insights for european audit committees: greater …...10 audit committee leadership summit, “audit...

InSights for European Audit Committees

Issue 18: August 2013

Greater business challenges call for stronger audit committees

Executive summaryTraditionally, the audit committee has been comprised of members who have deep finance and accounting expertise. These attributes have been necessary because of the committee’s statutory financial control and reporting duties. However, in recent years, the audit committee’s role has expanded. It now includes oversight of enterprise risk management and a number of specific risks, including increased regulatory involvement, bribery and corruption, and cybersecurity. This has prompted many boards and audit committees to reconsider the composition of their audit committee. One audit committee chair said: “There is a need for a universal refresh of what the audit committee needs and how we are sourcing audit committee members.”

EY commissioned research to explore audit committee composition and recruitment in today’s complex regulatory and economic landscape. Findings of the research are based on the views of leading audit committee chairs, accounting and risk advisors, academics, recruiters, internal audit executives and EY professionals. Key findings of the research undertaken by Tapestry Networks include:1

• The audit committee’s role is expanding. The global business environment has become more complex, and the risk oversight responsibilities of the audit committee have expanded accordingly. This increased responsibility includes a call by some regulators for “stronger audit committees” to handle the regulatory and business risks that companies face.

• Leadership, diversity and financial and auditing expertise are the key features of an effective audit committee. Diversity of culture, role and experience is the most important element of an audit committee, according to participants. Audit committees must also be comprised of members with financial expertise, experience in running a large corporation, accounting, auditing and industry expertise. Depending on the company’s sector and risk profile, participants identified several “nice to have” characteristics of effective audit committees, including technology expertise, significant international experience and a legal and compliance background.

• Boards are adapting their recruiting procedures to find new talent. Director recruiting is increasingly challenging. The limited talent pool may be further constrained by diversity quotas, and the time commitment on audit committees is only increasing. Boards are therefore looking at alternative geographies and industries to find effective members, and establishing orientation training methods for new audit committee members to get up to speed faster.

1 For a complete list of individuals interviewed for this document, please refer to Appendix A on page 16.

The audit committee’s role is expanding

The traditional financial controls and reporting duties of the audit committee are as important as ever, but the role of the audit committee has expanded significantly in the past decade. The audit committee’s workload now includes overseeing risk management, compliance and a series of emerging business risks that plague companies as they adjust to the post-financial crisis reality. Non-executive directors also face renewed scrutiny from regulators and investors.

The risk environment has become more complexResearch participants reported that risk management remains a priority for the audit committee on boards without a risk committee. Audit committee chairs said that the board relies on the audit committee to be the epicenter of risk oversight. “Audit committees feel that responsibility more than they ever did — making sure that the organization considers risk, monitors it and provides the necessary assurance that risk is being appropriately managed,” according to one audit chair.

The conditions in which businesses operate continue to fluctuate dramatically, with companies having to maneuver carefully through uncertain markets. Participants highlighted specific risks that are of prime concern for audit committees:

• Cybersecurity has risen to the top of the risk agenda. Audit committee chairs reported that cybersecurity is the most pressing risk faced by most companies. Confidentiality, integrity and sensitive information are all at risk from cyberattacks. Today’s adversaries are even capable of targeting physical assets, such as laptops, electric generators or reservoirs. Adversaries include national governments, criminal groups, company insiders and hacker activists. These groups use a variety of techniques to pursue objectives, such as stealing competitive intelligence and intellectual property, siphoning off money or disrupting operations. One risk executive interviewed for this report said: “Cybercriminals want to siphon off cash or destroy your systems and create chaos. It is clear that this is the number one risk that companies face today, and the number one risk that keeps audit committees awake at night.” Audit committees are allocating internal audit resources to test cybersecurity systems. They draw on the cybersecurity advice from the external audit firm and challenge management to deliver better metrics to measure cybersecurity progress.2

2 European Audit Committee Leadership Network, “Cybersecurity and the board,” ViewPoints, 16 January 2013.

Greater business challenges call for stronger audit committees2

“Cybercriminals want to siphon off cash or destroy your systems and create chaos. It is clear that this is the number one risk that companies face today, and the number one risk that keeps audit committees awake at night.” Risk executive

• Anti-bribery and corruption enforcement creates a compliance challenge. Companies have accepted that the economic environment in Europe remains uncertain, and are focusing on cutting costs and improving efficiency to increase profitability. For growth, they are looking to emerging markets, according to an EY global risk and opportunity survey.3 A feature of expansion into rapid-growth markets is the potential exposure to heightened fraud and corruption risk, and a more complex compliance landscape. As one advisor pointed out: “Foreign operations risk is a huge concern for the audit committee. Growth is coming from markets that many executives and non-executive directors in Europe are not familiar with. Bribery and corruption risks in Africa are orders of magnitude larger than they are in Europe. It’s all well and good for countries to send out values statements, but they need to understand what those values statements mean.”

