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February 13 2020

Board Structure Strategy

Fiona Lu Board Structure, Corporate Governance board composition, board culture, board of directors, board of directors best practices, Board Structure, corporate culture, corporate governance, independent directors

The board of directors is appointed by a company’s shareholders with the expectation that directors will govern according to the shareholders’ and company’s best interest. Their purpose is to discuss strategies and make key decisions on financial affairs that will lead the company towards long-term prosperity and sustainability, while protecting the interests of all shareholders and stakeholders. Ranging from corporate governance, to corporate ethics, to corporate social responsibility, board directors are expected to have individual areas of expertise and impart their knowledge during debates to collaborate with other directors on defining the best course of action. To execute this duty, boards are split into committees that each oversee a specific area of the company’s performance. The structure of these committees depends on the type of company it is and the company’s goals.

Best Practices for Board Structure

Typically, board terms are staggered to prevent hostile takeovers. The candidates are elected during a corporation’s annual general meeting by current board directors and shareholders, and should possess some level of managerial experience. Though today, many companies are changing their criteria for board candidates and reducing the amount of managerial or board experience required, instead focusing on the unique area of expertise a candidate can bring to the table that the company is lacking in. For example, a company may decide to appoint a former IT specialist or software engineer with no prior board experience if the company is trying to strengthen their technological strategies.

Having a certain quota of independent directors is also important regardless of the company type or direction because it minimizes bias and external pressures in the boardroom. The Securities and Exchange Commission (SEC) requires that public companies have a majority of their board be independent directors. The reason independent directors are preferred is because they are more likely to provide an objective opinion on what is best for the company and less prone to hop on bandwagon opinions that mostly serve upper management. Independent directors must also possess a strong level of business expertise in order to accurately translate their opinions into financial decisions and approve transparent financial statements.

While board members are expected to bring at least one area of outside expertise to the table, nowadays, the most successful boards are composed of directors who are experts in multiple topics. It is currently well-encouraged for company boards to recruit recent college graduates with a major in business and minors in related fields such as cybersecurity, data science, or marketing management. This ensures that the board is composed of the most up-to-date, well-rounded intelligence.

Another key topic to board composition is diversity. There has recently been increasing pressure for companies to appoint more women and people of color to their boards to reflect a more independent board selection process. The reasoning behind this is that companies with a predominantly white, male board most likely possesses some level of bias in their selection process and is not guaranteed to deliver a diversified range of opinions that serve public interest. The more diverse the board, the more diverse its range of robust expertise and perspectives.

Finally, boardroom best practices recommend establishing term limits to consistently refresh and evolve board composition. In the past, board members could expect an automatic reappointment at the end of their terms. This is no longer the case because it leads to boardroom stagnancy and a recycling of the same perspectives. With today’s fastly evolving technological and corporate landscape, board directors are expected to serve a maximum of 12 years in tenure. This standard is meant to open up more vacancies for new, forward-thinking members.

With these practices in mind, nominating committees have much to consider in electing the most qualified, highest performing board. The key takeaway to remember is that no matter the service a company provides or the industry it belongs to, all companies need a highly independent, diversified board with expert knowledge in a wide range of fields in order to successfully oversee management and lead the company to success.

March 5 2020

The Importance of Audit Committees

Fiona Lu Audit Committee, Board Committees, Board Structure, Corporate Governance audit, audit committee, board composition, board of directors, Board Structure, corporate governance, cybersecurity, independent directors, risk management, US GAAP

Public companies are required to have audit committees to perform annual audits of their financial reporting and disclose certain financial information. This requirement was established by the Security and Exchange Commission (SEC) in 2002 after the passage of the Sarbanes-Oxley Act (SOX), which formally defines the roles of the audit committee as overseeing financial reporting accuracy, hiring independent external auditors to examine financial statements, and reviewing the company’s internal accounting controls. Having accurate and honest financial reporting that abides by the standards set forth by the U.S. Generally Accepted Accounting Principles (U.S. GAAP) is important for conveying company performance to internal investors and external shareholders. In the past two decades, the roles of the audit committee have significantly expanded to encompass a greater risk management responsibility due to the emergence of new technological forms of risks (i.e. cyber risks, cloud safety, etc.)

Challenges Facing Audit Committees

With the ever changing landscape of technology, there has been a growing range of risks that the audit committee must oversee. Risk management is an imperative part of the audit committee’s job that has grown increasingly complex due to new components, such as cyber risk, Environmental, Social and Governance (ESG), and corporate culture. This rapidly evolving agenda of audit committees has led many firms to begin considering forming new committees to conquer and divide the responsibilities.

Of these roles, cybersecurity has been a hotly contended subject. Cybersecurity is a relatively new area of risk management that forms an important component of strengthening a company’s technological profile, efficiency, and data systems. While this area has been traditionally under the jurisdiction of audit committees, many firms have formed their own full-level “cyber risk” committees to oversee it. In today’s digital landscape, with many companies migrating their data and communication channels to cloud-based solutions, cyber risk becomes one of the greatest risks enterprises face, and audit committees manage an up-to-date eye on it by either focusing their resources to develop sound cybersecurity frameworks or assigning the role to a new committee.

Maintaining Independence

Audit committees also face the challenge of providing unbiased analysis of financial reports independent of their affiliations with or knowledge of the company. The SEC requires that audit committees be composed of independent directors in order to objectively manage a company’s accounting practices. Just like how having an independent board is important to overseeing the company’s welfare and balancing all party’s interests, maintaining an independent audit committee is especially important because it concerns providing an honest, accurate, and legally abiding accounting process and directly deals with profit misreporting or manipulations.

For this reason, the SOX requires public companies to hire external auditors for an added layer of security. Independent auditors are certified public accountants hired to provide an objective, third party assessment of a company’s financial reports and audit process. If they determine that a company complies with GAAP, then they will issue the company a standard audit report. Otherwise, they will order management to revise their statements and recommend changes to optimize the company’s system of internal controls.

How to Improve Audit Committees

Maintain and Refresh Committee Expertise. Since the roles of the audit committee are constantly expanding and evolving, companies must keep a vigilant eye on their audit committee’s governance and composition to ensure that they consistently include members of all areas of expertise. They must consistently reevaluate the company’s needs to assess new risks and expertise areas to recruit in.
Strengthen Cybersecurity within the Committee. Audit committees handle the company’s most sensitive information and are the most susceptible to data breaches. Educating audit committee members on basic data protection practices and establishing ground rules for communications, such as never using a personal email or texts, will reduce the risk of information leaks and hacks.
Understanding Regulations. Members of the audit committee should all be familiar with SOX. In 2003, the SEC adopted a new standard that mandates national securities exchanges to disallow listings from companies that do not meet the audit committee requirements of SOX. Since the audit committee’s key roles are all regulated by SOX, boards should understand these requirements in and out to ensure that their performance is in compliance.