Posts Tagged ‘risk’

Economic and Geopolitical Disruptive Forces: History Favors the Best Prepared

March 17th, 2015 | By

Now in its third year, NACD’s Directorship 2020® takes an investigative look at the trends and disruptors that will shape boardrooms agendas of the future. This initiative is designed to raise directors’ awareness of these complex emerging issues and enable them to provide effective guidance to management teams as they navigate the associated risks and opportunities.  The inaugural 2015 session was held on March 3 at the Grand Hyatt Hotel in New York City, where subject-matter experts from Broadridge, KPMG, Marsh & McLennan Cos., and PwC and corporate leaders explored the boardroom implications of geopolitical and economic disruption.

Illustrating the boardroom perspective on the impacts of economic and geopolitical disruption on corporate strategy.

Illustrating the boardroom perspective on the impacts of economic and geopolitical disruption on corporate strategy.

In his remarks on economic disruption, Peterson Institute for International Economics Visiting Fellow and International Capital Strategies Executive Chair Douglas Rediker examined the changing face of global competitive markets. Governments around the world are increasingly involved in market activities and are more likely to champion domestic businesses or businesses based in countries with which they have trade agreements. This situation creates a business environment in which companies seeking to expand must assess a foreign country’s protected business sectors in order to fully evaluate the endemic risks and opportunities.

Taking a geopolitical perspective, UBS Executive Director and Head of U.S. Country Risk Dan A. Alamariu considered the ripple effects of government regulation, using a case example of the sanctions recently imposed by the US and EU on Russia. Though these measures did diminish the buying power of the ruble, the sanctions also hurt Western companies operating in Russia because consumers could no longer afford to purchase foreign goods. He cited other examples as well. In its efforts to recover from the financial crisis, the Chinese government has recently implemented a number of economic reforms. While these reforms may succeed in re-establishing China as an “engine of growth,” the infighting that they have triggered among political elites could ultimately dampen growth and set the country on an uncertain course. Closer to home, persistent gridlock in the US government is preventing needed progress on issues critical to the business community, such as tax policy and infrastructure.

Both speakers alluded to the fact that as countries become more divided and inwardly focused—both internally and with respect to international relations—developing collective approaches to major transnational issues such as climate change and cyberattacks will become more challenging. Companies will therefore need to devise their own strategies for addressing these challenges.

Economic and geopolitical disruptors are inextricably linked, and the three main takeaways from both sessions are as follows:

  1. Embrace risk—you may discover opportunities. Directors need to start thinking like emerging markets investors. In other words, they should get comfortable working in a business environment that is volatile and unpredictable. This breed of investor has historically been focused on domestic, regional, and international political and economic risks. Because technology has created a world that is deeply interconnected, investors must proactively cultivate an understanding of geo-economic risks. By extension, it is also important to recognize technology as a major disruptive force that will continue to impact companies across all sectors. For example, tablet devices have completely changed not only how people communicate and access multimedia content but also how companies conduct business. By embracing disruptive technology, companies can in turn create the caliber of differentiated products that will transform the marketplace.
  2. Be prepared. This ageless scouting motto is especially relevant to anyone managing or overseeing a company. Businesses the world over are more interconnected than ever before, which forces companies to compete across national borders and exposes them to international political and economic risks. Boards need to consider the ultimate “black swan” events that could affect their companies. By extension, directors need to be mathematically literate—if they are not already. Black-swan events include natural disasters, such as Hurricane Sandy, which incapacitated businesses in our nation’s financial epicenter; political events, such as the outbreak of war; economic unpredictability; and technological innovation, which we have seen from the automobile to the iPad. Having a by-the-numbers plan for how the company could behave in specific scenarios will create a comprehensive understanding of the risks the business faces. Because it’s impossible to completely protect a company, it is essential to create resiliency. The board must therefore ensure that incident response plans are in place and must routinely test those response plans to confirm that they meet the company’s evolving needs.
  3. Beware of “herd mentality.” Directors need to periodically review the current board composition; and if there are gaps in the board’s collective knowledge that may prevent it from assessing areas of risk, it may be in the board’s best interests to bring in a third-party expert to help inform boardroom discussions. This is especially true of cyber risk. Many boards are still struggling to comprehend the depth and breadth of these threats, and because it’s neither possible nor desirable for every board to have a cyber expert in their ranks, it is imperative to bring in outside sources to inform and educate directors and management.

