Too Much Information

Annual reports are fast becoming the dustbin for every imaginable corporate risk. This presents a number of headaches for audit committee chairs as they seek to produce accounts that are true and fair, while still meeting expectations on compliance, bribery, culture and business model disruption.

Given the scope of what needs to be covered, keeping a sense of direction and purpose can be tough. Scott Knight, Head of Audit and Assurance at BDO, comments: “The audit committee must not simply respond to management and the auditors, or just edit the debate in some way. They need to control the agenda, even if some of it is merely putting a marker in the sand and saying: ‘Right, this issue is important but we will come back to it in a year’s time.’”

John Allkins, who is Chairman of the audit and risk committee at Punch Taverns, and Non-executive Director at Renold, Fairpoint and the Sweden-based Nobina, says: “The audit committee chair needs to be able to run a process that enables everybody to have their say, even if they are not the ‘financial experts’…. Provided each person can contribute, the committee will arrive at the best answers.

“That committee as a whole should talk to management, advisors, internal and external audit – and actuaries, if pensions are a big issue for a business.”

On the table

The pressure is mounting on audit committees to show a greater degree of scrutiny, notably in light of substantial EU audit reforms. Tom Beedham, Director of Programme Management at Criticaleye, comments: “When a public interest entity runs aground, accusations will inevitably be levelled at the non-executives about how they allowed a crisis to occur.

“Such criticism is justified if NEDs categorically fail to ask pertinent questions to both the CEO and finance director, not to mention each other.”

It means holding a wide range of conversations. John says: “I like to communicate beyond the normal committee members, including the CEO and CFO. I will talk to the head of internal audit, the financial controller, and the company secretary, who will be involved with issues like whistleblowing and bribery. That way, you tend to get a total view of the business.”

The axis between finance director, auditor and audit committee chair is vital. Theresa Wallis, Non-executive Chairman at medical devices company LiDCO, says: “In a small company, the auditors will speak with and see the finance director and finance department on a fairly regular basis. Given this, it is important for the chairman of the audit committee to also make time to establish a relationship with the audit partner.”

Andrew Walker, Chairman of the audit committee at Plastics Capital, says that it requires “people who are numerate and fully understand the class of business they operate in – things become unzipped when there is a lack of understanding of the real financial risks”.

If you are questioning these matters, such as capitalisation of development costs, you should expect pushback. “You need to be quite sure of your ground in order to be resolute; these are the crunch times when the audit committee earns its crust,” adds Andrew.

Seeing the wood for the trees

Aside from regulatory change and an expanding risk register, the biggest shift for audit committees relates to data and analytics. Scott from BDO says: “We have probably seen more innovation in audit in the past three years than over the last 20. It is changing the way audits are done, such as removing sampling so you can look at entire populations.”

At present, some committees lack expertise about how to use this information while also maintaining a healthy degree of scepticism. Scott warns: “There is a risk that audit committees can take false assurance. While an auditor might be able to scan ten thousand invoices a minute, this technology won’t be able to tell whether it’s a fake invoice or the real thing.

“Equally, the audit firms have very sophisticated tools looking for outlier type journals but if the general IT controls are weak, say around password security, then it is impossible to tell who is really posting those journals.”

It is essential for committees to be comprised of individuals who understand the different pressure points within an organisation. Theresa states that “you need people who are independently minded and are prepared to think carefully about the judgements that need to be made, who proactively ask good questions and don’t just accept the recommended approach”.

According to Tom at Criticaleye: “It is the responsibility of the chairman of the audit committee to ensure everyone understands their responsibilities and feels able to raise issues they believe are important.

“Without the right degree of openness, an audit committee can quickly become blinkered to the financial, operational and strategic risks within a business.”

In the current environment, no company can afford to have its board of directors behave like nodding dogs.

These views were shared during Criticaleye’s Global Conference Call, How To Create an Effective Audit Committee.

Don’t miss next week’s Community Update, which provides an outlook on the retail sector.

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A Bird’s-Eye View on Innovation

Managing risk and allowing innovation to flourish are two sides of the same coin. Today’s board directors must understand the value of both and create an environment that rewards them appropriately.

Sir Howard Davies, Chairman of the Royal Bank of Scotland, explains that while directors clearly should not be relied on for new product ideas, they have a key role in setting the right tone. “The board should be able to create an environment in which innovation is valued, supported and where people feel self-confident enough to take appropriate risks,” he says.

It’s a point shared by Andrew Minton, Managing Director at Criticaleye. He reasons: “It’s becoming increasingly clear that if a business wants to develop an innovative culture, the board has to create an environment within which people can experiment.

