Board Matters Quarterly

Transcription

1 EY Center for Board Matters Board Matters Quarterly Critical insights for boards and audit committees January 2015

2 2 Board Matters Quarterly January 2015

3 January 2015 Board Matters Quarterly In this issue The audit committee s role in disclosure effectiveness As overseers of a company s financial reporting and related processes, the audit committee can play an important role as companies make their disclosures more effective. Page 4 Trends in independent board leadership structures We review evolving trends around independent board leadership structures and examine the responsibilities most commonly assigned to these roles. Page 8 Taking sustainability awareness to the board level Investors are increasingly paying attention to sustainability, and many companies have begun to elevate corporate sustainability to the board level. A new guide offers insight for directors. Page 11 Board Matters Quarterly January

4 The audit committee s role in disclosure effectiveness The audit committee s role in disclosure effectiveness Making business and financial disclosures more effective has become a focus of regulators and standard setters around the world. The volume and complexity of financial reporting requirements have grown significantly. Users of financial statements often say that disclosure documents contain too much boilerplate and can be repetitive, making it difficult to find the most important information. At the same time, some investors and other users have called for new disclosures or improvements to existing ones. As a result, a current priority of the Securities and Exchange Commission (SEC) staff is to review the requirements of Regulations S-K and S-X to identify ways to reduce the costs and burdens on companies while improving disclosure of material information to investors. 1 The benefits of streamlined disclosure include the potential to increase investor confidence and improve efficiency and coordination between the organization, its board, regulators and external advisors. Some companies have begun to undertake initiatives to improve their disclosures, including consolidating duplicative information, using tables to replace narrative discussions and removing disclosures that are no longer relevant or material. 2 As overseers of a company s financial reporting and related processes, the audit committee can play an important role as a company makes its disclosures more effective. The SEC staff is encouraging companies to proactively enhance their disclosures by reducing repetition, tailoring the disclosures to focus on material information and eliminating outdated and immaterial information. 3 Support from the audit committee Developing appropriate processes to enhance disclosures often requires coordination with the audit committee. Top-down commitment throughout the organization is necessary to sustain the focus on improving the quality of information provided to investors. The audit committee should confirm and monitor that there is appropriate coordination with key stakeholders and timelines for implementing disclosure changes. Communication with the external auditor also is essential. In addition, an effective plan to improve disclosures may require additional documentation about significant judgments (e.g., materiality assessments), as well as better integration of people, data and systems that can benefit from audit committee support and oversight. Developing appropriate processes to enhance disclosures often requires coordination with the audit committee. Audit committees also can provide helpful input about the scope and extent of disclosure effectiveness efforts. Companies must consider time, cost and resource constraints, as well as regulatory disclosure requirements. It may be more productive for a company to target specific disclosure areas that are particularly complex or timeconsuming rather than start with a 4 Board Matters Quarterly January 2015

5 The audit committee s role in disclosure effectiveness blank sheet to rewrite the financial statements and SEC reports. Companies that have successfully streamlined their disclosures by focusing on relevant and material information cite improved coordination with the audit committee, including: Engaging audit committees earlier in the financial reporting process Addressing audit committee concerns about disclosures through a more holistic initiative Expediting the review of audit committee members by presenting information in a more logical, easyto-read manner A recent EY publication, Disclosure effectiveness: what companies can do now, provides, among other things, a road map of improvements a company can follow in drafting upcoming filings and financial statements to make their year-end disclosures more meaningful. Leveraging the disclosure committee An audit committee may also want to better understand the role of and improve coordination with the company s disclosure committee. Disclosure committees are not required, though the SEC recommends them for all public companies. 4 According to a recent survey by the Financial Executives Research Foundation (FERF) 5 and EY, Unlocking the potential of disclosure committees, 92% of respondents indicated having either a formal disclosure committee or another group with similar responsibilities. Disclosure committees are not boardlevel committees, but they do include senior-level executives, typically the corporate controller, chief accounting officer and general counsel, among others. These committees play an important role, centralizing a company s thinking about disclosures and validating that disclosures are relevant, timely, coordinated and consistent. Given their important role, it is surprising that 43% of respondents to the survey indicate that their disclosure committee has no formal interaction with the audit committee. Improved coordination with the disclosure committee may help the Board Matters Quarterly January

