The Board of Directors 527manager may justify some charge-offs, and since the directors don’t want to dis-
agree with the new chief executive officer during the honeymoon period, this
tactic is sometimes tolerated. If the inf lated earnings lead to extraordinarily
high bonuses in future years, the board may regret its failure to act.
Audit Committee Activities
In probing for the possible existence of any of the situations described above,
the audit committee takes two approaches. First, it asks probing questions of
management: Why has the receivables-reserve percentage changed? What is
the rationale for a large write-off of assets?
Then, and much more important, the committee asks similar questions of
the outside auditors. The audit committee usually meets privately with the
outside auditors and tells them, in effect, “If you have any doubts about the
numbers, or if you have reason to believe that management has withheld mate-
rial information, let us know. If you don’t inform us, the facts will almost cer-
tainly come to light later on. When they do, you will be fired.”
A more polite way of probing is to ask the following: “Is there anything
more you should tell us? What were your largest areas of concern? What were
the most important matters, if any, on which you and management differed?
Did the accounting treatment of certain events differ from general practice in
the industry? If so, what was the rationale for the difference? How do you rate
the professional competence of the finance and accounting staff ?”
Usually, these questions are raised orally. Because the auditors know from
past experience what to expect, they come prepared to answer them. Some
audit committees provide their questions in writing prior to the meeting.
Although cases of improper disclosure make headlines, they occur in only
a tiny fraction of 1% of listed companies. Most such incidents ref lect poorly on
the work of the board of directors and its audit committee. Increasingly, the
courts penalize such boards for their laxity. Directors are aware of the fact
that when serious misdeeds surface, the CEO often leaves the company, but
the directors must stay with the ship, enduring public criticism and the blot on
their professional reputation. Their lives will be much more pleasant in the
long run if they act promptly.
Quarterly Reports
In addition to the annual financial statements, the SEC requires companies to file
a quarterly summary of key financial data on Form 10-Q. Because the timing of
the release of this report usually does not coincide with an audit committee
meeting, most audit committees do not review it. Instead, they ask the CEO to
inform the committee chair if there is an unusual situation that affects the quar-
terly numbers. The chair then decides either to permit the report to be published
as proposed or, if the topic seems sufficiently important, to have the committee
meet in a telephone conference call or an e-mail exchange to discuss it.