good practice.

9. Duties of an audit committee - 5 • Reviewing any other published information, such as the directors’ report, any operating statement and ensure that it is consistent with the audited financial statements • Reviewing the exposure of the company to risk and any matters that might have a material affect the company’s financial position, including any matters raised by company regulators or stock exchange listing committees. (Sometimes the responsibility of a separate board Strategic Risk Committee) • Reviewing annually the charter of the audit committee itself and advising the chairman of the board if changes are necessary.

10. Functions of the remuneration committee • Establish a formal and transparent procedure for developing policy on top executive remuneration • Determine remuneration packages for each director • No director should be involved in fixing his or her own remuneration. • Levels of remuneration sufficient to attract and retain directors • The component parts of executive directors’ remuneration should be structured to link rewards with corporate and individual performance • The role of the remuneration committee has become significant and visible given shareholder and media concern about excesses • In most jurisdictions a company’s annual report must contain a statement of remuneration policy with details of the remuneration of each director. • Transparency is important in corporate governance.

11. Functions of the remuneration committee Remuneration ratcheting • International comparisons: “to ensure we hold executive directors of the calibre we need, we have to give rewards that are broadly comparable to those they could obtain in the industry anywhere in the world.” • The headhunter argument: “this director has to receive a package that is 30% more than that of the highest paid director. • The 'top of the industry' claim:“our firm prides itself on being one of the leaders in the industry, so we expect to pay our directors in the upper quartile of the industry range as shown by the comparator pay research.” • The fear of loss of people:“we could lose our directors to the competition unless we pay competitive rates.” • Doubling up the bonus: “we believe that it is important for directors’ rewards to be performance related. Moreover, we expect excellent performance in both the short and the long term. So we calculate bonuses on the annual profits, then we have a parallel three-year scheme which rewards directors if earnings per share grows by 30% over that period.”

12. The Nomination Committee • Standing committee of the main board • Comprised mainly or wholly of INEDs • Purpose – to avoid domination of director selection by CEO and/or chairman • Preventing board becoming self-perpetuating ‘club’ • Supposed independence can be illusory • If INEDs are themselves part of the ‘club’ • Need to support CEO and/or chairman • Owe an allegiance to those who nominated them.

13. Board committees To be effective, board committees need clear terms of reference with • a constitution and clear terms of reference • details of membership – committee size and quorum, qualifications for membership, nomination, terms of appointment, rotation, removal, remuneration • chairman’s appointment and responsibilities • committee duties –authority delegated by the board • relations between the committee and top executives, • frequency of meetings • secretary to the committee, notice for meetings, agenda, minutes • staff support, access to legal and other professional advice.

14. Board committees To be effective, board committees also need clear terms of reference on: • accountability, transparency, reporting requirements • circulation of committee minutes to all directors • opportunity for other directors to raise questions and discuss committee issues at main board meetings • regular review of committee’s performance and purpose • amendments to constitution and terms of reference where appropriate.

15. The role of internal audit The role of internal audit - to provide independent assurance that risk management, governance and internal control processes are operating effectively Internal auditors deal with issues that are fundamentally important to the survival and prosperity of any organization Unlike external auditors, they look beyond financial risks and statements to consider wider issues such as the organization’s reputation, growth, its impact on the environment and the way it treats its employees Internal auditors have to be independent people who are willing to stand up and be counted. They provide an independent, objective and constructive view. The Institute of Internal Audit

16. The role of internal audit Boards and their audit committees expect internal audit to provide • an ongoing analysis of business processes and associated controls • an evaluation of the extent and effectiveness of these control systems • regular reviews of operational and financial performance • assessments of the achievement corporate mission, policies and objectives • identification of areas for more efficient use of resources • confirmation of the existence and value of the company’s assets • ad hoc inquiries into possible irregularities and frauds • reviews of the compliance framework • identification of compliance issues and confirmation of compliance • reviews of the organization’s values and code of conduct or ethics And if no board strategic risk committee: • an evaluation of the risk assessment and review systems • regular evaluation of risk at all levels in the organization • ad hoc reviews of unacceptable levels of risk

17. Importance of the external auditor US Public Company Accounting Oversight Board PCAOB standards require auditors to: - obtain reasonable assurance that effective internal control over financial reporting has been maintained - assess the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk - perform such other procedures as are considered necessary in the circumstances.

18. Importance of the external auditor The appointment, remuneration and removal of auditors In most jurisdictions, the auditor of listed companies is formally appointed, reappointed or replaced by the shareholders in general meeting on the advice of the board, typically working through their audit committee. In private companies, the auditor is typically chosen by the board.

19. Importance of the external auditor The independence of external auditors The standing of independent external auditors hinges on the definition and confirmation of independence US PCAOB requires registered public accounting firm to describe to the audit committee of listed clients, all relationships between the auditor and the audit client or persons in financial reporting oversight roles at the audit client that may reasonably be thought to bear on independence.

20. The significance of the company secretary Many company law jurisdictions require the appointment of a company secretary (CoSec) with statutory duties In the United States the role of company secretary is known as the corporate secretary and is often taken by the company’s legal officer The company secretary is an officer of the company and has a duty to act in good faith in the best interest of the company.

21. The significance of the company secretary In the UK only public companies must have a CoSec. Private companies have the option to have a company secretary if the shareholders wish. In some jurisdictions, the company secretary can be a ‘legal person’ that is a limited company: in others the CoSec must be a real person.

22. Board effectiveness The Company Secretary (CoSec) The American Society of Corporate Secretaries suggests that they organize meetings of board, board committees and shareholders, maintain corporate records and stock records and liaise with the securities markets. “The corporate secretary should be “the primary liaison between the corporation’s directors and management.”

23. Board effectiveness The duties of the company secretary may include: • Advising the chairman on legal rules and regulations affecting the enterprise. • Convening board, board committee and company (shareholder) meetings • Advising on and guiding board and board committee procedures • Advising the chairman on agenda and writing the minutes for the chairman's approval • Maintaining the company’s statutory records such as the register of members (shareholders), register of directors and their interests, director’s service agreements, • Filing company law returns with the companies’ registrar or regulatory authority • Ensuring compliance with companies legislation, the corporate governance codes, and where appropriate the stock exchange listing requirements • Ensuring compliance with other relevant regulations and laws • Administering changes to the company constitution (memorandum or articles of association.

24. The significance of the company secretary “The company secretary has a key role to play in ensuring that the board procedures are both followed and regularly reviewed The chairman and the board should look to the company secretary for guidance on what their responsibilities are … and on how these responsibilities should be discharged All directors should have access to the advice and services of the company secretary The chairman is entitled to strong support from the company secretary in ensuring the effective functioning of the board” UK Cadbury Report (1992)

25. The significance of the company secretary “The company secretary should be responsible for advising the board through the chairman on all governance matters Under the direction of the chairman, the company secretary’s responsibilities include • ensuring good information flows • within the board and its committees • between senior management and non-executive directors • facilitating induction and assisting with professional development of directors”. • UK Corporate Governance Code

26. Board activities – corporate governance in practice We have reviewed: • committees of the board • the influence of the audit committee • the role of internal audit in corporate governance • the importance of the external auditor • the significance of the company secretary