The Committee for Economic Development (CED), a business-led public policy group, on Tuesday released a policy statement examining the state of corporate governance in the U.S. and offering practical recommendations for restoring public trust in business.
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“The high-profile corporate scandals of the past few years, coupled with numerous problems regarding financial statements, have shaken shareholders’ trust in many businesses leaders and their companies,” Roderick M. Hills, co-chair of CED and chair of the CED Subcommittee on Corporate Governance, said in a prepared statement. “It is imperative that we take concrete steps to restore the practices and processes that are the foundation of good business ethics. Specifically, I believe that the auditing process must reflect responsibility by company leaders, not just a rigid adherence to accounting rules. The auditing process needs to be guided by an over-arching set of principles that guarantee that the CEO, Board of Directors, and other top company officials know that they are fully committed to providing a truly fair and clear presentation of the firm.” Hill is currently a partner at Hills, Stern and Morley.
CED’s recommendations include:
- Making Audit Committees Autonomous and Vigorous In order to accurately present a company’s position, the board of directors must have access to all pertinent data. This will only occur if a board’s auditing committee is competent, independent and establishes effective control over both internal and independent external auditors. The relationship between the audit committee and the internal and external auditors is crucial. The audit committee should exercise the same tone of control over the internal auditor as it does over the external auditor, extending to decisions of hiring, firing and compensation.
- Ensuring that Users Understand that financial Information is Based on Judgments Financial statement would be more useful if they were governed by fewer rules and displayed more judgment that lies behind estimated numbers. Stock analysts, the investing public, and regulators, must recognize the inherently judgmental character of accounting statements and financial information. Ranges of values, rather than precise numbers, should be explained and understood as such. In addition, financial statements should be supplemented with non-financial indicators of value.
- Giving Sarbanes-Oxley a Chance to Work CED sees room to tailor the requirements imposed by Section 404 of Sarbanes-Oxley within the existing statute, and endorses the Public Company Accounting Oversight Board (PCAOB) and Securities and Exchange Commission (SEC) implementation guidance, based on their evaluation of the first-year experience. The guidance, issued simultaneously by the two agencies in May 2005, should lower the costs and increase the value of Section 404 compliance. Moreover, CED does not recommend a broad exemption from Sarbanes-Oxley requirements for small capitalization companies, but nevertheless, supports the objective of mitigating the costs to smaller companies.
- Taming Excessive Executive Compensation In CED’s view, the disparity of income between top corporate executives and average employees is a cause for serious concern. The differentials that exist today too often reflect neither market conditions nor individual performance. The procedure for determining executive compensation has been broken at far too many of our larger corporations, and CED believes that the solution to excessive compensation must be regarded as a matter of process and disclosure, including compensation committees must adopt measurable, specific, and genuinely challenging goals for the performance of their businesses, and judge management by them; the compensation process must be run by compensation committees composed of independent directors; the compensation committee should have direct authority over all terms of any management contract, including all forms of compensation; management should have a substantial equity interest in their company; and management should make a full, timely, and transparent disclosure to shareholders of its compensation.
- Using Independent Nominating Committees to Select and Appraise Directors A paradox of corporate stewardship is that, despite the principle that directors represent shareholders in the selection and retention of management, historically, most directors have been selected by management. In the CED’s view, the best approach to building high-quality boards is to assign to truly independent nominating committees the responsibility for recommending new board candidates and for evaluating the performance of existing board members. The nominating committee should also have the responsibility of recommending committee assignments.
“We acknowledge at the outset that no laws or policies will ever be sufficient to end all corporate misbehavior – or, for that matter, misbehavior in any segment of public life,” Hills continues. “We are confident, however, that truly independent and inquisitive boards of directors will provide the best safeguard against corporate wrongdoing.”
An executive summary of the recommendations in Private Enterprise, Public Trust: The State of Corporate America After Sarbanes-Oxley is available at www.ced.org.