Look for full coverage of this NACD Directorship 2020 session in the May/June 2015 issue of NACD Directorship magazine. For information on future events and recaps of past events, visit the NACD Directorship 2020 microsite.

Identifying Black Swans: The Many Facets of Risk Oversight

January 28th, 2015 | By

The Metropolitan Corporate Counsel recently interviewed NACD President Peter R. Gleason on how boards are recalibrating their approach to risk oversight and strategy development.  The original interview can be found here

MCC: Risk oversight is a key responsibility for corporate boards. What are the major areas of risk?

Gleason: It’s interesting. When you think about it, everything falls into the risk category. Where we used to have discussions around financial reporting or compensation, the conversation has evolved to financial reporting risk or compensation risk (or the risks in these areas). And traditional categories are still on the agenda, such as competitive, economic and reputational risk.

We see geopolitical risk, which is closely linked to cyber risk, at the forefront. Take, for instance, the falling price of oil, which benefits U.S. consumers but has complex global implications for companies or countries that are suppliers of oil. How do falling prices affect the countries’ economies? How does it affect the companies’ financial situations relative to competitors or their geographic environment?

MCC: Given this complexity, how does the board identify and prioritize the potential risks facing a company?

Gleason: While the board will use a variety of approaches to identify risk, these all rely on board engagement with the management team around strategy. Last October, NACD released a Blue Ribbon Commission report on strategy development that discussed how board members have to move away from the traditional review-and-approve approach to management’s strategy and, instead, engage in earlier-stage dialogue about the various options management is considering during the process.

For example, traditionally, the management team may discuss three or four options and then choose “strategy A” for presentation to the board. As part of this deeper engagement, directors should ask “but what other strategies were on the table? Why did they choose A over B? What were the assumptions underlying that strategy that we should discuss as a board?”

This level of dialogue allows boards to identify risks to the business and to the execution of a particular strategy. The engaged dialogue within the process helps identify risks within the strategy itself, within the industry, and then within the economic purview of the company as it relates to the global economy. With this level of knowledge, directors can quickly change course, as needed, if the company’s strategy is later disrupted by a previously unidentified risk or by a geopolitical event.

MCC: These are dynamic issues. What is the right approach to this world of emerging or unidentified risks?

Gleason: This topic is under constant discussion in our Advisory Councils: how do we know what we don’t know? Or as our CEO Ken Daly phrases it, “how do we make the completely unknown merely uncertain?” There is no way of knowing; by definition you can’t predict the proverbial black swan. There is, however, the idea of gathering different perspectives and more information, engaging in more dialogue, and establishing ongoing discussion with management that helps identify issues, or even realms of issues, that are not yet on the radar screen.

This idea of “constructive dialogue” is tied directly into the Blue Ribbon Commission’s focus on continuously reviewing and testing the assumptions that underlie management’s strategic plan. For example, in the context of geopolitical events, let’s say, as a company, that we get all of our “chemical AAB” from a country in Eastern Europe, but that chemical is no longer available because of terrorism activity. Where can we get the chemical now, and how does that change affect our supply chain, costs and pricing?

While this individual situation may seem minimal in the big scheme of the company’s strategy, those discussions are essential because they identify risks that the company may face more broadly.

Frankly, board engagement provides focus. Take the financial crisis, as another example, which arose from strategies that created incentives in the mortgage industry to drive volume, but not necessarily quality. This generated huge portfolios of poor-quality loans and major economic disruption. In hindsight, better oversight was needed to ask, fundamentally, about the risk within this strategy, and to identify and discuss the possible consequences before adopting it.

MCC: Which groups within the board should be responsible for risk oversight?

Gleason: The board’s job is to oversee the enterprise risk management process, to make sure measures are in place to identify risks, to get the right reporting, to bring insight from the directors’ own experiences, and to participate in dialogue with management about strategies to address the issues.

