The Director: Dysfunctional Boards: Todays greatest business risk

When it comes to advising clients undertaking board fee reviews, public relations experts may be as valuable as we, the remuneration consultants, are.
Dysfunctional boards pose potentially greater risks to New Zealand companies than natural disasters.
New Zealand-born and now London-based reinsurance expert Judith Hanratty told Chief Financial Officers summit in Auckland recently that, when it comes to risk management strategies, companies should take note of some research recently conducted by Britain’s Cass Business School.
The study examined 18 detailed cases of major corporate crises over the past decade which had even more drastic effects on the entities involved than any natural disaster. “Some of the firms were destroyed in their entirety,” said Hanratty.
The high profile corporate crises happened between 1999 and 2009 and included AIG, Arthur Andersen, BP, Cadbury Schweppes, Enron, Firestone, Northern Rock and Société Générale. In seven cases the company involved collapsed. In 16 cases the companies and/or executives were fined. In 11 cases the chairman or CEO lost their job and in four cases executives went to jail. In nearly every case the company lost capitalisation, its share price fell and its reputation and brand were seriously damaged.
The study detailed 100 specific risk lessons. These were distilled into seven key risk areas inherent to all organisations.
The risk areas are beyond the reach of insurance and mainly beyond the reach of traditional risk analysis and currently used management techniques. “But,” warned Hanratty, “they are ignored at an organisation’s peril.”
The seven key risk areas identified were:
• Board skills and non-executive directors ability to control risk – director skill and competency limitations and the inability of non-executive directors to effectively monitor and control the executive arm of the business.
• Board risk blindness – by which boards fail to focus on important risks, including threats to reputation and the licence to operate. Boards fail to set and control the company’s risk appetite. There is also failure to appreciate risks presented by complexity and its ability to cause and exacerbate events.
• Board failure to lead on ethos and culture – risk created by inadequate board ethos and culture leadership. US and UK governance models are particularly considered “not fit for purpose”.
• Defective communication – risk that comes from defective internal information flows.
• Risks from organisational and business complexity and change – including risks that come from acquisitions.
• Risks from incentives – includes risk created by the effects on behaviour from both explicit or implicit incentives.
• Risks from internal glass ceilings – come from an inability of risk management and internal audit teams to report on problems in upper levels of the organisation’s hierarchy.
“These risks can result in disasters even greater than the natural catastrophes compensated for through insurance systems,” said Hanratty. “This [state of affairs] will remain unchanged unless boards recognise the need to deal with the risks and employ people with the competencies and vision to help them do so.”
Cass Business School’s visiting professor in Risk Management, Alan Punter told commercial risk seminar in Europe recently that the study showed boards were not in control of their businesses, did not understand the fatal flaw in their business models or did not stand up to dominant CEOs. “The leaders lacked the skills necessary to exercise oversight over the business,” he said. And non-executive directors were too often “NEDs, or non-effective directors”.
Punter said to prevent such crises happening again, risk professionals needed to be able, and feel confident, to report on risks that may not be (or perceived to be) within their area of responsibility – particularly in relation to the activities and behaviour of their leaders.
“Risk professionals must feel able to report and discuss what they find right up to board level,” he said. “There needs to be rethink from the board down about how to capture emerging risks related to the company’s strategy, culture and behaviour.”