flowchart TD
B["<b>Board</b>"] --> A["<b>Audit committee</b><br>financial reporting,<br>internal control, auditors,<br>related party transactions,<br>vigil mechanism"]
B --> N["<b>Nomination and<br>remuneration committee</b><br>board composition,<br>appointments, evaluation,<br>remuneration policy"]
B --> S["<b>Stakeholders relationship<br>committee</b><br>security holder grievances"]
B --> R["<b>Risk management<br>committee</b><br>risk framework and<br>monitoring"]
B --> C["<b>CSR committee</b><br>policy, projects,<br>expenditure"]
A -.->|"recommends,<br>board decides"| B
N -.-> B
style B fill:#ede7f6,stroke:#7E57C2
style A fill:#ffebee,stroke:#C62828
style N fill:#e3f2fd,stroke:#1976D2
style S fill:#e8f5e9,stroke:#388E3C
style R fill:#fff8e1,stroke:#F9A825
26 Board Committees: Audit, Nomination and Remuneration
ImportantLearning Objectives
You will be able to:
- Explain why boards delegate to committees and what a committee can do that a full board cannot.
- Describe the composition and mandate of the audit committee and its central role in Indian governance.
- Describe the nomination and remuneration committee’s mandate and the principles governing executive pay.
- Identify the other committees required of Indian companies and what each addresses.
- Analyse a company’s committee structure and working practice and identify where accountability fails.
26.1 Introduction
Chapter 24 described what a board is for and Chapter 25 the directors on whom the answer most depends. This chapter covers where those directors do most of their real work.
A full board meeting is a poor instrument for detailed scrutiny. It is large, it is chaired by someone who may be an executive, management is present throughout, and its agenda covers the whole enterprise in a few hours. Committees exist because certain functions need something a board meeting cannot supply: a smaller group, composed mainly or wholly of independent directors, meeting more often, going deeper, and able to see people without the executive in the room (A. C. Fernando, 2019).
In India the committee structure carries more weight than in systems with dispersed ownership. Where a promoter controls the general meeting, a committee of independent directors with a statutory mandate is one of the few places a controller’s proposal must survive scrutiny by people the controller cannot outvote.
26.2 Why Committees
Delegation to a committee achieves four things a board meeting cannot.
Depth. A committee can spend three hours on the impairment assumptions behind a single number, which a board cannot without abandoning everything else.
Composition. A committee can be constituted entirely or predominantly of independent directors, so a matter can be examined by people with no interest in its outcome even where the board as a whole cannot be.
Access. A committee can require the internal auditor, the statutory auditor or the compliance officer to attend, and can see each of them without management present, which changes what those people say.
Frequency. A committee meeting four to six times a year on one subject accumulates knowledge that a board covering everything cannot.
A committee recommends; the board decides. That distinction matters because it locates responsibility. A board that treats a committee recommendation as automatically approved has delegated its judgement rather than the work, and a committee whose recommendations are never questioned should ask why.
26.3 The Audit Committee
The audit committee is the most important committee in Indian corporate governance, and the reason is specific: it is the body that stands between the controller and the numbers, and between the controller and related party transactions.
NoteComposition and Mandate
| Feature | The position |
|---|---|
| Composition | A minimum of three directors, with independent directors forming a majority. For listed entities the listing framework requires at least three members, two thirds independent, and a chair who is independent (Securities and Exchange Board of India, 2015) |
| Financial literacy | All members must be able to read and understand financial statements, and at least one must have accounting or related financial management expertise |
| Financial reporting | Review of the financial statements and the auditor’s report before submission to the board, with particular attention to accounting policies, significant judgements, and compliance with standards |
| Auditors | Recommendation on appointment, remuneration and terms of the auditor, review of independence and performance, and approval of non-audit services |
| Internal audit | Review of the adequacy of internal audit, its structure and staffing, and discussion of significant findings |
| Internal control | Evaluation of internal financial controls and risk management systems |
| Related party transactions | Approval or subsequent modification of transactions with related parties, and scrutiny of inter-corporate loans and investments |
| Vigil mechanism | Oversight of the mechanism described in Chapter 21, including direct access by disclosers to the committee chair |
| Valuation | Scrutiny of the valuation of undertakings or assets wherever necessary |
Two elements of that mandate carry disproportionate weight.
Related party approval. Chapter 23 identified the related party transaction as the instrument through which value is extracted from minority shareholders. The audit committee is the first gate, and material transactions additionally require approval by disinterested shareholders. A committee that approves related party arrangements on the basis of a valuation commissioned by the management proposing them has passed the transaction through the gate without opening it.
Auditor independence. The committee recommends the auditor’s appointment and approves non-audit services, and both exist to address the structural problem that the auditor is engaged and paid by the entity it audits. Where non-audit fees approach or exceed audit fees, the committee’s judgement about independence is the only protection.