In terms of who should have the primary responsibility, we look at risk oversight as a full-board function. Risk is too big for any one committee. Traditionally it has been the purview of the audit committee; however, adding oversight for the entire organization’s risk profile would overwhelm the committee’s already heavy agenda. Although we still see a number of companies placing risk oversight squarely on the audit committee, interestingly enough, NACD’s annual public company governance survey reflects that a significant portion of respondents from those companies believe that risk oversight really ought to be a full-board activity.

There has been a trend in recent years of establishing mandated risk committees ­– for example on the boards of financial institutions – and we may see similar changes in other industries going forward. At NACD, we don’t necessarily see a risk committee as the panacea. The bigger question is how does it execute? Every board takes a different approach to identifying and overseeing risk, and that’s okay because boards have to adapt their structure, style and processes to the company.

MCC: Expand a bit on how boards work effectively with the executive team to ensure that directors are asking the right questions and management is providing the right information.

Gleason: A prevalent challenge for every board is asymmetric information risk. This risk is inherent in directorship, given that management will – and should – have vastly more knowledge about the company’s business than the board ever will. A balancing act exists in that management needs to provide the board with the right information – not all the information – to enable a productive discussion of risk. Further, today’s directors own at least one device that provides access to any and all information about the company. So the question becomes, to what extent should board members rely, so to speak, on their own detective work to get information beyond what management reports? That balance is so critical because, in turn, directors can overwhelm management with one-off requests for information.

In sum, boards have to ask constructive questions about whether they are getting the relevant information, such as outside opinions from financial experts or reports from whistleblower hotlines, so they can make decisions about the company’s ongoing performance and sustainability.

MCC: Do outside perspectives vary as to assigning accountability for effective risk management? NACD’s Advisory Council on Risk Oversight has noted that “the general pattern is that investors are more tuned in, while regulators will blame the board.”

Gleason: Right now, we are looking at how shareholders themselves can present a risk to the organization. Look at what’s happening at DuPont with Trian Partners. Here’s a company that has outperformed the market and its peers for the last five years but is still facing an activist investor. Companies are wondering which of them will be the next to face challenges to management or board structures and corporate strategies; the number of activist engagements has doubled in the last couple of years, and the funding behind new activist initiatives is growing.

I think companies are facing unparalleled levels of pressure not only from investors but also from regulators. Large shareholders generally understand what boards face, but they have a responsibility to deliver a return on their portfolios. The regulators are proving to be a wildcard, of sorts. With the unfolding of Dodd-Frank they are putting pressure on boards to perform at a certain level in response to situations.

MCC: What is the general counsel’s role in optimizing the interaction between board and management?

Gleason: The GC or the corporate secretary is the gatekeeper, with information generally flowing through them from the management team to the board. Their job is to see that specific information is produced at the appropriate time and as aligned with the agendas of the standing committees. GCs and their teams also keep the board apprised of the company’s legal risks. So the legal team is in the middle of the dialogue between directors and shareholders, especially for large public corporations. For instance, in response to activist issues, GCs will play a central role in assessing the risks and addressing the legal requirements related to the production of disclosure documents.

MCC: Tell us about NACD’s Advisory Councils more generally. On what issues do they focus, and who participates?

Gleason: Our Advisory Councils are made up of committee chairs on Fortune 500 boards, as well as regulators and shareholders, and they all engage in a multi-stakeholder dialogue. We originally created three councils for the key committees – audit, compensation and nominating/governance – and then we added a fourth on risk. This Advisory Council on Risk Oversight is a bit of a hybrid because not many companies have a standing risk committee.

At council meetings, we invite speakers to talk about issues that the council has identified as top-of-mind priorities. We bring in large institutional shareholders like Vanguard and T. Rowe Price as well as regulators like the Financial Accounting Standards Board (FASB) or the SEC. Representatives from Institutional Shareholder Services (ISS) have joined us to talk about their perspective. So the councils are designed to get different perspectives around issues and, as you mentioned earlier, start to identify the unknown issues.