“As a result of increased transparency, non-executive directors must be cognisant of their role in setting the right culture and attitudes. If NEDs don’t appear to value innovation and fresh thinking, the rest of the business will follow suit.”

For Rita Clifton, Non-executive Director at ASOS and Nationwide, this goes beyond simply saying the right things. The modern boardroom must have vibrant, curious individuals who symbolise the behavioural standards and values that they expect from the wider organisation.

She says: “When I started sitting on boards 15 years ago, I would hear many chairmen, chief executives and directors talking about how the business needed to be more innovative; that it needed to move faster. I would look around the table and think: ‘Guys, you’re the problem, you don’t look as though you want to be innovative’.

“In my view, the board directors need to symbolise the best of your organisation. The standards and expectations they set are so important; people pick up cues from what the board appears preoccupied with. Regardless of what you say about culture, if your staff know that your main driver is profit you’re going to encourage fearful and short-term behaviour.”

Complaining about compliance

The challenge for boards is to find the time for strategic thinking when the immediate focus needs to be on regulatory compliance, corporate governance and effective risk management.

Sir Howard, who has sat on FTSE 100 boards for over 25 years, has seen a shift in the board’s approach to governance. He believes that time, which would otherwise be spent looking forward and assessing growth opportunities, is being eaten-up by “the pressure to demonstrate a robust control framework”.

What can you do to redress the balance? Sir Howard answers: “You can make better use of the risk committee, which should take a lot of the heavy-lifting off the main board. However, be careful that you don’t create two classes of director, one who is focused on risk and the other who can ignore it”.

“The key thing is that the board isn’t dragged too far into the detail and can afford to pull itself into more strategic thinking. You could also ensure that there are board and off site meetings in which risk and control are banned topics and you focused on innovation.”

For Guy Elliott, Deputy Chairman at SABMiller and Non-executive Director at Royal Dutch Shell, boards need to embed their obligations into strategic discussions.

“Often compliance and risk are segmented as a special discussion on the board. Board members may think they tick that off every six months, and if the audit committee has said that the processes are fine, they feel they’ve done their job,” he says.

“You have to go further than that. What you should be doing with risk, a lot of the time, is integrating it with strategy and futurology. For example, one might think about what’s going to happen to consumer habits; what rate of growth you’ll see in emerging markets compared to a developed one. Integral to that is exploring how you are going to chase an upside risk or mitigate a downside one.”

All-pervasive technology

The nature of innovation in the digital age means that directors require a much deeper understanding of technology. Natarajan Chandrasekaran, CEO and Managing Director of Tata Consultancy Services, says: “All of us, in every industry, are going through a transformation; the biggest [challenge] is that before technology was supporting business, now it’s leading it.

“It’s no longer the case that once the business model is decided, you deliver the technology to support it. Now, it’s absolutely essential that you appreciate the power of technology so that you’re able to define the future of the business.”

This sentiment is echoed by Stine Bosse, Member of the Supervisory Board of Allianz and Chairman of BankNordik. “I would argue that you can’t talk about anything in the future without considering technology. Last year, it took up about 30 per cent of board time. That included educating the board – we have to go into the machine room and understand the technology, then we can think about its impact strategically,” she comments.

“At Allianz, we have just had a full day looking at where disruption is likely to come from – a full day for the board is a lot of time. We were thinking about driverless cars and the implications for insurance.”

Even with this level of education, Stine believes that the composition of the board room will change. “The average age will fall because boards will need to have age diversity. Intuitive knowledge of technology [needs to] enter the board room. Of course, [everyone] has to be able to satisfy the regulators’ requirements, but let’s not be too frightened about that; you can educate yourself to that end.”

Ultimately, it’s a case of developing a board that has the confidence to invest in change and encourage the business to move forward. Guy says: “We have to have more discussion about technology and disruption in the boardroom. That doesn’t necessarily mean that a CIO needs to sit on the board, but they need to be there, talking the language of the board. It is important that what they say actually means something to everyone around the table. It’s difficult to make that linguistic transformation, but it can be done.”

Of course, the other side is that to ignore market disruption is a dereliction of duty. Rita notes: “Risk management can be seen as putting a brake on proceedings and trying to stop things from happening. With the speed at which most markets change these days, a key risk is not to innovate. If we’re not careful, the board will be seen as trying to stop things from happening.”

These comments were made during a panel discussion at Tata Consultancy Services’ European Summit in Berlin.

By Joshua Tearney, Account Manager, Advisory Practice

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Should NEDs be Paid More?

As the extra responsibility, time commitment and reputational risk continues to reshape the role of a non-executive director, one may question whether it’s time to change how NEDs are remunerated. Should pay be more reflective of the greater workload, or could this lead to a conflict of interest?

