Improving Audit Committee Effectiveness

The strength of our public company financial reporting system relies on many stakeholders playing different but interconnected roles in a process designed to provide investors and our markets with high-quality, reliable financial information. Audit committees play a vital role in the financial reporting system through their oversight of financial reporting, including the audit of the company’s financial statement and internal control over financial reporting performed by the external auditor.

Increasingly, audit committees are also responsible for overseeing other areas of corporate reporting, such as cybersecurity; environmental, social, and governance (ESG); and other non-generally accepted accounting principles information. Given the increasing scope of oversight, how audit committees manage and disclose these responsibilities is an important consideration in today’s environment.

My organization, the Center for Audit Quality (CAQ), and NACD recently convened an investor, James Andrus; an audit committee member, David Herzog; and an academic researcher, Lauren Cunningham to discuss the evolving role of the audit committee and identify best practices related to effective audit committee oversight and responsibilities. The discussion, led by Vanessa Teitelbaum, senior director, Professional Practice at the CAQ, had several important takeaways.

The Agenda of the Audit Committee Has Become Increasingly Crowded

The discussion explored the results of two publications recently released by the CAQ. The first, the CAQ’s ninth annual Audit Committee Transparency Barometer, reflects a long-term positive trend of increased transparency in several areas by audit committee members. The second publication, Audit Committee: The Kitchen Sink of the Board, developed with academic researchers at the University of Tennessee Knoxville’s Neel Corporate Governance Center and the Pamplin College of Business at Virginia Tech, offers leading practices for audit committees. This includes how boards can effectively allocate oversight responsibilities to the audit committee, how audit committee members can keep up with an ever-evolving workload, and how audit committees can improve their disclosures related to their oversight responsibilities.

Lauren Cunningham, one of the researchers who authored the Kitchen Sink report, observed during the webinar that the scope and workload of audit committees is increasing, with 40 percent of the audit committee members interviewed for the report referring to the audit committee as the “kitchen sink” of the board. According to the report, emerging areas of focus such as cybersecurity, ESG, and enterprise risk management are increasingly being assigned to the audit committee, but this can lead to suboptimal work.

Audit Committees Are Using a Variety of Methods to Improve Their Practices

The Kitchen Sink report also identified several leading practices audit committees are using to manage their increased workload. One important consideration for audit committee members is to be purposeful about developing skill sets that match their oversight responsibilities. They can do this by actively assessing the committee’s key risks when planning for continuing education opportunities and utilizing specialists where needed; regularly evaluating whether audit committee refreshment is needed to keep up with the necessary skill sets to properly oversee evolving risks; and carefully managing the committee agenda by mapping out risks to allow for deep dives on a rotation of topics throughout the year. 

Audit committees can also free up time for additional responsibilities by managing the agenda and relationships. This includes working with management to fine-tune the types of materials delivered in advance and hold audit committee members accountable for reading through materials in advance, reflecting on whether meetings allowed for sufficient time to evaluate management’s response to key risks.

“At MetLife, the pre-reads are written documents—we don’t just get slides without context. These written reports really help before we walk through a presentation,” said Herzog. “We also utilize a calendar that helps us organize our meetings. We meet 11 times a year and make liberal use of off-cycle meetings to dive into deeper topics.”

Maintaining a collaborative relationship with management and adopting leading practices to manage shared governance across board committees can also help audit committees free up time.

There Is Need for Improvement in Disclosures

While the CAQ’s 2022 Barometer found that there were several positive disclosure trends among S&P 500 audit committees, including increased disclosures about oversight of cybersecurity year over year, there were still many areas for improvement. For example, while 71 percent of audit committees of S&P 500 companies disclose auditor tenure in the proxy statement, only 9 percent of such audit committees disclose how the audit committee considers length of auditor tenure when reappointing the external auditor. And while 51 percent of audit committees of S&P 500 companies disclose that they are involved in the selection of the audit engagement partner, few disclosed what their involvement in the selection of the audit engagement partner entails.

Cunningham noted, “One thing we saw is that there are two types of audit committees out there. There are those clinging to the [US Securities and Exchange Commission]’s bare minimum rules and who have a ‘check the box’ mentality. Then there are those who are going beyond these rules and disclosing important information about their work that investors want to know.”

“We love to say it just takes one person to enhance disclosures. It either takes a corporate secretary or general counsel that believes in the importance of corporate transparency, or it can be the audit committee sharing resources like the Barometer,” said Cunningham. “It’s really easy for them to forward these documents and say, ‘can we just have a conversation about this? This is what our peers are doing.’”

Herzog, who chairs MetLife’s audit committee, noted on the webinar that board structures can make a difference in how companies manage and effectively communicate their disclosure. “There’s no one size fits all. At MetLife, we have five standing committees that are thoughtfully designed and fit for purpose. These committees are structured so that together they address the risks that MetLife faces.”

Investors want to see clearly defined roles and responsibilities assigned to the audit committee, an explanation for why audit committee members are appropriate for the specific company, examples of continuing education for audit committee members, more explanation for how audit committees address key risks, and details that reflect broader audit committee responsibilities.

“One thing that was important from the Barometer report was that it said, ‘increased transparency improves investor confidence,’” said Andrus, interim managing investment director, board governance and sustainability at CalPERS. “That hits the nail on the head. When we view the people on the audit committee as professional, competent, and good, then we have confidence. The concern becomes when committees do not take their responsibilities seriously and we can’t gauge that there are problems at their company.”

He added, “In many cases, we’re unaware of the other things the audit committee is doing, and they aren’t getting credit for it! We’d have more confidence in the company if we knew of the work audit committees are doing, so I really applaud the Kitchen Sink report for outlining what that work looks like.”

Final Thoughts

When it comes to the audit committee, transparency is the key to investor confidence. Audit committees should take both a quantitative and qualitative approach to personalized disclosures to give investors more insight into the processes, considerations, and decisions made by the audit committee.