Results of FERF''s Corporate Governance Survey
In cooperation with The Board Institute (TBI), the Financial Executives Research Foundation (FERF) surveyed members from Financial Executives International (FEI) in April 2004 to examine issues related to audit committees of both public and private organizations. Survey questions were derived from The Audit Committee Index, which was developed by TBI and FERF to assess and benchmark audit committees. The public and private organizations that responded ranged from $25 million in annual sales to more than $1 billion. Four public organizations were larger than $5 billion. About 10 each were listed on the NYSE and the NASDAQ, and three were listed on AMEX.
Among the most encouraging findings from the survey was that most public firms feel their audit committees are effective (see Figure 1). A closer look at the results indicates clearly that some other areas need improvement for truly effective corporate governance.
What Drives Governance?
Guidance for governance compliance showed considerable variance by firm. Some firms reported extensive guidance to help them comply with the new regulations â primarily from external legal counsel, internal legal counsel and external auditors â while others reported very little.
They also listed a variety of reasons their organizations are making an investment in corporate governance:
- U.S. government (four respondents):Departments of Defense, Transportation, and Energy;
- Credit rating agencies (three): Proxy research, investment bank/underwriter;
- Customers (three): Making it part of the request for proposal process;
- Suppliers (two): Sarbanes-Oxley Section 404 certifications, ethical; and
- Eligibility for social responsibility indexes and rating services (two).
It is interesting to note that, until recently, issues like Sarbanes-Oxley 404 certification and social responsibility rating indexes did not exist. Also notable, several private firms indicated concern about social responsibility indexes.
More than half of both public and private firms note that key terms of director and officer (D&O) insurance have become more unfavorable. These organizations are being driven to enhance corporate governance in order to improve D&O policy terms and to favorably affect the terms of debt agreements.
Board and Audit Committee Evaluation
The survey found that 67 percent of public companies evaluate overall board performance, as well as audit committee performance, annually. For private companies, only 29 percent evaluate the board annually, and only 14 percent evaluate the audit committee that frequently.
The challenge of board evaluation, while critical, needs to become more objective and credible. Based on respondent comments, typical board evaluation currently consists of a subjective survey of board members themselves. A few organizations use a corporate governance committee or other source to provide a more independent assessment of audit committee performance.
Credible and valid board evaluations require a more formalized approach similar to environmental compliance or other compliance issues that require inputs from a knowledge network beyond simply the board members.
One respondent provided an excellent summary of what audit committees do:
- Review operations;
- Visit manufacturing plants;
- Participate in executive sessions with external auditors;
- Examine business finances, accounting processes and results; and
- Ask tough questions and hold management accountable.
It is interesting that perception of audit committee effectiveness is not always paired with actual performance measures. Most public organizations (96 percent), believe their audit committees are effective, yet only two-thirds currently evaluate committee performance. About two-thirds of private organizations believe their audit committees are effective, yet only 14 percent currently evaluate committee performance.
Investment in Corporate Governance
The most obvious finding from this survey is that public firms are substantially ahead of private firms in organizational governance. This finding is not surprising since private firms are not yet subject to Sarbanes-Oxley. Nearly half of public firms invested over $400,000 in corporate governance compliance in 2003, and eight firms invested over $1 million. Most private firms (87 percent), invested less than $200,000 in corporate governance compliance in the same time period. Two firms reported investment of $400,000 to $600,000.
Investment in corporate governance compliance services, including Sarbanes-Oxley Section 404 certification, is shown in Figure 2.
Board Compensation
The greatest variance in this survey occurred regarding audit committee compensation. The total compensation for boards that paid their members can best be presented by looking at the findings for small organizations (less than $25 million â $100 million), and large organizations ($500 million to more than $5 billion). Small companies reported paying $200 to $2,000 per meeting, while their larger counterparts paid $25,000 to $35,000 annually, plus options. Some organizations paid nothing extra for board service. One board paid directors $80,000 annually, and another paid them $65,000. The board chair typically received a premium of $2,000 to $10,000 per meeting.
Private firms seemed to fall into two groups: either zero or minimal compensation, or a range of $25,000 to $35,000. Judging by the differences in responses, the higher compensation group clearly has substantially advanced corporate governance.
Compensation through equity (for public boards only) is most commonly 20 percent of total compensation. The typical amount cited was 1,000 to 2,500 shares as options, often shown as worth $20,000, but the range went up to as many as 200,000 shares.
Most boards pay audit committee member expenses. For public companies, this amounts to $25,000 to $35,000 annually, plus options. For private, the rate is $350 to $35,000 per meeting, with an average of about $20,000.
Future Inquiry
This survey provides a baseline for research on the progress of corporate governance. These findings also highlight the need to answer other questions, such as:
- How can audit committees and boards be evaluated in a credible and valid manner?
- What are the trigger points that should initiate action to improve audit committee governance?
- What are the criteria and core competencies for effective audit committee members?
- What actions are appropriate for public and private audit committees?
- What is an appropriate compensation package for audit committee members?
- Should audit chairs be paid a premium?
- What differences are appropriate in corporate governance between public and private organizations?
Summary of Findings
The most encouraging finding from the survey is that most public boards and about two-thirds of private boards believe their audit committees are effective. These results are significant because nearly half of public firms invested over $400,000 in corporate governance compliance last year and eight firms invested over $1 million.
Factors pushing enhanced corporate governance come from many directions, such as the needs to: 1) work with federal regulatory compliance agencies, 2) gain high credit ratings, 3) prepare for investors, 4) meet customer and supplier expectations, and 5) qualify for social responsibility indexes.
A major gap seems to be that only two-thirds of audit committee mem- bers in public companies are fully informed of their responsibilities. The more engaged and knowledgeable the audit committee is, the more risk is diffused and deflected. Currently only one-third of the private firms that responded have chosen to apply the new regulations. The other gap occurs in creating performance measures for audit committees, since only one-third of public firms and one-seventh of private firms currently measure audit committee performance.
Predictably the sustained high qual- ity of audit committee performance will require credible and valid performance measures. These data show that as organizations work to enhance audit committee performance mea- sures, they are making substantial investments in time, education and money targeted to improving the audit committee process.
Originally published by Financial Executives Research Foundation, Inc. (FERF). Reprinted with permission from FERF. For more information or to order additional copies, visit www.ferf.org.
