Risk Oversight; Effective Board and Committee Leadership

Editor’s Note: Jeffrey Stein is a partner in the Corporate Practice Group at King & Spalding LLP. This post is based on two reports from the Lead Director Network by Mr. Stein, Bill Baxley, and Rob Leclerc, available here and here.

Board oversight of risk and effective board and committee leadership are high priorities for virtually every board of directors. While success in these matters has always been essential to maintaining a high-performing board, how boards approach the risk oversight function and seek to maximize board and committee leadership continues to evolve. Strategic risks can threaten a company’s very existence and stakeholders continue to challenge traditional approaches to board leadership.

The Lead Director Network (the “LDN”) and the North American Audit Committee Leadership Network (the “ACLN”) met on June 4th and June 5th to discuss risk oversight and effective board and committee leadership. Following these meetings, King & Spalding and Tapestry Networks have published two ViewPoints reports to present highlights of the discussion that occurred at these meetings and to stimulate further consideration of these subjects. Separate reports address Board Oversight of Risk and Effective Board and Committee Leadership.

The following post provides highlights from the LDN and ACLN meeting, as described in the ViewPoints reports.

1. Risk Oversight

A. Boards are worried about long-term strategic risks

  • The big risks. Boards are focused on the risks that pose a threat to the very existence of a company, such as disruptive technologies and the emergence of new business models. LDN and ACLN members noted that it is essential for boards to evaluate how much risk a company is assuming, and what the returns would be relative to that risk. Finance professionals often consider whether their activities are akin to “picking up pennies in front of a moving steamroller”; LDN and ACLN members likewise emphasized the importance of understanding the risks a company was taking in its business relative to potential returns. Moreover, it is also critical for directors to understand the models used to analyze risk to guard against “false precision” in any management risk assessment.
  • The board’s role and management’s role. Management must be deeply involved in all risk assessments, though the board should carefully monitor a company’s risk. Finding the right balance between management and the board can be a delicate process, as one director remarked that “we can’t be setting strategy. But we don’t want to feel like we’re watching a Greek tragedy. We want to play a part.”

B. Engagement of the full board

  • All directors should engage in risk oversight. ACLN and LDN members expressed a strong view that all board directors, and not just certain committee members, bear responsibility for strategic and operational risk oversight. Not only do directors get involved as members of committees that take on specific elements of risk oversight, but they inevitably play a role as members of the full board, which directors emphasized is ultimately responsible for risk oversight. If risk oversight is assigned to multiple committees, the full board or the committee taking the lead should ensure that oversight activities are coordinated.

C. Risk disclosures

  • Risk disclosure should match up with the board’s discussion of risk. Disclosures about risk, risk management, and the board’s oversight role are increasingly important elements of reporting to regulators, shareholders, and the wider public. In that light, a company’s disclosure of risk should match up with the board’s discussion of risk and boards should regularly review the risk factors disclosed in periodic reports to ensure they are aligned with the board’s view of risks.

2. Effective board and committee leadership

A. Committee coordination

  • Formation of committees. According to the 2012 Spencer Stuart Board Index, S&P 500 companies average 4.2 standing committees, with 70% of companies having at least four committees and 14% having six or more. LDN and ACLN members suggested that each committee should have a clearly defined scope and be confident that it has the full support of the board. Other LDN and ACLN members were opposed to increasing the number of standing committees beyond the usual three, with one director lamenting that “every time an issue comes up, the answer is to form another committee.”
  • Committee scheduling. Many LDN and ACLN members strongly supported scheduling committee meetings sequentially. While sequential scheduling requires more time, it ensures that all directors are up to speed on all the issues and is particularly beneficial for the CEO, board chairman or lead director who wants to attend every committee meeting. Other members prefer to schedule meetings concurrently, citing efficiency as their motivation. In addition, some members schedule certain committee meetings concurrently or sequentially depending on committee membership and interest (for example, finance and audit committee meetings might be scheduled at different times, if many of the same people would attend, while governance and compensation might have less overlap, and be scheduled to be held at the same time).
  • Agenda setting. Lead directors and audit committee chairs work with their boards, committees, and management teams to set the board and committee agendas. Some members reported that most of the board’s work is scheduled well in advance (often 12 months) of a given meeting.
  • Written and oral committee reports. Members noted that many boards make a practice of sharing all committee materials (including agendas, supporting materials, and minutes) with all members of the board, a task that has become much easier with the widespread use of electronic board portals. More important than the written communication from the committee (which some members would avoid entirely) is the committee’s oral report at the board meeting. The best committee reports are characterized more by their detail than by their length. Ultimately the report should satisfy other directors that the responsibilities they have delegated to the committee are being handled properly.
  • Executive committee. The opinions of LDN and ACLN members are divided over the benefits of an executive committee, although the balance of the membership is generally against establishing them, or limiting their use where they do exist. Some members value the coordinating and time-saving advantages of an executive committee, which can handle routine administrative matters. But other members are critical of the executive committee, saying that technology has rendered it unnecessary, or that it tends to create two classes of directors, hampering board engagement and potentially upsetting shareholders.

B. Rotation, retirement and removal

  • Rotation and retirement. Some LDN and ACLN members were opposed in principle to rotating committee members or leadership positions if such functions were being performed effectively. But several directors saw benefit in periodic change and had rules of thumb for rotation, often ranging from three to seven years. Both audit chairs and lead directors said that too-frequent rotation of their roles would be damaging. According to one member, lead directors “need to establish themselves” to be a true counterweight to the CEO; audit committee chairs need continuity, particularly against the backdrop of five-year mandatory audit partner rotation. In addition, one member pointed to mandatory retirement as an alternative to having a rotation policy.
  • Removal. Many members were concerned that rotation and retirement policies could provide a ready-made excuse for avoiding difficult conversations about (and with) an underperforming director. Members said that it is obvious to the board when someone is not pulling his or her weight, and anticipated departures should not excuse healthy and robust board evaluation and conscious decisions about membership. One director noted that boards should also be willing to consider replacing a director whose performance is satisfactory when “a committee is looking for fresh ideas, growing stale, or the board needs someone with different experience.”

 

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