Unleashing the Watchdogs

Audit boards are trying to show teeth. It won't be easy

In anyone's list of culprits in the Enron (ENE ) bankruptcy, the board's audit committee appears near the top. Its poor performance underscores something audit committee members have known for years: They have the most difficult and hazardous job on any board. As boards struggle to reform their own audit committees in Enron's murky wake, they face a truly difficult task: making badly needed improvements to an audit-committee system that has resisted improvement in the past. And the boards need to do so without creating unintended new problems in the process.

In boardrooms and executive suites across Corporate America, Enron has prompted a fundamental rethinking of how audit panels are recruited, paid, and expected to perform. Audit committees' main task is to oversee the external audit and to monitor company finances. But over the years, many audit panels have fallen down on the job. They often sign off on hiring "independent" auditors, who, in fact, come with massive conflicts of interest, including multimillion-dollar consulting contracts with the company they're supposed to be auditing. And even the most upstanding audit panels often fail to ask the tough questions.

To address those problems, boards are considering a host of reforms. Tops on the list are more frequent meetings and more generous pay for committee members. Companies also are casting the net wider in hopes of finding topflight financial executives willing to serve as audit-committee chairmen. And they are beginning to ask directors with financial ties to the company to step aside.

Will such changes transform these committees into corporate watchdogs with real teeth? That will be tough because the proposed reforms do little to address the problems--and they may even create new ones. Many governance consultants now suggest that the audit committee add an extra two meetings a year, for example. But that's unlikely to be enough to improve oversight significantly, especially at companies like Enron Corp. or Tyco International Ltd. (TYC ) with hugely complicated financials. And more frequent auditor committee meetings would do nothing to solve the biggest problem: "At some companies, external auditors feel they work for the chief financial officer," says Bruce R. Chizen, CEO of Adobe Systems Inc. (ADBE ) "That should change."

Then there's the issue of pay. Given the increased amount of work involved, compensation experts say many companies are considering paying audit panel chairmen an additional $5,000 on top of the $10,000 most of them receive now. However, that's hardly enough of an incentive for busy, talented executives to serve. And the more audit committee members are paid, the more the risks increase from the inherent conflict that exists when any watchdog is on the company payroll.

Recruiting CFOs and former chief executives of Big Five accounting firms to serve on the audit committee, as both Adobe Systems and Accenture Ltd. have done, is a more promising approach. Who better to grill auditors than someone who does it for a living? Unfortunately, there are only so many of these folks to go around. Assigning the audit committee a staff of its own or making the committee's chairmanship a full-time job, two other alternatives that have been gaining currency among corporate leaders, place the audit committee on a slippery slope. Give the audit committee a bureaucracy, a budget, a salary, and benefits, and it would be virtually indistinguishable from management.

So do companies that want to ensure that their audit panels get the job done have any options? The best place to start would be insisting that the audit committee, not the CFO, choose and hire the outside auditor. And committee members should have frequent contacts with the auditors--without management present--to discuss any accounting issues that arise.

Those moves would go a long way toward making it clear who's the boss when it comes to auditing. Fundamentally, though, the key to building a successful audit committee lies in attracting directors who know enough about finances to ask the right questions and who are brave enough to stand up to the chief financial officer and the rest of management when they smell something fishy. Unfortunately, there are no good rules for achieving that.

By Louis Lavelle in New York

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