• Companies are still wary of macro economic risks and political shocks. Audit committees continue to monitor the macroeconomic environment. Five years after the financial crisis, it remains unstable. EY’s report on the most significant, relevant business risks found that market volatility, interest rate fluctuation, sovereign debt default risk and tempered customer demand are causing concern for many companies.4 One audit committee chair said: “There’s still a feeling of uncertainty in the boardroom — that the economic situation could get much worse very quickly and companies will be back to crisis management.” As The Economist pointed out in March 2013: “The risk of political shocks, not just in Italy but in other Mediterranean countries, will only increase as long as economies are stuck in recession. Fourth-quarter output across the Eurozone fell by 0.6% compared with the third quarter. Although Germany suffered a similar decline, the economic reverse was worse on the periphery of the euro area. GDP fell in Italy by 0.9% and in Portugal by 1.8%.”5

• A spotlight on the auditing profession. In the wake of the financial crisis, global regulators enhanced their scrutiny of the auditing profession. In late 2011, the European Commission (EC) released two proposals to enhance auditor independence and make the statutory audit market more dynamic.6 The proposals included measures on the mandatory rotation of audit firms, an open and transparent mandatory tendering procedure and an end to providing non-audit services to audit clients. The European Parliament is currently considering these measures. In response to the EC’s proposals, many have called for strengthening audit committees. An EY briefing noted that “while the EC did not cover audit committees in the Green Paper, the proposed legislation includes provisions that we believe would strengthen audit committees by enhancing their independence, expertise and their oversight of the audit. The proposals would require a majority of audit committee members to be independent and at least one member to have competence in audit.”7

In the US, the Public Company Accounting Oversight Board (PCAOB) — an independent regulatory body for the audit profession — has released two solicitations for comment (concept releases) focusing on audit firm rotation and the auditor’s reporting model, as well as a proposed standard on communications between the auditor and the audit committee.8 Ninety-four percent of comments received by the PCAOB did not support mandatory firm rotation and many respondents instead called for strengthening the audit committee.9 On July 8, the House of Representatives of the US congress voted in favour of a bill which bans mandatory auditor rotation. In India, lawmakers also have their sights set on improving external auditors and audit committees. India’s Companies Bill prescribes elements of an audit committee’s composition, including the requirement that it consists of a minimum of three directors, with independent directors forming a majority.

3 Business Pulse: Exploring dual perspectives on the Top 10 risks and opportunities in 2013 and beyond, EY Global Limited, 2012.

4 Ibid.

5 “Still Crunching: Credit in the Euro Area,” The Economist, 9 March 2013.

6 “Restoring Confidence in Financial Statements: The European Commission Aims at a Higher Quality, Dynamic and Open Audit Market,” European Commission news release, 20 November 2011.

7 European legislative proposals on audit policy, Point of View, EY, December 2011.

8 Jay D. Hanson, “Concept Release on Auditor Independence and Audit Firm Rotation” (speech at the PCAOB open board meeting, Washington, DC, 16 August 2011).

9 European Audit Committee Leadership Network, ViewPoints, 11 May 2012, page 5.

3Greater business challenges call for stronger audit committees

A need for stronger audit committeesAudit committee chairs said that the expanding corporate risk profile requires audit committees to continue demonstrating their strength in challenging management. Leading legislators have also posited that audit committees can drive the engagement of the board. Last year, five members of the European Audit Committee Leadership Network participated in a dialogue with key Members of the European Parliament (MEPs) to discuss the EC’s Green Paper on audit policy. In the discussion, one MEP, Sebastian Bodu, Shadow Rapporteur for audit policy on the Committee on Legal Affairs, noted the importance of the audit committee in holding executive management to account. He said: “The independence of the audit committee chair and the board is very important … The strength and skills of the directors are important. Directors need a mix of skills, prior experience as an executive and experience in the industry and in other industries.”10

As the committee primarily responsible for risk oversight, audit committees believe it is their duty to ensure that management is effectively monitoring and managing the company’s most important risks. As the risk environment has changed, participants have posed the question: “What does an effective audit committee look like?”

Questions for audit committees• What are the most pressing risks facing companies?

• How are these risks affecting the role of the audit committee?

• How is the audit committee preparing to respond to these risks?

“The independence of the audit committee chair and the board is very important … The strength and skills of the directors are important. Directors need a mix of skills, prior experience as an executive and experience in the industry and in other industries.” Sebastian Bodu, Shadow Rapporteur, Member of European Parliament

The audit committee’s role is expanding continued

10 Audit Committee Leadership Summit, “Audit Policy Initiatives in the European Union and United States,” ViewPoints, 11 May 2012.


Leadership, diversity and financial and auditing expertise are key features of an effective audit committee

Courage and confidence were mentioned by most research participants as characteristics that must be represented on the audit committee. One audit committee chair said: “In the boardroom, courage is the capacity to raise good questions, to challenge management. That’s important for the committee, the board, the people who are working with the audit committee and the audit committee chair. I think about the external and internal auditors. We have to encourage these key people to be frank and courageous.” In addition, there are a number of more tangible skills and experiences that are seen as critical to the role of the audit committee.