TipPractitioner Insight: The Three Questions an Audit Committee Must Ask Privately
The committee’s power comes less from what it reviews than from whom it can see alone. Three questions, asked of the right person without management present, do more than any amount of document review.
To the statutory auditor: what did you propose that management resisted, and how was it resolved? Auditors rarely volunteer disagreements that were eventually settled, and settled disagreements are exactly the map of where judgement was stretched.
To the internal auditor: what did you want to look at that was not in your plan, and who decided the plan? An internal audit function whose scope is set by the people it examines is an assurance in name.
To the chief financial officer, alone: which number in these statements would change most if a different but defensible assumption were used? The answer identifies where the reporting is most sensitive, which is where the committee should spend its time.
A committee that has never held these conversations, or that holds them with the managing director present, has the form of the function and not the substance.
26.4 The Nomination and Remuneration Committee
This committee decides who sits on the board and what the executives are paid, which makes it the committee with the greatest long-term influence and the one most often reduced to a formality.
NoteComposition and Mandate
| Feature | The position |
|---|---|
| Composition | Three or more non-executive directors, of whom not less than half are independent. For listed entities, at least two thirds independent with an independent chair (Securities and Exchange Board of India, 2015) |
| Identification | Identifying persons qualified to become directors and senior management, and recommending appointment and removal |
| Criteria | Formulating criteria for determining qualifications, positive attributes and independence of a director |
| Evaluation | Specifying the methodology for evaluation of the board, its committees and individual directors |
| Remuneration policy | Recommending a policy relating to the remuneration of directors, key managerial personnel and other employees |
| Balance in pay | Ensuring the level and composition of remuneration is reasonable and sufficient to attract and retain, that pay relates to performance, and that it balances fixed and incentive pay reflecting short and long-term objectives |
26.4.1 Executive Remuneration
Chapter 23 set out the three failures of incentive pay: manipulable metrics, asymmetric reward, and short horizons. The committee’s work is to design against them.
| Principle | What it requires in practice |
|---|---|
| Pay for performance that is actually performance | Metrics reflecting value created rather than activity, resistant to timing and to accounting choice, and measured after the cost of capital |
| Symmetry | Structures where reward falls as well as rises, rather than options whose holder shares only the upside |
| Horizon | Vesting and holding periods extending beyond the executive’s likely tenure, so decisions with long consequences are felt |
| Recovery | Provisions permitting reduction of unvested awards and recovery of paid awards where results are restated or misconduct emerges |
| Proportion and disclosure | Ratios of executive to median employee remuneration disclosed, and total pay explained in terms shareholders can assess |
| Independence of the decision | Determined by independent directors, with the executive concerned absent, and benchmark data not selected by management |
WarningCommon Misconception: Benchmarking Sets Fair Pay
The standard method is to compare against a peer group and position pay at or above the median. Applied across a market, the method has an arithmetic consequence that nobody intends: if every company targets the median or better, the median rises every year regardless of performance, because it is being chased rather than measured.
Two further problems attend the practice. The peer group is usually proposed by management or by a consultant management engaged, and its composition can be adjusted until the answer is comfortable. And benchmarking answers a market question rather than a value question, telling the committee what other companies pay rather than what this executive’s contribution is worth to this company.
A committee that wishes to do better asks three additional questions. What would we pay if there were no benchmark? What is the ratio to the median employee here, and can we explain it? And what part of last year’s outcome was the executive’s doing rather than the market’s? None of these has a comfortable answer, which is the point.
26.5 The Other Committees
| Committee | Required of | What it addresses |
|---|---|---|
| Stakeholders relationship committee | Companies with prescribed numbers of security holders, and listed entities | Resolution of grievances of shareholders, debenture holders and other security holders, including transfer, dividends and reports |
| Risk management committee | Prescribed listed entities | The risk management framework, including cyber security, and monitoring of the risks the board has accepted |
| Corporate social responsibility committee | Companies meeting the prescribed net worth, turnover or profit thresholds | Formulation of the CSR policy, recommendation of projects and expenditure, and monitoring (Government of India, 2013) |
The CSR committee sits at the boundary of this module and the next. Its statutory function is compliance with a spending obligation, while the substantive questions of environmental and social performance belong to Module V, and Chapter 40 examines the increasingly common decision to give a board committee explicit oversight of environmental, social and governance matters rather than confining the subject to CSR spending.
26.6 Case Studies
26.6.1 Case Study 1: The Transaction That Passed the Gate
The following situation is constructed rather than reported.
An audit committee of three, two of them independent, considers a proposal to acquire a business from a promoter-owned entity. The papers include a valuation report from a firm engaged by the chief financial officer. The committee meets for fifty minutes, during which the managing director presents the strategic rationale and remains for the discussion. One member asks whether an independent valuation should be obtained; the chair notes that the valuer is a reputable firm. The committee recommends approval. The board approves the same day. The transaction is later approved by shareholders, with the promoter abstaining as required, on a turnout of nineteen per cent.