6 The audit committee s role in disclosure effectiveness audit committee carry out its oversight role and support a company s process to enhance disclosures. Meaningful and lasting change to the disclosure regime will take time. For now, companies can lead by taking action to make their disclosures more meaningful, and audit committees can encourage disclosure effectiveness initiatives by providing support and oversight. Endnotes: 1 The initiative grew out of a December 2013 study of disclosure requirements in Regulation S-K, which was required by the Jumpstart Our Business Startups Act. In this study, the staff of the SEC s Division of Corporation Finance recommended that the SEC comprehensively review the existing disclosure requirements. SEC Chair Mary Jo White has called the disclosure effectiveness initiative a priority. 2 Let s talk governance: companies respond to calls for more meaningful governance disclosure, EY, May Questions for boards and audit committees to consider Does the company have a plan and process to improve disclosure effectiveness? If so, what are the planned improvements, and how were the targeted disclosure areas identified? If the company is planning to enhance its disclosures, is there a clear timeline and project management support to meet the deadlines? What people within and outside the company are involved in the process? Does the audit committee interact with the disclosure committee? Do both committees equally understand plans to improve disclosure effectiveness? Has the company reached out to analysts and investors to obtain feedback about the quality and transparency of its disclosures? What disclosures are most important to the company s analysts and investors, and has the company recently considered how to enhance those disclosures? Have analysts or investors requested additional disclosures? If the company has eliminated immaterial disclosures, how did management evaluate and document its materiality considerations? 3 Disclosure Effectiveness: Remarks Before the American Bar Association Business Law Section Spring Meeting, Keith F. Higgins, SEC Director, Division of Corporation Finance, 11 April Disclosure committees became popular following the passage of the Sarbanes-Oxley Act of 2002 and SEC rules requiring companies to maintain disclosure controls and procedures. 5 Financial Executives Research Foundation (FERF) is the nonprofit 501(c)(3) research affiliate of Financial Executives International. 6 Board Matters Quarterly January 2015

7 Insights from our audit committee networks The North American Audit Committee Leadership Network (ACLN), a group of audit committee chairs from leading North American companies, convened in New York in September Participants discussed how audit committees can improve their performance in the face of mounting challenges and demands from different stakeholders, including regulators who see audit committees as important gatekeepers for protecting investors and the public. ACLN members talked about the topics and areas of concern that have risen on their agendas in recent years. They also discussed audit committee composition, emerging good practices and evaluating the audit committee s performance. ViewPoints: improving audit committee performance provides a full summary of the meeting with comments from audit committee chairs. A series of additional meetings brought together 80 audit committee chairs, who together sit on the boards of more than 120 public companies. These meetings offered participants the chance to engage in candid discussions as part of Tapestry and EY s regional Audit Committee Networks (ACNs). The meetings included dialogue with members of the Public Company Accounting Oversight Board (PCAOB). Participants recognized that improving audit quality depends on audit committees and the PCAOB acknowledging their common goal of fostering audit quality and investor confidence in audited financial reports. Other topics discussed during the fall ACN meetings focused on what a changing China will mean for the global economy generally as well as for individual companies operations; the new converged standard on revenue recognition, which goes into effect at the beginning of 2017; and management s responses to operational, regulatory and fraud risks that, if not properly identified and understood, can become strategic risks. A full summary of the meeting was published in VantagePoints: anticipating change. You can download ViewPoints and VantagePoints from the audit committee resources section of ey.com/boardmatters. Board Matters Quarterly January

8 Trends in independent board leadership structures Trends in independent board leadership structures Board leadership structures have evolved dramatically over the past decade or so, with more companies separating the positions of chair and CEO and appointing independent board leaders. Today around 90% of S&P 1500 companies have some form of independent leadership compared to only 10% in These leadership positions vary among companies and include independent chairs and lead and presiding directors. The responsibilities assigned to these positions vary among companies as well. There is no consensus on best practice. Directors have different thoughts on which leadership structure is most effective and thoughts on what works best may change based on company-specific circumstances. Views among investors differ too. For some investors, there is no substitute for an independent board chair, while others find lead or presiding directors to be sufficient provided the responsibilities are clearly defined and robust. Current SEC rules require companies to disclose in the proxy statement whether and why they have chosen to combine or separate the CEO and board chair positions and why this leadership structure is the most appropriate. Companies with a combined CEO/chair and a separate lead director are also required to disclose the specific role the lead director plays in the leadership of the company. Both investors and proxy advisory firms use this disclosure to evaluate the company s chosen structure. Using our proprietary corporate governance database, this report reviews evolving trends around independent board leadership structures, examines the key responsibilities most commonly assigned to these roles and highlights investor initiatives in this area. Independent board leadership landscape The trend is clear: having an independent board leader has become standard practice. Most common are independent board chairs or lead directors with position responsibilities such as setting board meeting agendas and controlling the flow of information to the board. Fewer companies have presiding directors, likely because they are often viewed as having a more passive role. Larger companies are more likely to have independent lead directors, while independent board chairs are more common among smaller companies. Companies in the construction industry and the power and utilities industry are most likely to have independent board leadership, while companies in the media and entertainment industry and the telecommunications industry are least likely. Independent board chairs are most common among companies in the construction and pharmaceuticals industries, while lead directors are most common among aerospace and defense companies. Board leadership debate plays out via shareholder proposals Shareholder proposals seeking the appointment of an independent board chair, as well as companyinvestor engagement on this topic, are drivers of change in board leadership structures. The increase in independent board chair shareholder proposals from 2000 to 2013 mirrors the significant increase in the appointment of independent board leaders over the same time period. Despite record numbers of shareholder proposals, support levels have declined in recent years. This may represent the general lack of consensus over a preferred structure. 8 Board Matters Quarterly January 2015

