BoardMatters Quarterly, January 2012
From the chair
"We need CEOs and boards to have the courage to do acquisitions, innovate and develop new products.”Eileen Mallesch, Audit Committee Chair for Bob Evans Farms and State Auto Financial Corporation
One audit committee chair’s perspective on planning for the future, board diversity and other current issues.
We recently sat down with Eileen Mallesch, Audit Committee Chair for Bob Evans Farms and State Auto Financial Corporation, to talk about several issues of importance to her and other board members. She shared her thoughts on risk, succession planning, supporting business growth, board diversity and more.
Following are excerpts from her discussion with Diane Larsen, a partner at Ernst & Young LLP and our Americas Assurance Markets Leader.
Eileen Mallesch is the Audit Committee Chair for Bob Evans Farms and State Auto Financial Corporation. She can be reached at firstname.lastname@example.org.
Diane Larsen is an audit partner at Ernst & Young LLP and can be reached at email@example.com.
- The audit committee’s role in addressing risk and supporting growth
Diane Larsen (DL): Can you start by reflecting on your role as audit committee chair in the last three years? What’s been the most significant change you’ve seen and what do you think the focus will be moving forward?
Eileen Mallesch (EM): I would say first and foremost, the biggest change is the heightened sense of urgency around establishing a robust risk management approach, particularly as it relates to emerging risks. It’s been on the top of the agenda for audit committees for the last three years and will continue to be in 2012.
In addition to risk management, strategy and business development should be top agenda items in 2012 for boards and audit committees.
It’s important to understand management’s approach to risk, but it’s a death knell if you do not consider the other side of what’s called the risk coin, and that’s risk aversion.
Although the pace of the economic recovery has been very slow and bumpy, we still need CEOs and boards to have the courage to make acquisitions, innovate and develop new products. Apple is an outstanding example of an organization that continues to come up with innovative products and designs and proves that you can have great growth and profitability, even in this environment.
DL: In terms of risk, it seems some companies struggle with focusing not only on financial risks but also on operational and reputational risks, including questions about who will take ownership of oversight.
EM: It is important to note that oversight of enterprise risk management rests with the entire board. Ultimately, the responsibility for risk management and its internal controls has to permeate the entire organization. I don’t take comfort just because a company has a chief risk officer. My test is how the company is demonstrating that risk management has been operationalized.
It is too easy to fall into a silo risk management mind-set that fails to bridge risks within the organizational processes.
DL: There was a time when companies only asked senior-level executives about risks. In recent years, as organizations have been getting larger and more global, many are realizing that staying at that C-suite level might not be enough. They recognize that they need to consider the real operators down on the ground, right?
EM: Absolutely. I’m sure it’s no surprise that at Bob Evans, food safety is the number one risk, and it doesn’t make a difference if the C-suite or the next level down is all over understanding it; it’s a mind-set that must translate to the front-line associates who are out in the restaurants on a day-to-day basis.
You want to ensure the right processes are in place and that people are following those processes as part of enterprise risk management.
DL: Great example. If you have a food failure, some sort of issue on the ground or a product recall, there will be financial repercussions, but there is reputational risk as well.
EM: That is correct; food safety is also one of the elements of reputational risk for the company.
- The role of the CFO
DL: I’ve always encouraged audit committees not only to think about their risks but also to evaluate whether or not they have people with the right skills to address those risks.
EM: Businesses have a life cycle, and they’re changing constantly. To use the role of CFO as an example, there are periods in the life of a business when you need a CFO who is very strategic. Other times, you may need one who is more process oriented.
It’s a challenge for most companies, especially if they’re smaller and not able to bring in talent, develop them and have a robust succession plan that sources talent across the organization.
In contrast, larger companies, such as GE for example, are better able to develop that deep talent inside the organization.
A smaller company probably has to go externally to fill some of its key roles. Bob Evans just went through this situation when the long-tenured CFO retired. The CEO/Chairman and the board discussed where the company was on its journey and what type of CFO would best meet the needs of the organization … and the conclusion was a strategic CFO.
DL: It sounds like the audit committee played a major role in that.