Discussion questions
- Identify every structural weakness in this process, distinguishing those that breach a requirement from those that comply and fail.
- What should the committee have required, and at what point in the sequence?
- The disinterested shareholder vote passed on a nineteen per cent turnout. What does that tell you about the strength of that protection in practice?
26.6.2 Case Study 2: The Scope That Was Set by the Audited
The following situation is constructed rather than reported.
A company’s internal audit function reports administratively to the chief financial officer and functionally to the audit committee. The annual internal audit plan is prepared by the head of internal audit in consultation with the chief financial officer and presented to the committee for approval. For three years the plan has excluded procurement at the largest plant, on the ground that it was covered by a special review in an earlier year. The committee has approved the plan each time without discussion. A whistle-blower report later concerns procurement at that plant.
Discussion questions
- Apply the second of the three private questions. What would it have revealed, and when?
- Whose failure is this? Assign responsibility between the head of internal audit, the chief financial officer and the committee, and justify the allocation.
- Redesign the internal audit planning process, stating who proposes, who challenges and who approves.
26.6.3 Case Study 3: The Pay That Rose With the Sector
The following situation is constructed rather than reported.
A nomination and remuneration committee reviews the managing director’s remuneration. A consultant engaged by the human resources function presents a benchmark showing the company at the fortieth percentile of a peer group of twelve companies, four of which are substantially larger. The committee recommends an increase to reach the median. Company performance over three years has been in line with its sector, which rose. The managing director’s total remuneration is now a large multiple of median employee pay, disclosed as required. No member asks what part of the three-year performance was attributable to the sector.
Discussion questions
- Identify each of the three problems with benchmarking present in this case.
- Apply the three additional questions from the misconception callout. What answers would you expect, and what would each change?
- The disclosure requirements were met in full. Explain the difference between disclosure and accountability using this case.
26.7 Applying the Chapter
ImportantExercise: A Committee Structure Review
A listed Indian pharmaceuticals company discloses the following. The audit committee has three members: two independent directors and the promoter chairman, who is non-executive. It met four times; average duration, from the minutes, was under an hour. Its report to shareholders describes its terms of reference and the number of meetings. The statutory auditor attended two meetings, always with the chief financial officer present. Non-audit fees paid to the audit firm were roughly twice the audit fee, for tax and transaction advisory work. Internal audit reports to the chief financial officer and its plan is approved annually without amendment. Related party transactions totalling a significant share of revenue were approved as a single omnibus item at the first meeting of the year. The nomination and remuneration committee has three members, two independent, chaired by an independent director who has served eleven years. Board evaluation was conducted by circulating a questionnaire; the result was reported as satisfactory. Managing director remuneration rose thirty per cent over two years; the peer group used was proposed by a consultant engaged by the human resources head. There is a stakeholders relationship committee and a CSR committee. There is no risk management committee.
Working in a group, produce the review. CO-4 requires evaluation of accountability and identification of governance gaps, so name gaps and rank them.
- Test composition against requirement. For each committee, state whether the composition appears to meet the Companies Act and listing requirements, and flag anything doubtful.
- Assess the audit committee’s capacity to perform each element of its mandate, taking the elements one at a time. Identify which elements it cannot be performing on these facts and why.
- Evaluate auditor independence given the non-audit fee ratio and the attendance pattern. State what the committee should have done and what you would ask it now.
- Assess the related party approval. Explain what an omnibus approval at the start of a year does to the protection Chapter 23 described, and state what a properly functioning gate would look like.
- Assess the remuneration decision against the six principles of pay design, and state which are absent.
- Identify the missing committee and what its absence means for this particular company.
- Rank the governance gaps, at least six of them, and for each state the harm permitted, who bears it, the change required, and who must make it.
- Recommend. Write the five questions you would put at the annual general meeting, one to each committee chair and two to the board as a whole, framed so that a non-answer is informative.
Present the review as a committee-by-committee assessment table, a ranked gap register, and the five questions.
26.8 Summary
NoteChapter Summary
Committees exist because a full board meeting cannot supply depth, independent composition, private access to assurance providers, or frequency (A. C. Fernando, 2019). In India they carry extra weight, because where a promoter controls the general meeting a statutory committee of independent directors is one of the few places a controller’s proposal must survive scrutiny by people the controller cannot outvote. A committee recommends and the board decides, and a board that treats recommendations as automatic has delegated judgement rather than work.
