Chairman’s Style Governs Board Dynamics

Audit committees occupy center stage in the wake of corporate scandals and the resulting reforms brought on by Sarbanes-Oxley. With significantly increased responsibility to oversee the accuracy of corporate financial reporting, audit committees are understandably nervous these days. Although they have always been critically important in corporate governance, these committees are now feeling the glare of governmental and public scrutiny like never before. This newly intensified public role is resulting in new organizational as well as psychological challenges that need to be understood and addressed.

As a consultant to CEO’s and directors on issues involving boardroom dynamics and relations between boards and senior management, I’ve seen close up the organizational and psychological stresses confronting the audit committee. These stresses can result in a wide range of potential dangers that the audit committee and the full board needs to be sensitive to in order for the audit committee to effectively meet its charter mandate.

One danger is the possibility that audit committees will become paralyzed by this increased scrutiny, fearful that any move they make will be watched and criticized. In the name of accountability, they run the risk of becoming overly conservative in their oversight role, and even inhibiting the management team from taking reasonable risks and being creative — albeit in a legal way.

The newly mandated role of the “audit committee financial expert” is also fraught with psychological pitfalls. While some audit committees have sorely needed a dose of rigor and expertise, they now might invest undue power in the person who holds this role. The “audit committee financial expert” is in danger of becoming viewed as the ultimate authority who will keep the company honest, despite the fact that this unenviable expectation far exceeds what any one individual can do. Will the expert acquire so much authority that he becomes cast in an unfortunate power struggle with the CFO or the CEO? And could the “audit committee financial expert” become the object of envy and competition from other board members, or diminish the role of the chairman?

Various factors might account for the apparent laxity of some audit committees in the past. Members of audit committees are human, and subject to all the natural forces of group dynamics that can be expected under these circumstances. When you have a personal stake in believing that something you are overseeing is being done right, there is an expectable pull either to be extremely cautious and scrupulous, or to not look very deeply at all. We may veer towards the latter in circumstances where the prevailing culture is one that rewards conformity and cohesiveness rather than open debate and dissent. Reports provided by management, internal audit and the external auditors may be accepted a bit too much on faith, and there might be an unspoken peer pressure to gloss over questions they might otherwise be pursued. Retaining membership in an “exclusive club” by not making waves, can become more important than doing what is right.

Audit committees are like the chaperone on the high school trip: they’re supposed to keep an eye on the occasionally unruly kids, but they also know that it’s a perennial struggle to get a close enough, real-time view. Neither Sarbanes-Oxley, nor any other rule-based approach, can guarantee that audit committees will catch every misdeed.

A real danger is the potential view of these committees as saviors. But just as audit committees are at risk of being blamed, they are also at risk for being seen as knights on white horses. This view may lead to some members acquiring an exaggerated sense of their own importance. What about the relationship between the audit committee and the larger board? Will audit committees now acquire more influence and power, and inadvertently disempower the board as a whole? Will members of the audit committee be envied for their power, or pitied for the weight of their increased responsibility? Will board members be reluctant to serve on audit committees? And what about the prospects for tension between the “audit committee financial expert” and other members of the audit committee, the board or management?

While there are no easy answers to these questions, the best way for audit committees to avoid the pitfalls is to be alert to their possibility in the first place, and to frequently examine and reflect on their performance as individuals and as a group. This might include a formal self-evaluation, an approach now being adopted by many companies based on proposals from the NYSE, seeking more constructive feedback from management and the board, or the use of external consultants on organizational dynamics.

Audit Committees are facing a time of tremendous change with increased pressures to meet ever higher expectations; and with increased responsibility comes the opportunity to make a difference. There is no formula for audit committee success, but ongoing vigilance and heightened awareness to the organizational dynamics and psychological dimensions of their roles can strengthen an audit committees functioning and help insure that they continue upholding the highest standards of accountability.

Kerry J. Sulkowicz, M.D., founder of The Boswell Group LLC in New York City, advises senior executives and boards of directors on psychological aspects of management and governance. He also writes the “Corporate Shrink” column for Fast Company magazine, and can be reached at 1-212-737-1542 orkjs@boswellgroup.com.