Critical skills for audit committeesThe European Union’s 8th Company Law Directive requires all “public entities” to have an audit committee. EU Member States determine “whether audit committees are to be composed of non-executive members of the administrative body and/or members of the supervisory body of the audited entity and/or members appointed by the general of shareholders of the audited entity.” In addition, “at least one member of the audit committee shall be independent and shall have competence in accounting and/or auditing.”11 In the US, the Sarbanes-Oxley Act requires public companies to have an audit committee that is composed of all independent members, including one member with accounting or financial management expertise.12

Participants said financial and auditing expertise is important for reasons that go beyond the regulatory requirements:

• Financial expertise. Financial expertise requires a keen understanding of international accounting rules and how to apply those rules to company-specific judgments, internal controls expertise, and experience in disclosure to the investment community. Former CFOs and former audit partners are among the individuals who fill the board’s “financial expert” requirement. One audit committee chair said: “The more prosaic things the audit committee needs to do are as equally important as the emerging risks. One of those things is reporting to investors.” EY’s 2012 CFO and beyond study found that boards increasingly see a former CFO as the natural choice to chair the audit committee, as shareholders increase their disclosure demands and international standards setters continue to refine reporting standards and guidance.13

11 European Union, 8th company law directive, article 41.

12 Annemarie K. Keinath and Judith C. Walo, “Audit committee responsibilities disclosed since Sarbanes-Oxley,” CPA Journal, June 2008.

13 The CFO and beyond: the pathways and possibilities outside finance, EY Global Limited, 2012.


• Accounting and auditing expertise. Overseeing the internal audit department and the external auditors is among the most critical of the audit committee’s responsibilities, and several participants said that audit committees must have at least one member who has experience working with both functions. One audit committee chair said: “You want someone who has had experience controlling major audits. External auditors are there on behalf of the shareholders, and their effectiveness has to be managed and monitored. They have to be skeptical, otherwise the system breaks down.”

Several participants said that former audit partners are in high demand for the audit committee and suggested they make excellent audit committee members because they are skeptical by training, and are intimately familiar with accounting rules, regulations and judgments. In addition, they are well equipped to have the audit committee’s relationship with the external auditor be as effective as possible.

Participants also identified leadership experience, industry or sector expertise, and experiential and cultural diversity as critical skills that audit committees should have. While not mandated by law, these skills are important in helping the audit committee navigate management through the company’s risk environment:

• Experience leading a major organization. Audit committee chairs agreed that the committee must include someone who has run a major organization. In particular, audit committees are seeking individuals who have been CEOs and CFOs of sizeable entities and have experience managing business units

and leading a diverse set of employees. One recruitment executive said: “Audit committees are much more involved in analyzing management business decisions than acting as guardians of compliance. In Europe, the audit committee is there to provide tools and information to management to help them take the right decision in terms of the business strategy.” In addition, audit committee chairs said that operational experience is critical for risk oversight because audit committee members need to test management’s plans against their personal experience. “On the audit committee, the person geared to commercial success is less important than the person running the operations,” said one audit committee chair. “Do audit committee members believe that compliance is more important than turning a profit?”

• Industry or sector expertise. Participants emphasized the importance of having audit committee members with industry knowledge. One audit committee chair said: “It is very important to have someone in the industry who knows the regulatory environment and knows the competition.” Participants also said that audit committee members with experience outside the industry can bring valuable additional perspectives. One audit committee chair remarked: “It is very powerful when people move from one audit committee to another audit committee. They transfer a lot of knowledge.”

Leadership, diversity and financial and auditing expertise are key features of an effective audit committee continued


14 James Kanter, “E.U. Considers Quotas for Women in Boardrooms,” New York Times, 4 March 2012.

“I am extremely happy with the composition of my audit committee because it is so diverse. There is a wide variety of backgrounds and experience represented, so we can penetrate deep into the issues. Industry knowledge, combined with different backgrounds, enables you to penetrate the deeper issues of the business.” Audit committee chair

Diversity of culture, role and experienceA diverse representation of the skills outlined earlier supports a healthy debate on the audit committee and ensures that many perspectives will be taken into account when considering complex issues. Industry, geographic and gender diversity is important in fostering a constructive discussion and encouraging skepticism. One audit committee chair said: “I am extremely happy with the composition of my audit committee because it is so diverse. There is a wide variety of backgrounds and experience represented, so we can penetrate deep into the issues. Industry knowledge, combined with different backgrounds, enables you to penetrate the deeper issues of the business.”