The audit committee is the most important, standing between the controller and both the numbers and related party transactions. It requires a majority of independent directors, financial literacy in all members and financial expertise in at least one, and for listed entities two thirds independence and an independent chair (Securities and Exchange Board of India, 2015). Its mandate covers financial reporting, the auditors and their independence, internal audit, internal control, related party transactions, the vigil mechanism, and valuations. Two elements dominate: related party approval, where a committee relying on a valuation commissioned by the proposing management has passed a transaction through a gate it never opened, and auditor independence, where the committee’s judgement is the only protection once non-audit fees grow large. The committee’s real power lies in whom it can see alone, and three private questions do more than document review: what the auditor proposed that management resisted, what internal audit wanted to examine and who set the plan, and which number would move most under a different defensible assumption.
The nomination and remuneration committee decides who sits on the board and what executives are paid, giving it the greatest long-term influence and the most frequent reduction to formality. Its mandate covers identification of directors, criteria including independence, board evaluation methodology, and remuneration policy balancing fixed and incentive pay. Pay design must address the three failures from Chapter 23 through performance metrics resistant to timing and accounting choice, symmetry so reward falls as well as rises, horizons beyond likely tenure, recovery provisions, proportion disclosure, and decision by independent directors using data management did not select. Benchmarking to the median is arithmetically self-inflating when every company does it, uses a peer group management can shape, and answers a market question rather than a value one.
Other required committees address security holder grievances, the risk framework, and corporate social responsibility, with the last sitting at the boundary of Module V.
TipKey Terms
Committee delegation · Depth, composition, access, frequency · Recommend and decide · Audit committee · Financial literacy and expertise · Independent chair · Review of financial statements · Auditor appointment and independence · Non-audit fees · Internal audit scope · Internal financial controls · Related party approval · Omnibus approval · Vigil mechanism oversight · Private session with the auditor · Nomination and remuneration committee · Criteria for directors · Board evaluation methodology · Remuneration policy · Pay for performance · Symmetry · Holding period · Clawback · Pay ratio disclosure · Benchmarking to the median · Peer group selection · Stakeholders relationship committee · Risk management committee · CSR committee
Summary
| Concept | Description |
|---|---|
| Why Committees | |
| Committee delegation | The device through which a board obtains what a full meeting cannot provide |
| Depth | The capacity to spend hours on a single judgement without abandoning the rest of the agenda |
| Composition | The ability to constitute a body wholly or largely of directors with no interest in the outcome |
| Private access | The power to see auditors, internal audit and compliance without management in the room |
| Frequency | The accumulation of knowledge from meeting repeatedly on one subject |
| Recommend and decide | The division locating responsibility, since a board approving automatically has delegated judgement |
| The Audit Committee | |
| Audit committee | The committee standing between a controller and both the numbers and related party transactions |
| Financial literacy and expertise | The requirement that all members read financial statements and one hold financial expertise |
| Independent chair | The listing requirement placing an independent director in the chair |
| Review of financial statements | Examination of policies, significant judgements and compliance before submission to the board |
| Auditor recommendation | Recommendation on appointment, remuneration and terms, and review of independence and performance |
| Non-audit fees | The fee category whose growth makes the committee's independence judgement the only protection |
| Internal audit scope | The plan that is an assurance in name if set by the people internal audit examines |
| Internal financial controls | The systems the committee must evaluate rather than operate |
| Related party approval | The first gate against extraction, defeated by reliance on management's own valuation |
| Omnibus approval | Approval of a year of transactions as one item, which opens the gate without inspecting anything |
| Vigil mechanism oversight | Oversight of the disclosure channel, including direct access by disclosers to the committee chair |
| The Private Questions | |
| Question to the auditor | What was proposed and resisted, which maps where judgement was stretched |
| Question to internal audit | What was wanted but not in the plan, and who decided the plan |
| Question to the finance head | Which number would move most under a different but defensible assumption |
| Nomination and Remuneration | |
| Nomination and remuneration committee | The committee deciding who sits on the board and what executives are paid |
| Criteria for directors | Qualifications, positive attributes and independence, formulated in advance of any candidate |
| Board evaluation methodology | The specified method for assessing board, committees and individual directors |
| Remuneration policy | The policy balancing fixed and incentive pay against short and long-term objectives |
| Designing Executive Pay | |
| Pay for performance | Metrics reflecting value created, resistant to timing and accounting choice, after cost of capital |
| Symmetry | Structures in which reward falls as well as rises, unlike an option's one-way exposure |
| Holding period | Vesting and retention extending past likely tenure, so long consequences are felt |
| Clawback | The provision reducing or recovering awards where results are restated or misconduct emerges |
| Pay ratio disclosure | The published ratio of executive to median employee pay, which invites the explanation |
| Benchmarking to the median | The method that inflates itself arithmetically when every company targets the median or better |
| Peer group selection | The choice management or its consultant can adjust until the answer is comfortable |
| Other Committees | |
| Risk management committee | The committee required of prescribed listed entities for the risk framework including cyber |