David Dumeresque, Partner at executive search firm Tyzack, says: “People attacked NEDs, most notably those on the boards of HSBC and Tesco, for not knowing what had gone on during company failures. We felt this was actually expecting a new level of knowledge – NEDs hadn’t even thought about some of the issues they were questioned on.”

As a result of this increased scrutiny, David argues that NEDs are required to be more involved in the business, in part to protect themselves if things go wrong. “It’s important to make sure NEDs are properly remunerated,” he says. “If pay stays static and potential reputational risks increase, it’s likely that fewer people will want to be NEDs, or the wrong people will be NEDs because they won’t fully understand those risks.”

According to Andrew Minton, Executive Director at Criticaleye, the true value of a non-executive director lies in their input around strategy: “By sharing their knowledge, on for example digital transformation, talent management or international expansion, NEDs can move the conversation around the boardroom table onto bigger strategic issues, helping secure the future of the business.

“NEDs should be properly compensated for their time in the role, but there is a balance to maintain – the last thing you want to do is bring the independence of a non-executive director into question.”

Criticaleye spoke to a mix of non-executives to find out their opinions on this complex issue:

Olivia Dickson, Non-executive Director at FTSE 100 financial services concern Virgin Money:

While NEDs of financial services (FS) companies are typically paid more than their non-FS counterparts, the difference does not fully reflect the additional time it takes to fulfil regulatory responsibilities.

The underlying, historic issue is the inflexible structure of NED remuneration. In financial services, fees do not typically flex as the demands on a NED’s time changes with different circumstances. Furthermore, the ethos of collective responsibility among the board has historically driven NED remuneration to minimise differences in pay between members with different responsibilities.

I expect to see more flexibility in NED reward structures emerging, with fees for those chairing committees increasing to properly reflect the time, skill and knowledge required, as well as the increased accountability and personal liability associated with the introduction of new regulatory regimes.

The current inflexible reward structure for NEDs seems to be from a previous era and out of touch with the demands and liabilities of NED life in the 21st century.

Bernie Waldron, Criticaleye Board Mentor, and Non-executive Director at several companies, including Servelec Group and private equity-backed IT and communications company Node4

I’m not currently pursuing any FTSE 250 roles because I think the enjoyment level, reward and hassle are out of sync. There are a lot of great public companies but private equity-backed companies, where there is financial alignment and a more focused objective, are on balance more enjoyable places for many NEDs. This reduces the NED talent pool available to public companies.

The NED remuneration structure for UK public companies makes no sense to me – normally all that’s available is a fee. You can buy equity at the market rate, but you don’t have any options that put you in the same boat as the executive team.

I understand the argument – this is done to reinforce independence – but I don’t agree with it. If you’re worried that giving your NEDs a financial interest in the company, which would align them with the investors and the executive team, could cause them to preside over fiddling the books, then you’ve got the wrong NEDs in the first place.

Geraint Anderson, Senior Independent Director at Volex, which is listed on the FTSE Fledgling Index: 

A significant increase in fees could be a big problem for employees and shareholders. For the amount of time you’re putting into it, the rate per hour is not attractive but you’re not there to make money for yourself, you’re there to add value and hopefully you enjoy being involved.

I do see the case for an increase in compensation related to time but I’m not in it for that. I stepped down from my exec role in 2014 in order to pursue a plural route, the first being Senior Independent Director and Chairman of the remuneration committee at Volex. Being the chairman of a Remco takes significantly more time than in the past, due to disclosure and interaction with shareholders, so you have to be careful not to over commit your time.

If you’re going into this purely to make money, you shouldn’t be doing it. Share incentive schemes, for example, would be highly wrong and would blur the line between the non-execs and execs.

Gareth Davis, Chairman of FTSE 100 building materials distribution company Wolseley

It’s fair to say that over the past five or six years there has been a step change in the responsibilities of NEDs, but no corresponding change in remuneration as far as I can see. As long as the fees are fixed and of a reasonable amount, I think an increase makes sense as it acknowledges the additional work they have to conduct, especially if they are chairing the audit and remuneration committees.

In terms of the amount of time you must commit, you’re looking at about 25 or so days a year. For a committee chairman it can be anything up to 35. In financial services, it’s going on for a full-time role.

Many companies haven’t kept pace but I’m not talking about huge increases here. The fees should be fixed and reasonable and, of course, there must not be any element of variable pay as that brings independence into question.
By Dawn Murden, Features Editor- Advisory

Do you have a view on this subject? If you have an opinion you’d like to share, please email Dawn at