Gender balance on the supervisory board has become a prominent issue in Europe. Several European countries have already established quotas, including Belgium, France, Italy, the Netherlands and Spain (although the last two have no sanctions for non-compliance).14 In India, the New Companies Bill prescribes that certain classes of companies shall have at least one woman director. Meanwhile, a European Commission consultation, focusing specifically on gender imbalance in the boardrooms of listed companies, ran from 5 March to 28 May 2012. Led by EU Justice Commissioner Viviane Reding, the EC’s report cited the limited progress on increasing the number of women on boards

and asked for input on possible action at EU level, including legislation.15 In November 2012, the authority in Brussels passed a diluted form of corresponding proposed legislation by the European Commissioner Reding. The initiative calls for a minimum of 40% of the “under-represented sex” to be included on the non-executive boards of publicly listed European companies by 2020. One audit committee chair said: “Boardroom gender diversity will be very much at the forefront of the corporate agenda over the next decade. And Europe seems to be leading the way on this issue.”

Participants said it is imperative to have cultural diversity on the audit committee. The audit committee should be sensitive to the cultural norms of the countries in which the company operates. One audit committee chair remarked: “We tend to look for people who have run an international division where they have had bottom-line responsibility and cultural responsibility. It’s important that the audit committee understands the cultural differences and, therefore, can ensure the right sort of culture of integrity, and accountability is driven down into the organization.”

15 European Commission, “European Commission Weighs Options to Break the ‘Glass Ceiling’ for Women on Company Boards,” news release, 5 March 2012.


“You need people in the Far East if you are ramping up your business in Singapore. It is comforting for the staff if someone is well recognized in those areas.” Audit committee chair

16 CFO and beyond: the possibilities and pathways outside finance, EY Global Limited 2012, page 43.

17 Heidrick & Struggles and Women Corporate Directors, “2012 Board of Directors Survey,” page 4.

18 Ibid

“Nice to have” skills for audit committee membersIn addition to the critical skills discussed above, participants highlighted several other characteristics that are increasingly in demand for audit committees, depending on the risks their companies face:

• Technology expertise. Some participants said operational knowledge of technology is becoming increasingly important for audit committees. One audit executive remarked: “IT security is important for many companies. Every quarter, we have a discussion about IT security trends that are emerging, because the company is changing and things are changing so rapidly in the environment.” A 2012 global EY CFO survey pointed out that technology expertise could become a significant “differentiator” for individuals looking for a board role: “There will … be a growing need for board members who understand the business implications of highly dynamic technologies, such as social media.”16 However, participants pointed out that there is a dearth of potential directors who combine technology experience with a sufficiently broad business background. As one audit committee chair said: “As important as cybersecurity is, you don’t want someone on the audit committee just because they have technology expertise.”

• Legal and compliance expertise. Directors remain concerned about the uncertain regulatory environment. A 2012 global Heidrick & Struggles survey found that directors agree that the greatest obstacle to achieving their companies’ strategic objectives is the regulatory environment.17 A recruitment executive remarked that an overwhelming challenge for boards remains striking the right balance between governance and

acting as a regulatory policeman. “The audit committee is caught in that crossfire with its own particular risk oversight responsibility. So it is important that the audit committee can handle the regulatory challenges that the company is facing.” In addition, some participants said it is important to have an attorney on the audit committee who has experience of dealing with regulators. One audit committee chair said: “There’s an increased focus on regulatory compliance. As a result, there is a need on the committee for an attorney with regulatory expertise and knowledge of cutting-edge compliance trends.”

• Experience in important overseas markets. In global companies, it is important to have someone on the audit committee with knowledge about the geographic reach of the business. Overseas locations have very strong and very different business protocols, regulatory frameworks and cultures. As one audit committee chair said: “You need people in the Far East if you are ramping up your business in Singapore. It is comforting for the staff if someone is well recognized in those areas.” Several participants cited the value of having individuals attuned to different cultures and different ways of doing business on the audit committee. “One always recruits into someone’s likeness if one is not careful.” However, international experience remains a gap in most boards. Only 5% of men and 7% of women believe international or global experience was their strongest skill set. This figure is relatively unchanged from 2011, according to the 2012 Heidrick & Struggles survey.18



Characteristics of the audit committee chairAudit committee chairs set the tone for the rest of the committee and lead the committee’s interactions with management and the auditors. Therefore, the chair should have the right temperament, skills and set of experiences to lead the committee. Effective audit committees are chaired by individuals who:

• Are knowledgeable about the competitive environment and business risks — and engaged with the business. Audit committee chairs must meet with a wide array of management and advisors on a regular basis, to understand the company’s key risks and the way in which the company is handling them. Former senior executives and audit partners with industry experience demonstrate the ability to assess how the company identifies and manages its key operational and strategic risks. One executive remarked: “You need an engaged audit committee chair. If you have someone with a solid pedigree but they are not interested in the business, they are worthless.”

• Have a willingness to challenge management. Several participants said that the best audit committee chairs are former CEOs who do not hesitate to challenge senior management when questions about a particular issue arise. “You can supplement the audit chair’s skills with complementary skills from the other members. But the chair must have a broad business background and the willingness to tell management when something doesn’t seem right,” said one recruiting executive.