All of our councils function on a similar basis, and we keep it fresh, relevant and topical. For example, council meetings aren’t always standard roundtable discussions. Recently, the Advisory Council on Risk Oversight staged a mock cyber crisis in which everyone had an assigned role to play, including the role of the CFO, the GC, the risk committee and the advisory council itself. The idea was to play out the scene, identify the issues and decide how to approach the crisis. Interestingly, during this scenario disclosures became a primary concern. In a cyber breach, while you know you have regulators to satisfy, law enforcement may be telling you to wait, essentially to allow them time to catch the perpetrator in the act. So the question debated in the meeting was: what do you do when the SEC says you need to disclose to your investors right now, but the FBI is saying you can’t?

MCC: And of course this is all done for the benefit of NACD’s members.

Gleason: Yes it is. At Advisory Council meetings, it is NACD’s job to capture and distribute the key discussion points so our members can learn from them. Our membership ranges by ownership structure – from public and private, to nonprofits – and by size, from the smallest to the biggest global players. They all appreciate our ability to convene different perspectives around critical issues, facilitate group discussion and then deliver insights in exceptional reporting and educational programs.

The largest companies out there are participating in our Advisory Councils and education programs, and our in-boardroom programs also help us surface the important issues. We have peer exchanges on a regular basis where we put a topic on a table, let a group of seven to ten directors discuss it and then report out.

That is a goal of NACD’s 2020 initiative, now in its third year, which ties together the key components of effective board leadership with emerging risk oversight in programs we offer nationwide. Through this initiative, directors can learn about how various boards have approached disruptive forces and then look forward to how boards will operate in 2020. Our goal is to keep the directors informed and help them do their jobs better.

It is important to remember that all boards are struggling with risk to some degree, and managing it is a balancing act. One commissioner from our Blue Ribbon Commission on Risk Governance said it well: “A car in neutral goes nowhere.” If you’re not driving the business, you’re not going to face any risks, and you’re not going to enjoy any rewards.

Please email the interviewee at with questions about this interview.

Complexity and the Boardroom

October 14th, 2014 | By

At the final plenary session of the 2014 NACD Board Leadership Conference, NACD President and CEO Ken Daly spoke with Steven Reinemund, director of Walmart, Exxon Mobil, Marriott, and American Express, and Gen. H. Hugh Shelton (Ret.), chairman of Red Hat and director of L-3 Communications on the issue of business complexity. The current environment is dynamic, fast-paced, and tumultuous, Daly observed. Not only must boards stay vigilant of disruptive forces—including those identified by NACD’s Directorship 2020®: economics, geopolitics, competition, technology, demographics, innovation, and environment—these forces rarely appear solo. Indeed, multiple forces can strike a company at once, creating a formidable force: complexity.

Drawing from his military background, Gen. Shelton suggested applying a process of “branches and sequels” in boardroom discussions to reduce unknown factors. This process requires that strategy development takes into account all possible actions of your adversaries or competitors—forcing directors to consider the “knowns and the unknowns.”

Reinemund used different terminology to address unknown and unanticipated factors. He said that boards may wish to view disruptors and risks through both offensive and defensive lenses. Most importantly, boards must also combine the two. Although defensive moves can be easier for boards to understand and address, by considering offensive actions the board can help move the business forward.

Turning to the topic of innovation, Daly noted that an unusually high number (95%) of the Standard and Poor’s 500 company earnings have been used to buy back stock or pay dividends. He posed the question: does returning earnings to shareholders reduce or limit the funds available for innovation or acquisitions?

Both panelists agreed that many companies have a large amount of cash available, but often the board can’t find a potential acquisition that fits the company strategy, or the target has such a high multiple that it is not a good purchase. Despite these potential issues, though, the panelists agreed that most large companies need to invest in innovation, through acquisitions or otherwise. Above all, the board has to think in terms of the amount of risk they are willing to take and—if necessary—encourage management to make innovation a priority.

The session ended with a discussion on board accountability. The panelists noted that directors must hold each other accountable for recruiting the right leaders, keeping their skills current, and maintaining the right mix of directors on the board.