9 Trends in independent board leadership structures Having an independent board leader has become a more standard practice No consensus view Independent leadership positions vary and include board chairs, lead directors and presiding directors Independent leadership at S&P 1500 companies since 2000 Board chair Lead director Presiding director 45% 47% 35% 3% 30% 7% 9.7% 11% 9% % 86% 89% 8x Overall, independent board leadership has grown among the S&P 1500 by nearly 8 times over the last 14 years. Independent vs. non-independent chair 55% of S&P 1500 companies separate the positions of chair and CEO. Of the 55% that separate the positions 63% independent chair 37% non-independent chair 63% 37% 45% combine chair/ceo Presiding director Lead director Board chair Indicates at least 50% of the ª companies with such position specifically assigned the responsibility; all others reflect where between 25% and 50% of companies with such position assigned the responsibility. Roles differentiated based on responsibilities and levels of authority assigned to them Fortune 100 company independent board leadership responsibilities* Authority to call meetings of the independent directors Chair meetings of the independent directors Serve as liaison between management and independent directors Approve board meeting agendas and schedules Approve information sent to the board Be available, when appropriate, for consultation and direct communication with shareholders Lead CEO performance evaluation (often in coordination with compensation committee) Lead annual board performance evaluation (often in coordination with nominating/governance committee) Authority to call meetings of all directors Authority to call shareholder meetings Chair shareholder meetings** Chair board meetings** Lead CEO succession planning (often in coordination with compensation or nominating/governance committee) Recommend committee membership and/or chairs Based on the most recent proxy statements, corporate * governance guidelines and bylaws of 88 Fortune 100 companies. Of these, 22 have independent board chairs, 48 have independent lead directors, 13 have independent presiding directors and 5 do not have an independent board leader in place. Reflects primary responsibility for chairing board and shareholder ** meetings. Most lead and presiding directors have responsibility for presiding over board meetings in the chair s absence, and some lead directors have responsibility for presiding over shareholder meetings in the chair s absence. Board Matters Quarterly January

10 Sustainability awareness has to start with the board. The risk issues are so significant, with climate change, human rights and others all having a major potential impact. 10 Board Matters Quarterly January 2015

11 Taking sustainability awareness to the board level Taking sustainability awareness to the board level While many companies have begun to elevate corporate sustainability to the board level, others still consider it to be a softer issue. Those companies may be missing out on significant opportunities to not only address risk but also to weave sustainability into their strategy and drive business value. Sustainability awareness has to start with the board, says Carol Casazza, of our Climate Change and Sustainability Services. The risk issues are so significant, with climate change, human rights and others all having a major potential impact. But the opportunities are also substantial and need to be factored into the business strategy so that sustainability rises above the operational noise. Raising awareness of sustainability as a board-level issue is a key theme of the Director s Handbook on Oversight of Corporate Sustainability Activities, which EY co-produced with the National Association of Corporate Directors (NACD). The handbook details the current state of sustainability governance and offers a how-to guide for companies to elevate sustainability awareness within their organization and set up proper governance at the board level. This can be a challenging conversation, Casazza says. The board may not be fully conversant yet in all the issues related to corporate sustainability. Key recommendations One of the key recommendations in the handbook is that directors grasp the company s definition of sustainability and how it fits with the company s strategy and specific situation. Among other recommendations, the handbook suggests that board and management: Align on the sustainability message and the information they choose to report publicly Clarify roles for oversight responsibility of sustainability activities, including external reporting Establish parameters for sustainability reporting to the board One reason boards should take oversight of corporate sustainability activities is that investors are increasingly paying attention to the topic. In 2014, nearly half of all shareholder proposal submissions were related to environmental and social matters, says Allie Rutherford of EY s Center for Board Matters. Sustainability issues are gaining traction with a broader range of investors, Rutherford says. Institutional investors are increasingly raising these topics as they seek to understand the potential longer-term financial impact of sustainability on companies in their portfolios and the level of board oversight. They are drawing attention to the topic and influencing corporate disclosure. Engaging in dialogue Almost one-third of the shareholder proposals were withdrawn after companies agreed to take action mostly in the form of disclosure or committed to ongoing discussions about sustainability. In many cases, simply engaging the shareholders in a dialogue is a viable response. The increasing awareness of sustainability at the board level represents a natural evolution as boards come to grips with understanding their companies social license to operate, Casazza says. Sustainability needs to be taken out of the silo and embedded into corporate strategy. Download a summary of the recommendations made by NACD and EY as part of this year s handbook. The complete report is available exclusively to NACD members. To become an NACD member, please contact Kelly Dodd, Membership Development Officer, at or kkdodd@nacdonline.org. To learn more about NACD, visit NACDonline.org. For more information, go to sustainability. Board Matters Quarterly January