• Possess influencing skills. In many ways, the job of an audit committee chair is more art than science. The chair must deftly manage relationships with management and both

internal and external audit, while prioritizing the audit committee’s role as custodian of the shareholders’ assets in its risk oversight responsibility. Former CEOs and CFOs who are experienced in influencing senior leadership are well-suited for this role. One audit committee chair remarked: “The audit committee’s role is, ever so firmly and nicely, to take a critical but supporting look over the areas of the business for which they have responsibility. It is a behavior thing. It simply does not work if you do not build confidence in those who are being subjected to audit committee oversight. Audit committees must be monitoring activities clearly and in a manner that is aiming at continual improvement of the organization and is not a witch hunt.”

• Take a “no-nonsense” approach to compliance. As regulators and standards setters continue their aggressive oversight, compliance experience and judgment is critical for the audit committee. The audit committee should take a firm stand against even minor shortcuts that may suggest a cultural problem, and the chair must set the tone for the rest of the committee. These behaviors are demonstrated most clearly by former audit partners who have a good record of using their judgment to solve difficult accounting questions and taking a skeptical approach to management decisions. One audit committee chair said: “There’s an inclination in management sometimes to say, ‘You have to take shortcuts to turn a profit.’ But an audit committee chair can’t accept that. We know the real world is different, but we are there to protect the company’s reputation and assets. We must have zero tolerance for this kind of activity.”


In addition, stakeholders interviewed for InSights reported on some important debates about the composition and recruitment of the audit committee.

A team of experts or a team of generalists?Audit committee chairs described a debate taking place about the ideal composition of the committee. Should it be composed of a team of specialists, each with specific and relevant expertise, or a team of generalists, with broader business backgrounds? The committee may decide that it needs members with high-level specialists. For example, it may require one member who has been the risk manager for a large company, one former auditor, one former finance director and one former industry expert. This is a group of experienced people dealing with all the major dimensions of the various topics that the committee has to oversee. The group then relies on those individuals to deal with the issues in which they are experts.

One audit committee chair suggested that this method is ineffective in forming a team because it discourages collaboration, which is an important element of a successful audit committee. “You need to have a very strong chair who is an experienced financial expert. You need to surround the chair with experienced people who have been living through a lot of complexities and can smell when something is wrong — experienced business people who can read body language. You need a team that is passionate about the mission of the organization and can work together in a challenging and collaborative way.”

What is the value of financial experts on the audit committee?A second debate taking place in some boards concerns the amount of financial expertise needed on the audit committee. While all participants agreed that it must contain at least one financial expert, some participants said that financial expertise is now just “hygiene” and only one expert is needed. “Our finance staff and external auditors are world class, and the most significant risks lie elsewhere,” said one audit committee chair. A risk executive remarked that audit committee members need to have an appreciation for how the business functions work together in a holistic way: “Audit committee members need an understanding of the business the company is in. You need to have an understanding of how finance, IT strategy and marketing [come] together. But you also need to be able to engage with


some level of expertise on something that is purely IT related, or purely marketing related.”

On the other hand, some participants said that financial expertise remains critical. The interconnected global marketplace is adding complexity to financial decision-making, and strong financial stewardship is more important than ever. One audit committee chair remarked: “Boards do appreciate having true audit committee financial expertise. Members who have the background of a CFO or an audit partner are really appreciated. With the challenges of the accounting rules and the auditing standards, that kind of knowledge is very important.”

Do diversity quotas help or hurt?Participants outlined the case for the European board diversity quotas:

• They will inject new perspectives into the boardroom. Some observers have noted that women are more likely to be open to new ideas than their male counterparts. A study published recently in the International Journal of Business Governance and Ethics found that women were more likely to use “co-operation, collaboration and consensus building” when dealing with complex decisions … While male directors more often made decisions by using “rules, regulations and traditional ways of doing business.” One advisor noted: “To be quite honest, the old boys’ network does not work in the same way if women are there. It gives them a different perspective.”

• They will improve the pipeline of female directors and executives in the long term. Diversity quotas are encouraging boards to recruit and train women executives for board positions. One audit committee chair said: “When they imposed the quota, I was against it. But my thoughts on this are evolving. Yes, there will be token appointees, but the new wave of women directors is very different. I am seeing, in quite a few companies, younger women with tremendous executive experience but no board experience beginning to get appointed to the board. In the long run, this will help the women directors and the companies they serve.” Recruitment executives also pointed out that more females will be appointed to the executive committee as a result of the diversity mandates, and they will challenge management to place more females in executive roles.

