THE DIRECTOR : Governance Failed the World – Here’s how to put it right

Boards and directors have been found wanting in the wake of the most serious global financial and economic collapse in more than 60 years and series of outrageous fraud scandals in the years immediately running up to the recession. Some thinkers on the subject, like Auckland University of Technology’s associate professor Coral Ingley, are calling for re-think of the fundamentals of governance, suggesting in these pages two months ago that corporations are “feudal” in structure and in their approach to leadership. But if poor governance and leadership is responsible for the world’s organisational excesses and the demise of many iconic companies, what is to be done? Good governance in uncertain economic times is critical if business is to both enhance its performance and claw back its reputation, says Dunedin-based Doug Matheson, professional director, governance specialist and the author of two books on best practice governance.

You have expressed concern about the role of governance in the current economic crisis. What are your concerns?
The world’s economic crisis was a failure of management and governance.
Boards have not re-evaluated their strategic direction and strategies in light of continuing external developments and uncertainties. There has been inadequate board oversight of risk management. There has been excessive focus on internal key performance indicators (KPIs) and inadequate focus on developing external warning signs. Few (boards) predicted the magnitude or nature of the recession.
There was an excessive focus on quarterly and half yearly earnings targets, in other words “short-termism” and, finally, executive compensation practices encouraged excessive management risk-taking.
Consequently, the crisis has alerted investors, governments, the media and the public to inadequacies in governance and management.
Earlier this year, United States management consultancy McKinsey & Company, invited directors to do an online survey to gather opinions on how boards were responding to the economic crisis. Responding directors acknowledged that many boards were not providing the leadership demanded by the crisis.
More than third said their boards had not been effective and 14 percent were not sure how to rate their boards’ effectiveness. Roughly half the corporate directors said their boards’ chairs hadn’t met the demands of the crisis, and an equal percentage of board chairs believed the same about their board members. Though most boards had implemented changes to their procedures in response to the crisis, more than 60 percent said their boards needed to change even more.
In June this year McKinsey interviewed two highly respected business strategists who agreed there had been dramatic failure in management and governance. They called it ‘smooth sailing’ fallacy. The fallacy was the idea you can predict disaster risk by looking at the bumps and wiggles in corporate results. The history of bumps and wiggles didn’t predict disaster for the Titanic or the Hindenburg and they didn’t predict economic disaster either.
Attempting to predict disaster risk by looking at the variations and trends is like thinking that to ensure smooth sailing you only have to predict the weather – as opposed to designing boat that is capable of withstanding all sorts of different weather. There has been tendency for managers and directors to believe that you can actually predict the future – plus or minus 10 percent.
The smooth-sailing fallacy arises when boards and management mistake measure for reality. They mistook measures like KPIs for reality and focused on ‘meter readings’ rather than exploring and gaining deeper understanding of the real forces at work.
To see the financial disaster coming they needed to look beyond the current performance data. They needed to really observe and consider the external environment in which companies were operating and on which they were dependent.
The objective is not to try and control things you can’t control but rather to be relatively better at delivering results and performance over time, no matter what the weather. Those who detected and accepted the early warning signs implemented strategies and actions to help weather the storm.
You have been researching board performance, what are some of your findings?
Most boards and management now find themselves in uncharted territory, with new paradigm of unpredictability. Going into crisis mode to respond to immediate issues won’t solve many problems. Boards need to take longer term approach. Directors and boards must improve their performance in the two key governance roles and responsibilities:
•Strategic positioning.
•The oversight of risk management.
The problem is governance in practice, in other words applied governance. Directors don’t do some key requirements of good governance very well. Others don’t do them at all.

Do we need to re-think the role and rules of governance? Are they still appropriate?
I don’t think they need to be redesigned. But I do think directors and boards need to focus on, and improve their performance in the two key roles and responsibilities of good governance I mentioned before. Boards must not forget that above their legal, fiduciary and compliance duties they need to focus on strategic positioning and oversight of risk management.
Strategic positioning means the board is responsible for the direction of the company through the development and approval of strategic goals and strategy. Neither management nor directors should forget that in spite of all the modern management techniques and ‘how-to-do’ management tools, ‘what-to-do’ is the central challenge. That is strategy.
The financial crisis and uncertainty brought about by the global economic crisis has exposed companies to risks they never anticipated. Boards must take close look at whether current risks affect the viability of the existing business model and whether the company’s strategic direction is viable in the new environment. As part of this process, boards should be increasingly aware of current and proposed government regulations, changes in an industry, the status of the company’s business relationships and other factors that affect the company’s ongoing strategic plan.
Even the highest levels of uncertainty don’t prevent businesses from analysing predicaments rationally. Planning in uncertain times simply requires different mind-set. Bottom-up analysis, and forecasting based on that analysis is no longer relevant. There are simply things that are fundamentally unknowable in truly ambiguous world.
Boards need strategies for the uncertainty their organisation faces. They must be rigorous in thinking through strategic decisions when facing a range of future possibilities. Directors should work backwards from potential strategies to what the situation should be for those strategies to succeed. This type of environment calls for the use of scenario-planning techniques.
If the current financial crisis is due to inadequate oversight of risk and risk management, boards should review this. Directors must understand the major risks a company faces. Through the audit and risk committee they should be satisfied management is properly assessing risks, and be satisfied with current risk management practices throughout the company. The board cannot and should not be involved in day-to-day management activities. It should provide informed oversight of risk rather than management of risk.
As part of overall risk management, the board should review its chief executive compensation practice to ensure that he or she is not incented or rewarded for excessive risk-taking. And the board should review chief executive compensation to ensure that compensation is in line with appropriate standards.
Boards must ensure that their performance expectations are met, will continue to be met, and that performance continues to benchmark favou