EM: The CEO/Chairman created a special committee of the chairs of the audit, nominating and corporate governance, finance, and compensation committees, and we all interviewed the candidate. However, it is important to note that the CEO owned the CFO hiring process, and he led the process with, in my view, a best practice by leveraging the experiences of this committee to provide perspective.There has to be chemistry between the CEO and CFO. A business can be taken to new heights when the CFO and the CEO are deeply aligned in executing the business strategy.
DL: So the CFO can be someone who is process/technical/financial focused or sometimes strategic.
EM: That pendulum swings back and forth. After everything blew up with Enron and WorldCom, the pendulum swung more to a technically astute and process-focused CFO with a CPA background. Then CEOs rightly challenged that model.
If you have a strong strategic CFO, the audit committee must ensure that there’s a great support staff and a strong controller who has the courage to challenge the CFO when needed.
- Succession planning
DL: Are you spending time focused on succession planning?
EM: Absolutely. Succession planning is the board’s key responsibility. Leading succession practices focus on leadership development across the organization. The company will benefit in governance and in investor circles and will be able to retain the best talent.
If you’re on the board of a Russell 2000 company, you sometimes have to go externally. You may not necessarily have all the talent that you need embedded within the company, but it doesn’t prevent you from developing a great leadership development process.
The boards I serve discuss succession issues on a quarterly basis. You have to consider where you are today and where the company is going. The CEO you need today may differ from the one you need for the next step in the strategic journey of the organization.
DL: What about getting to know the internal pool? Do you ask different individuals to meet with the audit committee?
EM: I’m very passionate that the time commitment for audit committee members is not just for the formal quarterly meetings or earnings release meetings or reviewing 10-Qs and the 10-K. It’s really about interacting with the organization and getting a real sense if individuals are walking the talk of what you’re hearing at the board level.
We bring in department leaders and their support staff. It’s a win on so many levels. Not only do you get a sense of how the tone at the top is cascading down, but also you get a sense of succession planning and where there’s talent within the organization.
- Making the case for diversity
DL: So, to shift gears, I want to talk a bit about the importance of diversity on boards. Can you share your perspective and your own experience as a female board member?
EM: I recently read in CFO magazine that in 2011, only 6.9% of audit committees are chaired by women1 . So there’s clearly a lot of work to be done. I recognize that I have been asked on the candidate slates by virtue of being a woman; however I had to demonstrate my capabilities to get the role. I’m also not shy about saying why I’ve transitioned my career from active CFO to one of serving on public boards.
I’m a passionate advocate of diversity on all boards because I believe the company performs better because of it. And my definition of diversity is multi-gender, multi-skilled, multi-national, multi-ethnic and multi-generational.
Earlier this year I participated in The Wall Street Journal’s Women in the Economy program, and representatives from McKinsey & Company provided a really compelling position for diversity and the power of women in the economy and what that means for greater growth and profits in the business. They demonstrated that there’s a business case for diversity.
I think that’s the only way that you’ll start to see real diversity take hold, and I think stakeholders even want to see that now. I am proud that Bob Evans Farms and State Auto Financial have diversity on their boards.
There are organizations that are pushing the envelope to say that if you don’t have diversity represented in your C-suite or on your board, you will not see me choose to invest in you. That’s why I’m optimistic. I think we’re going in the right direction. I think it will be a win-win for everyone, stakeholders and businesses.
- Considering the regulatory landscape
DL: Could I get your perspective on the current regulatory environment, specifically related to the recent PCAOB concept release on audit firm rotation and on the auditor’s reporting model.
EM: I applaud that the PCAOB is working hard to further bolster audit credibility, especially after the most recent financial crisis. However, as a former CFO, I’m inclined to respectfully disagree with the auditor rotation proposal as one of the solutions.
Getting new auditors up to speed is costly, and it puts further pressure on already stressed finance teams. The lead partner moving off an account after five consecutive years adequately addresses the independence concerns.
Regarding the changes to audit reports, I support elements of the proposal, specifically auditor assurance on other information outside the financial statements. I welcome assurance on earnings releases, non-GAAP information and the MD&A.
I know it’ll probably cost more, however, the last line of defense is the audit committee for these items, and I would greatly appreciate a deeper partnership with the independent auditor on this.
1 Governance Metrics International, Inc., 2011 Women On Boards Report, 8 March 2011.