However, others believe that diversity quotas will make boards


“Audit committee members need an understanding of the business the company is in. You need to have an understanding of how finance, IT strategy and marketing [come] together. But you also need to be able to engage with some level of expertise on something that is purely IT related, or purely marketing related.” Risk executive

19 Elena Ralli, “Launch of the ‘Global Board Ready Women’ database,” NewEurope Online, 12 December, 2012.

and audit committees less effective in the short term by limiting the talent pool that boards are sourcing from. Boards that need to fill a position and have not reached the gender quota, will need to recruit from a pool of women directors only, which will require companies to cast a wider net in their search. One recruitment executive remarked: “There is a smaller pool of candidates to choose from now. It’s a supply and demand question, which can be exacerbated by diversity quotas. The pool is so limited that you have to look outside the traditional industries and functions to find good people. The supply side is not strong enough.” This will be healthy in the long term because it will ensure that more candidates have board experience, but may weaken boards in the short term. One audit committee chair said the committee is so important to the governance of the company that “you can’t tolerate a weak member. It’s a big responsibility, a lot of work and you have to have people who are confident in their abilities and have the courage to challenge management.” Another said bluntly: “You are not picking the best people anymore. We will have to recruit younger women. Gender is first, competence is second.”

As part of Commissioner Reding’s proposal, the European Business Schools Women on Boards Initiative established an online database of 8,000 names of women ready to serve boards of global, publicly held companies. The list will be accessible to all companies looking for new board members. Upon the launch of the database, Commissioner Reding said, “I often hear the argument that there are not enough qualified women to occupy positions in the boardroom. Today, European Business Schools and their colleagues around the world are shattering those myths, as well as glass ceilings. The list shows that the qualified women are there — 8,000 of them. Companies should now make use of this untapped pool of talent.”19

One audit committee chair said that the diversity quotas will encourage boards to scrutinize all potential candidates — men and women — because the discussion about director competence has now been elevated: “The new regulation will give more importance to qualifications among potential directors. Giving a higher profile to qualifications and expertise is a good thing. When you recruit a new audit committee member, you are considering all of their qualifications — not just gender. By focusing on the qualifications, that opens the board to more diversity in terms of gender and national diversity, but it upgrades the overall talent of the men as well.”

Questions for audit committees• What is the ideal composition of your audit committee?

What skills must the audit committee have?

• How important is diversity of expertise and other board service when determining the composition of the audit committee? How important is gender and national diversity?

• Certain countries have adopted regulations or set voluntary targets around board diversity. How have those quotas affected companies’ ability to recruit?


Boards are adapting their recruiting procedures

Participants reported that the process for recruiting non-executive directors — and audit committee members — is straightforward. Many boards maintain matrices that identify the skills that the board needs and how those needs are currently being met. Ideally, the matrix will reveal gaps that the board must fill when members of the audit committee rotate onto other board committees, retire or resign. The nominating and governance committee will develop a shortlist of needs that the board has and attempt to meet those needs in two ways: by tapping into directors’ personal and professional networks and by hiring a recruitment firm to find an individual that fits the ideal profile.

In the words of one audit committee chair, the committee will look for a “director first, and committee member second.” But in all cases, the committee and the board will have a good idea about the committees that the recruit will serve on if selected. The time that the director will spend as a general board member before joining the audit committee depends on the board culture and the audit committee’s immediate needs. Some boards require directors to serve 6 to 12 months before joining the audit committee, whereas others prefer to have the director join the audit committee right away to accelerate the individual’s understanding of the company.

The task of recruiting effective directors has been challenging in recent years due to the limited talent pool and the increasing time commitment required. The Wall Street Journal reported that “European boards convene an average of nine times a year … and Board service and travel consumes an estimated 300 hours a year in Europe.”20 The time commitment for an audit committee member is higher. One audit committee chair remarked: “You don’t want people who are so busy that they can’t get into the numbers. You want people to devote the time to survey the financial data. You typically have 600 pages to read three days prior to the board meeting. It’s a huge workload. So you’ve got to have a penchant for detail.” The time commitment makes it difficult to attract current executives to join the board. One recruitment executive said that some sitting CFOs who look to join more than one board are prohibited by their own boards.

20 “Shattering myths and glass ceilings: Launch of database of Global Board Ready Women,” Europa press release, 12 December, 2012.


A constrained talent pool and limited time commitment have always been challenges for boards and recruitment firms. But those challenges have been intensified by diversity quotas, a need for new skills on the board and the enterprise-wide risks that are demanding more engagement from boards and, particularly, audit committees. These challenges pose some important questions for boards, nominating committees and audit committees. As one recruiter said: “It is a simple business. But it is very difficult to execute and the stakes are enormous.” Boards are still searching for the best ways to recruit new directors. According to a 2012 global survey of directors conducted by Heidrick & Struggles: “Only a little more than a third (36%) of non-US directors say their boards have an effective process for director succession.”21 In this section, we will explore:

• How are companies expanding their search for effective directors?

• How will the recruitment process adapt to these challenges?

• How can the audit committee support new members?

How are companies expanding their search for effective directors?Participants noted that boards are exploring diverse geographies, industries and sectors outside the traditional scope to find strong director candidates.

