Maximising value

Professor Paul Kerin considers the merits of board committees and the growing significance they play in today’s corporate world.

It is often said that much of a board’s real work is done by its committees. Indeed, some research shows that certain committees can add more value than the overall board itself. Therefore, amongst the most important decisions that boards and chairs can make, are which committees to have and what their memberships should be. As board spots are always limited, these decisions inevitably involve trade-offs. Committees often have a bad name. However, some committees, with appropriate membership and activity levels, can help boards better achieve organisational goals.

Why committees? In part, it is “because we have to”. For example, S&P/ASX 300 companies are required to have audit and remuneration committees. However, research conducted before such requirements were imposed showed that the existence of these committees and the strong independence of their members improved organisational performance. Boards delegate to committees to enable deeper consideration of key issues than is possible in board meetings and to economise on directors’ time.

Committees also help overcome the “free-rider” problem that can occur on large boards: as individual director performance on small committees is more visible, this raises members’ sense of accountability and incentives to perform. The proportion of a board’s work done by committees has risen in the last 10 to 15 years, partly due to increased regulatory requirements. The frequency of committee meetings has doubled during that time. For Australia’s largest companies (which average 9.8 board meetings a year), audit and remuneration committees each meet about six times a year and nominations committees about 4.5 times a year.

While some committees are required, many boards establish other committees to deal with issues that are particularly important to them. Banks typically have technology committees. Research and development companies have innovation committees. Miners have sustainability committees. Of the discretionary committees, research has shown that finance committees are most likely to improve company value.

Australia’s largest companies have an average of 4.3 committees. While committees are valuable, there are benefits in keeping the number of standing committees small. Ad-hoc committees can be formed only as required. Some companies decide that certain issues are better dealt with by a “committee of the whole”, that is, all directors. Apart from meeting independence requirements on certain committees, careful committee membership selection is critical. High levels of independence can be valuable on some committees but not on others. For example, in my own not-for-profit sector (universities), Australian research indicates that more independent board committees improve both financial and research performances; however, they hurt teaching performance. Researchers classify directors into four types: business experts (CEOs), support specialists (lawyers), community influentials and insiders. Different committees require different mixes of member attributes. For example, research shows that finance committees are most effective in improving organisational performance when their members are primarily business experts and support specialists.

Expertise and connections matter. Business experts and community influentials are more likely to be nomination committee members. Business experts are also more likely to be audit and remuneration committee members. While it is not appropriate for insiders to be on some committees, they can be valuable on others (for example, technology).

Research shows that overlapping memberships between certain committees – such as audit and remuneration committees – improves performance by facilitating knowledge-sharing. They improve the quality of financial reporting and result in executive compensation being less dependent on accruals that can be manipulated and more driven by shareholder returns. Large Australian companies appear to recognise these benefits – in 60 per cent of cases, the chair of the audit committee is on the remuneration committee. The fact that these two committees have the biggest workloads leads to a further key point: it is usually not optimal to try to spread committee work evenly between all directors.