What strengths and weaknesses were present related to Comptronix’s board of directors and audit committee?

Question

What will be an ideal response?

Answer 1

The Comptronix board did not appear to be heavily represented by inside directors given that only
28.6% of the board consisted of insider directors. And, the board was not unduly large, given that it
consisted of seven members. By 1991, most of the directors had served on the board for about five
years, which should have increased their familiarity with Comptronix’s operations. While the outside
board members did receive cash compensation and options to purchase Comptronix common stock,
those types of compensation arrangements are typical for outside director service on boards. And, the
board included representatives of the venture capitalist and bank that provided significant funds for
Comptronix before it went public. Their inclusion on the board would be considered appropriate, given
that they, like other Comptronix shareholders, had a personal stake in insuring that company executives
acted in the best interests of the shareholders. Thus, on the surface, the Comptronix board appeared
reasonable.
However, a closer look at the board membership reveals that many of the outside directors had
affiliations with top executives outside their role as an outside director. One of the non-management
directors served as the company’s general legal counsel, which likely generated significant fees for that
director related to professional services rendered. Another non-management director was a significant
customer, which meant that Comptronix was a major supplier of parts for that director’s company.
These two directors also served on the three-member compensation committee of the board. Both of
these relationships may have reduced the directors’ objectivity as they assessed top management actions
and compensation. A third director was president of a company based in Taiwan. The location of that
director relative to the company’s Alabama headquarters increased the difficulty for that director to
effectively monitor management.
Section 301 of the Sarbanes-Oxley Act of 2002 now requires that the audit committee of
public companies be composed entirely of independent, outside directors. According to the proxy
statement sent to shareholders, Comptronix did have an audit committee that did not include any
inside directors. And, the audit committee did meet occasionally. However, one of the audit committee
members represented a gray director who had close affiliations with top management. Inclusion of a
gray director may have decreased the objectivity of the audit committee. And, the audit committee
only met two times in 1991 even though Comptronix issued financial statements four times during
1991. Thus, the audit committee was not as active in monitoring the financial reporting process as
might be expected for publicly traded companies.