• Alternative geographies. Companies are looking beyond their borders to find audit committee members to fit their needs. Indeed, according to the Wall Street Journal, European boards are looking toward the United States to attract executive women. Several executive recruiters describe a recent groundswell in European boards’ pursuit of female American business leaders, partly because the US has a larger pool of senior executive women.22

• Alternative industries and sectors. Boards are looking beyond the traditional pool of director candidates to find new members. One recruiting executive said: “Given the shrinking talent pool, you may have to consider alternatives. In the past, most companies might hesitate to put a pure academic on the board, but a person running a large university may be fantastic on a board: they are bright and, most likely, have dealt with a large organization.” In addition, venture capitalists are increasingly in demand among boards because of their experience at the cutting edge of strategy and industry disruption. “Venture partners are so on top of technology trends, they’ll help you assess which risks and trends are emergent,” said one audit chair.

“Given the shrinking talent pool, you may have to consider alternatives. In the past, most companies might hesitate to put a pure academic on the board, but a person running a large university may be fantastic on a board: they are bright and, most likely, have dealt with a large organization.” Recruitment executive

21 Heidrick & Struggles and Women Corporate Directors, “2012 Board of Directors Survey,” page 4.

22 Ibid.


How will the recruitment process adapt to these challenges?As companies search for board members outside the traditional boundaries of industry and geography, observers have wondered whether the traditional board recruitment process will change. Andrew Hill, of the Financial Times, called LinkedIn “potentially the biggest menace to recruitment firms.”23 Hill wrote: “As new generations of directors take office, boards will get more comfortable with internet matchmaking, even for senior positions. They will cull superficial and superfluous relationships, maintaining links only with higher-caliber, specialized advisors — the search equivalents of bespoke travel agencies, risk-specific insurance brokers and city-center boutiques.”

The traditional model of recruitment firms and directors’ own relationships continues to be the main vehicle to finding committee members. As one recruiting executive put it: “Can you find one large, global company that has recruited a board member through a social networking vehicle?” However, many agreed that technology tools will play an increasingly important role in the long term, at least as a complement to more traditional methods. As one audit chair said: “It is rare to find even directors who do not use social networking sites, at least passively. As directors get younger, and technology becomes more important, it is easy to see social networking playing a bigger role in recruiting directors.”

How can the audit committee support new members?With its burdensome workload and increasingly complex portfolio, the audit committee expects new members to get up to speed very quickly. And they must adapt quickly too, because the issues and the risks are changing constantly. This challenge is intensifying, because the audit committee must consider more inexperienced talent, leading some boards to set up an onboarding process for new members. Participants described two ways in which audit committee members learn on the job:

• Informal mentorships. Some new audit committee members shadow current audit committee members to gain a better understanding of the job. One audit committee chair said that the mentorship model works very well: “You cannot be an effective audit committee member in the first six months that you are a director. So having certain people who you can rely on to answer questions when they come up can be very helpful in enhancing your understanding of the business.”

• Formalized training programs. Internal audit, external auditors and management can provide training based on the new audit committee members’ needs. For example, this can encompass technical or sector knowledge. One audit committee chair provided an example: “We have a six-week program for all people coming into the board. New board members attend two audit committee meetings. And new audit committee members go through three to four education sessions with someone from the external audit firm. The firm outlines rules and regulations and they go through the important elements in the industry.” In some cases, the audit committee may bring in outside consultants to brief new audit committee members on high-risk areas, such as corruption, compliance and technology risk.

Questions for audit committees• What are the most significant challenges your board faces

in recruiting new audit committee members?

• Should the “traditional” board recruitment process change? How is the pool of candidates for boards and audit committees changing?

• How can the audit committee support new members?

Boards are adapting their recruiting procedures continued

23 Andrew Hill, “Executive Heads Hunted by New Tribes,” Financial Times, 4 March 2013.


Conclusion

About this documentInSights is produced by Tapestry Networks. Its purpose is to provide assessments of key issues of interest to audit committee members in Europe. It is distributed by EY and Tapestry Networks. Anyone who receives InSights may share it with those in their own network. The ultimate value of InSights lies in its power to help all constituencies develop their own informed points of view.

The views expressed in this document represent those of the individuals who participated in the research. They do not reflect the views nor constitute the advice of network members, their companies, EY or Tapestry Networks.

About Tapestry NetworksTapestry Networks is a privately held professional services firm whose mission is to advance society’s ability to govern and lead. Since 2002, Tapestry Networks has helped to tackle some of the most significant strategic challenges facing institutions and society, including raising standards in corporate governance in the United States, Canada and Europe; developing strategies for a more sustainable health care environment in Europe; and enhancing national security in the United States through public-private collaboration. Tapestry Networks organizes and leads nine audit committee networks with the active support and engagement of EY. Collectively, the networks consist of chairs of about 255 audit committees who sit on over 450 boards at some of the world’s leading companies. For more information, please visit www.tapestrynetworks.com.

