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Governance @ Distance

In board members, corporate governance, Finance, fraud, General, Management, Uncategorized on April 5, 2019 at 1:12 pm

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Transparency, higher commitment, and independence are buzz words for good corporate governance. The role of independent directors plays an important role in Corporate governance to keep an eye on the board activities to flag off non-promoter group issues. However, the challenge is neither the independent directors get appropriate compulsory training to understand their roles and responsibilities in an organisation nor the appropriate data promptly to act upon effectively. Board has a limited duration to understand and reflect on issues. Sometimes the independent directors are from different industries and are not able to understand the context and indulge in granularities, though, diversity of thoughts may add significant value. Governance at distance is often seen where the board chairman leads the discussion and independent directors often distant from reality less engaged in a discussion.

According to recent Board Practice Report by Deloitte Centre for Board Effectiveness and Society for Corporate Governance, almost 80% of board members think that their primary focus is on company strategy, 42% attributes risk oversight as important and 29% focuses on board selection. To sum up, strategy formulation, risk oversight and board selection are three important roles of board. In this blog, I will talk about the issues related to the first two.

In the current business environment, the markets are turbulent more than ever. World over, not only regulators, every stakeholder such as partners, and creditor are accusing board if anything goes wrong in governance. Social media and newspapers have abundant stories of poor risk governance. A board strategy cannot be the same in normal, turbulent and crisis situations. Strategic change has become important for companies. Punjab National Bank (PNB) in India has recently faced one of the biggest frauds in history, and within a short period, the company’s board needs to change the strategy of the company to address the crisis. Not only the fraud affected the PNB strategy, but it also impacted the strategy of other banks in India and the global market. The strategies perfectly working in normal market conditions may not work in crisis situation. Are companies’ board trained and prepared to handle how to change the company’s strategy in normal, volatile and crisis situations?

Post-2008 crisis, the role of the board in enterprise-wide risk oversight has become challenging. No specific training is provided to the board to refresh their knowledge on the subject. Many companies still don’t know what are their key risks and issues in the management of risks. Surprisingly, directors don’t know their roles and responsibility in risk oversight. Understanding the inter-connectivity of risk is the next big challenge, and a very few companies are able to link risk management with strategy and compensation system. How the board of directors perform their duty in overseeing the executive decisions and how compensation structures and practices drive an executive’s risk-taking. Many such questions need to be answered.

Let us understand the logic of why the understanding of risk is paramount for the board for effective corporate governance. Shareholders want a higher return for higher risk and vice-a-versa. One of the roles of the board is to define the risk appetite (the amount and extent of risk the company is willing to take as promised to shareholders) in the company. The informal approach of risk management will bring several surprises in the organization and may hinder the fulfillment of organisational objectives. To deal with the situation, the board needs to effectively oversee the organisation key risks holistically and disclose them to shareholder at appropriate times so that value at risk can be calculated. The only quantification of risk exposure will not suffice; the quality of risk-taking directly impacts the profitability of a company. Quality of risk profile also needs a significant attention. Balancing the risk while adding value to the organisation is only possible when risk management is well understood by board, implemented in a formal way and linked to the organisational strategy.

I strongly believe that the board should get a refresher course or a certificate course to carry out their duties effectively. Governance at a distance is not working. Categorization of risks in market risks, operational risk, and strategic risk has become bizarre and mundane.  Helicopter view of risk for oversight has become unacceptable as stakeholders want to understand what were the key risks of the organisation last year, whether risks are increasing or decreasing and the reasons behind them. Higher interaction and participation of the board by probing questions will certainly enhance the current state of governance. Higher engagement of the board is the key to good governance.

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