The Functioning of Public Company Board Committees

A company’s board of directors is responsible for oversight of management and providing strategic guidance from an outside perspective. They also play a major role in protecting shareholders’ interests. Board committees exercise oversight over specific corporate governance functions. They play a key role in assisting the board of directors and management with fulfilling its duties.

Audit Committee

A company’s audit committee is responsible for overseeing reports of the company’s financial results, internal controls, audit reporting, and ensuring compliance with company codes of conduct with respect to financial reporting.

All of the members of the audit committee must be independent. Independence is defined based on the stringent requires of the Sarbanes-Oxley Act and the Securities and Rule 10A-3 set by the Securities and Exchange Commission (SEC). The two major U.S. stock exchanges, the New York Stock Exchange (NYSE) and Nasdaq, also require compliance with these independence standards.

Each member of the audit committee must be “financially literate,” meaning they can read and interpret key financial statements. In addition, at least one member of the audit committee must have “financial expertise,” meaning they have accounting or related financial management expertise and must satisfy the criteria of being an “audit committee financial expert” under the rules and regulations of the SEC. Under the Sarbanes-Oxley Act, an audit committee financial expert is an individual that has all of the following skills:

  • An understanding of generally accepted accounting principles (GAAP);
  • The ability to assess the general applications of GAAP;
  • Experience preparing, auditing, or evaluating financial statements that present a reasonably complex range of accounting issues, or experience actively supervising such activities;
  • An understanding of internal controls for financial reporting;
  • An understanding of the roles and responsibilities of the audit committee

Compensation Committee

A company’s compensation committee is responsible for formulating the company’s executive compensation principles and key compensation policies, as well administering and approving compensation for executive officers.

All of the members of the compensation committee must be independent, subject to limited exceptions for controlled companies. The rules of both the NYSE and Nasdaq require the independence evaluation to take into consideration whether any sources of director compensation could impair their judgement. The stock exchanges prohibit any director from accepting any consulting, advisory, or other compensatory fee paid by the company or its subsidiaries.

The compensation committee will perform functions such as, among other things:

  • Approving participation in equity awards and grants under the company’s equity plans;
  • Reviewing and discussing with management the Compensation Discussion & Analysis disclosure to be included in the company’s 10-K annual report;
  • Reviewing and discussing with management and the board of directors the company’s compensation principles and practices and benefits to employees;
  • Reviewing and making recommendations to the board with respect to executive incentive compensation arrangements;
  • Making recommendations to the board of directors regarding director compensation;
  • Reviewing and making recommendations with respect to executive officer succession planning;
  • Monitoring compliance with stock ownership rules and the company’s clawback policy

Nominating and Governance Committee

A company’s nominating and governance committee is responsible for formulating and continually reviewing the company’s governance structure and practices.

All of the members of the nominating and governance committee must be independent, subject to limited exceptions for controlled companies. The nominating and governance committee will perform functions such as, among other things:

  • Overseeing the annual self-evaluation process for the company’s directors and management;
  • Reviewing and evaluating stockholder proposals and director nominees proposed by stockholders;
  • Assisting the board on corporate governance matters;
  • Searching for qualified director candidates;
  • Reviewing proposed waivers of the code of conduct and ethics for directors and executive officers

Other Board Committees

In addition to the three main board committees—the audit committee, compensation committee, and nominating and governance committee—that companies are mandated to have by securities regulations and stock exchange rules, companies may opt to have additional board-level committees. Additional board-level committees may be put in place as a result of industry practice or to address topics that require more specific attention.

For example, for companies in the industrial and energy sectors, it is more common to see a board-level safety and sustainability committee. Such a committee will have responsibility for oversight of the company’s environmental, health, safety, and sustainability measures.

Other examples of specialized board committees include a public policy committee, a cybersecurity committee, a risk management committee, and a credit committee. Under the requirements of the Dodd-Frank Act, publicly traded bank holding companies with greater than $10 billion of assets are required to establish a risk management committee.

Companies may occasionally establish ad hoc committees on a temporary basis in order to address specific challenges. For example, a special litigation committee may be temporarily implemented in order to determine whether claims in a shareholder derivative lawsuit brought against the company should be settled or dismissed.

Executive Sessions

The non-management directors are expected to meet regularly in executive sessions. The executive sessions provide the independent members of the board with a forum to have open discussions about topics such as management performance and CEO succession planning. Companies listed on the NYSE are required to hold regular executive sessions; companies listed on Nasdaq are required to hold executive sessions at least twice per year. While executive sessions serve an important function by allowing problems to be discussed outside the presence of management, board members should also take precautions to make sure that such sessions do not have a negative impact on board collegiality.