The pressures on audit committees are enormous and continue to grow. Audit committees are responsible for greater risk oversight and are performing their duties under intense scrutiny. As a result, the composition of the audit committee is more important than ever. Audit committees require members with diverse backgrounds, yet they must also ensure that certain skills and characteristics are present. These include financial expertise, industry or sector knowledge and auditing experience. Many audit committees are seeking qualities beyond these “must-have” skills. These include technology expertise and sensitivity to different cultures and compliance customs. However, the pool of potential audit committee members is shallow. And this situation is exacerbated by the diversity quotas that have been established in certain European countries.

The good news is that many dimensions of professional life can be training grounds for the audit committee. One audit committee chair remarked: “It is most important for the audit committee to ask the right, penetrating questions. People who have been exposed to a wide array of challenges in life learn that, every time they get into a new area, they learn the techniques to ask the right questions. It is amazing to see how quickly people with very limited specific knowledge get to the heart of the matter. It is important to have people with a variety of life experiences — whether you are a government minister, executive, director or academic — and it is a good sign when people have been able to make it in a variety of aspects in life.”

“It is most important for the audit committee to ask the right, penetrating questions. People who have been exposed to a wide array of challenges in life learn that, every time they get into a new area, they learn the techniques to ask the right questions. It is amazing to see how quickly people with very limited specific knowledge get to the heart of the matter. It is important to have people with a variety of life experiences — whether you are a government minister, executive, director or academic — and it is a good sign when people have been able to make it in a variety of aspects in life.” Audit committee chair


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About EY’s Assurance Services Strong independent assurance provides a timely and constructive challenge to management, a robust and clear perspective to audit committees and critical information for investors and other stakeholders. The quality of our audit starts with our 60,000 assurance professionals, who have the experience of auditing many of the world’s leading companies. We provide a consistent worldwide audit by assembling the right multidisciplinary team to address the most complex issues, using a proven global methodology and deploying the latest, high-quality auditing tools. And we work to give you the benefit of our broad sector experience, our deep subject matter knowledge and the latest insights from our work worldwide. It’s how EY makes a difference.

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The views of third parties set out in this publication are not necessarily the views of the global EY organization or its member firms. Moreover, they should be seen in the context of the time they were made.

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Appendix A: Research participants

Tapestry Networks interviewed a broad range of board directors, investors and subject matter experts. All discussions were held under a modified version of the Chatham House Rule, whereby views expressed during the discussions are not attributed to individuals or their organizations. In addition to seeking the views of audit chairs on the various networks run by Tapestry, the following directors and subject matter experts were interviewed specifically for this issue of InSights:

• George Anderson, Consultant, Board Advisory practice, Spencer Stuart

• R Balachander, National Leader, Accounting, Compliance and Reporting, EY India

• Aldo Cardoso, Audit Committee Chair, GDF SUEZ

• David Cookson, Consultant, CFO and Board Practice, Russell Reynolds

• Ángel Durández, Audit Committee Chairman, Repsol

• Richard Emerton, Managing Partner, Board & CEO Services, EMEA, Korn/Ferry

• Guido Ferrarini, Vice Chairman, European Corporate Governance Institute

• Judith Hanratty, Chairman, Commonwealth Education Trust, Nominating & Governance Committee and Audit Committee Member, PartnerRe

• Reg Hinkley, Audit Committee Member, Society of Lloyd’s

• Rebecca Hill, Diversity & Inclusiveness Leader, EMEIA Transactions, EY

• Lou Hughes, Audit Committee Chair, ABB

• Andy Hunter, Founder and Managing Partner, Ridgeway Partners

• Joost Kuiper, Audit Committee Chair, ING

• Daniel Lebègue, President, Institut Français des Administrateurs

• Daniela Mattheus, Executive Director, Head of Corporate Governance Board Services GSA, EY

• Luke Meynell, Co-leader, European Board Services Practice, Russell Reynolds

• Bertrand Richard, Co-leader, Board Services Practice in Europe, Spencer Stuart

• Pierre Rodocanachi, Audit Committee Member, Vivendi

• Mark Rogers, Founder and CEO, Board Prospects

• Nick Rose, Audit and Risk Committee Chair, BT Group

• Ruby Sharma, Leader, Audit Committee Center, EY

• Guylaine Saucier, Audit Committee Chair, Areva

• Dominic Schofield, Senior Client Partner, Board & CEO Services, Korn/Ferry

• Jakob Stausholm, Audit Committee Chair, Statoil

• Natacha Theytaz, Chief Audit & Risk Advisory Executive, Roche

• Marcel van Loo, Country Managing Partner, The Netherlands, EY

• Dominique Vincenti, Vice President of Internal Audit and Financial Controls, Nordstrom

• Bernd Voss, Audit Committee Chair, Continental AG

• Suzzane Wood, European Financial Officers Practice Leader, Russell Reynolds

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