Boards of directors across America are starting to speak the language of finance. As the deadline neared last year for complying with Sarbanes-Oxley requirements to have financial experts on the board, companies scrambled to add directors with CFO and accounting backgrounds.
They succeeded admirably. According to executive search firm Spencer Stuart, last year S&P 500 companies identified 832 financial experts on their boards, up from 146 the year before. In all, 91 percent of S&P 500 boards identified at least one financial expert, compared with just 21 percent in 2003.
Nearly half of the experts who were new to audit committees last year were also new to the board – a clear sign of a race to meet the Sox deadline. Around 40 percent of new audit committee chairmen have CFO or accounting backgrounds, a dramatic increase from 10 percent in 2003.
The newcomers represent a dramatic shift in how corporate boards go about their business; against the backdrop of greater director accountability under Sox, they are sharpening their boards’ focus on financial matters. They are also helping to educate fellow board members on financial reporting and auditing issues, says Ron Conlin, a partner at JD Power & Associates, a global marketing information firm. ‘They are asking lots of questions, poking lots of holes,’ he points out. ‘The better qualifications of the designated financial expert are raising the financial acumen of boards.’
Their presence ‘is adding a very valuable dimension,’ agrees Charles King, managing director of global board services for executive search firm Korn/Ferry International. ‘I would be very surprised if there were not some directors who have questions about financial reports, and it would be the responsibility of the audit committee to provide some clarity to those directors.’
Bring on the experts
That influence is even spreading, in some cases, to the corporate rank and file, as audit committees assume control for certifying the soundness of internal financial controls as well as for reviewing the books. ‘Boards are getting involved in overseeing financial reporting at a more detailed level – and kind of driving management nuts in the process,’ says Conlin.
Interestingly, the push to find specific financial talent for boards has also prompted a shift in the way other board vacancies are filled. Companies now look for specific skill sets, often reaching down into corporate ranks to find them, rather than immediately turning to current and retired CEOs to fill board slots.
‘The process now is very different,’ says Ted Jadick, co-chairman of Heidrick & Struggles. ‘It used to be a case of, Who do you know?. It has now become a particular focus – they start with specifications and take it from there. I think it’s positive. It makes for a healthier board, compared with having all members come from the same area.’
Peter Gleason, COO and research director for the National Association of Corporate Directors (NACD), agrees. ‘I think it’s good for boards,’ he comments. ‘We advise them to match the skills on the board with the strategy of the company.’
‘There is a kind of portfolio effect,’ adds King. ‘Everyone brings something to the table, and there is less overlap in skill sets.’
The new finance experts are not necessarily shifting the emphasis from strategic thinking to narrow auditing or accounting issues, governance experts say. ‘Just because someone has a finance background, it doesn’t make him or her a ‘small picture’ person,’ explains Charles Elson, director of the University of Delaware Center for Corporate Governance. ‘And just because someone has, for example, a legal background, it doesn’t make him or her a ‘big picture’ person, either.’
That said, there is a risk inherent in the Sox-inspired focus on financials, cautions Gleason. ‘There is so much focus on compliance that boards are moving away from the strategic aspect of board service,’ he explains. ‘In the process they may be missing some of the prudent risks companies need to take.’
Some governance experts also see a risk of an over-emphasis on recruiting accountants to serve on audit committees, to the exclusion of other disciplines. According to Spencer Stuart’s board index survey, in 2004 the number of CFOs and accountants serving on audit committees was about equal, whereas in 2003 CFOs outnumbered accountants four to one – suggesting a recent surge in recruiting accountants for board service.
‘We emphasize the importance of also having non-accountants on audit committees, so boards don’t get too caught up in the technical details,’ says Catherine Bromilow, a partner in the corporate governance group at PricewaterhouseCoopers (PwC). ‘It’s important to read a financial report with the perspective that an individual investor would bring. Audit committees should include the kind of person who would ask, Does what we are reporting to the public make sense?.’
Beyond that, audit committees should guard against dominating the discussion of financial results to the exclusion of non-experts, several observers caution. KPMG’s Audit Committee Institute (ACI), which provides research and other resources to audit committee members, found in a survey of members last year that nearly two thirds saw a risk of audit committee members inappropriately deferring to the company’s designated financial expert. Usually that person is the chair of the audit committee. ‘All issues need to be considered thoroughly by all audit committee members as a group,’ says Scott Reed, a partner with the ACI. ‘There is a risk the designated expert will become, in effect, a committee of one.’
Perhaps to guard against such a possibility, some companies are designating more than one audit committee financial expert (ACFE). A study by PwC of 250 proxy statements filed in 2004 by companies with revenues over $5 bn shows 55 percent name one financial expert, 16 percent name two, and 13 percent list everyone on the committee as a financial expert. That may provide safety in numbers, in case – as some directors suspect, despite SEC denials – the designated ACFE is more likely than other directors to bear the brunt of liability if a company’s finances go bad.
But there may be a simpler explanation. ‘Some boards say, All our audit committee members are financial experts – that is why they are on the audit committee,’ concludes Gleason.