12 In 2014, audit committees continued to face significant challenges in overseeing their companies compliance with financial reporting, legal and regulatory requirements. This document is designed to help audit committee members prepare for their upcoming discussions with management and the independent auditors. We pose a series of questions for the audit committee to consider and provide links to additional information. Inside: 25 questions Financial reporting Regulatory developments Risk management Tax Audit regulatory initiatives August 2014 Issue 8 Executive summary This 2014 proxy season update is EY s third report on the topic of audit committee reporting. Beginning with February 2013 s Audit committee reporting to shareholders: going beyond the minimum and continuing with September 2013 s Audit committee reporting to shareholders 2013 proxy season update EY has sought to advance discussion among audit stakeholders by providing data-driven insights into current audit-related disclosure practices. Our research shows a consistent movement by Fortune 100 companies to enhance the depth and scope of audit committee-related disclosures. Top companies are progressively supplementing mandatory disclosures with additional voluntary information sought by investors. The 2014 proxy season saw signi cant growth in audit committee transparency. Continuing the trend of the past several years, an increased number of Fortune 100 companies are going beyond the minimum disclosures required. These disclosures are also more robust providing valuable perspectives on the activities of audit committees, including their oversight of external auditors. This conclusion is based on a review of companies in the Fortune 100 in 2014 that led proxy statements for three consecutive years as of 15 August (80 companies in total). This data is based on the EY Center for Board Matter s proprietary database, which covers more than 3,000 public companies listed in the US. Context The recent movement toward increased audit committee transparency has been encouraged by a variety of factors and entities. In addition to the ongoing disclosure effectiveness review by the US Securities and Exchange Commission (SEC) involving a holistic review of the US corporate disclosure regime, audit committee disclosures are receiving signi cant attention from a variety of stakeholders. These stakeholders include US and non- US regulators, investors, and policy organizations. Reasons for supporting greater audit committee transparency include enhancing investor con dence in the important oversight work performed by audit committees; improving communication with investors about audit committee responsibilities including their oversight of external auditors; and better informing shareholders in their consideration of auditor rati cation proposals. More insights Access additional information, including the following, at ey.com/boardmatters: EY Center for Board Matters 2014 year-end issues for audit committees to consider EY Center for Board Matters Let s talk: governance Audit committee reporting to shareholders 2014 proxy season update Audit committees continue to enhance voluntary disclosures Contacts 2014 year-end issues for audit committees to consider This is designed to help audit committee members prepare for upcoming discussions with management and independent auditors. Topics include financial reporting, regulatory developments, risk management, and tax and audit regulatory initiatives. Questions for the audit committee to consider about each issue are also provided. Oversight of Corporate Sustainability Activities This new handbook details the current state of sustainability governance and offers a how-to guide for companies to elevate sustainability awareness within their organization. Audit quality indicators initiatives Several initiatives are under way to develop audit quality indicators (AQIs) that are of interest to audit committees, management and investors. Read our summary. Audit committee reporting to shareholders: 2014 proxy season update Audit committees continue to enhance voluntary disclosures. We provide data to show how disclosures have changed since Ruby Sharma Ernst & Young LLP ruby.sharma@ey.com Mark Manoff Ernst & Young LLP mark.manoff@ey.com Center for Board Matters on the go Download the Flipboard app on your mobile device and search for the Center for Board Matters to access current articles on board and governance topics. EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. About the EY Center for Board Matters Effective corporate governance is an important element in building a better working world. The EY Center for Board Matters is committed to bringing together and engaging with boards, audit committee members and investors to exchange ideas and insights. Using our professional competencies, relationships and proprietary corporate governance database, we are able to identify trends and emerging governance issues. This allows us to deliver timely and balanced insights, data-rich content, and practical tools and analysis to boards, audit committees, institutional investors and others interested in governance topics Ernst & Young LLP. All Rights Reserved. SCORE no. YY ED None This newsletter may include copyrighted materials of third parties. No part of this newsletter may be reproduced, distributed, displayed or published without the express written permission of Ernst & Young LLP and the copyright holders of any included materials. All permission requests should be forwarded to Sara Brandfon at sara.brandfon@ey.com. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com About this publication Board Matters Quarterly is published four times a year and includes articles previously published online and distributed electronically to our subscribers. To access or sign up to receive similar content relevant to board members, please visit ey.com/boardmatters.