The Board’s Role in Addressing Geopolitical and Regulatory Shifts
Assumptions about the geopolitical and regulatory environments are critical inputs into strategy-setting. If one or more assumptions prove invalid, the strategy and business model may require adjustment, and whether the organization is proactive or reactive is often a function of the effectiveness of its monitoring process. Protiviti recently met with 22 active directors during a dinner roundtable. The discussion revealed directors’ oversight concerns amid escalating geopolitical tensions and significant regulatory shifts.
The jury is still out regarding what the Trump administration and Congress can accomplish on major policy fronts. What has become evident is that there are many policy initiatives that could have significant impacts on business at home and globally. These initiatives include tax reform, fair trade, energy independence, immigration policy (including H-1B visas), infrastructure investment, employment and labor, and streamlining of governmental agencies, among others.
Regulatory shifts are also possible, including healthcare reform, dismantling Dodd-Frank, and a scaling-back of the Environmental Protection Agency. Regulations could be impacted by cutbacks at several agencies.
Some directors expressed concern over the short-termism of thinking inside the Beltway, as well as longer-term sustainability issues such as income inequality, student debt levels, and pay-for-performance. They also voiced concern about policy decisions that could create talent shortages.
What role does the board play in overseeing developments in policy and regulatory reform, and how often is the board briefed on fresh developments? How are significant geopolitical developments considered?
Several concepts for sound oversight were discussed.
1. A process is required to navigate the effects of policy, regulatory, and geopolitical shifts. This process should include monitoring legislative, regulatory, and global market developments through hiring insiders and consultants; tracking developments in published sources; monitoring geopolitical hot spots; and keeping close tabs on special interest groups. The process also entails engaging legislators, regulators, and policymakers through a variety of communications tactics, and continues with responses to new legislation and regulations through performing impact assessments, updating policies, and modifying existing and implements new processes and systems.
During the roundtable, several directors expressed concern about fair trade and risk of protectionist policies. The new administration appears to be committed to a reset of the North American Free Trade Agreement (NAFTA) and the Trans-Pacific Partnership. It is also focused on addressing trade issues with China. How these policy initiatives play out can significantly affect companies’ operations in or exports to these foreign markets and even transactions with suppliers in these markets.
2. Evaluate strategic assumptions. Every organization’s strategy has underlying explicit or implicit assumptions about the future that represent management’s “white swans,” or expectations about the regulatory environment and global markets. In these times of uncertainty, it makes sense for the board to assess the underlying strategic assumptions in light of likely policy actions by the executive or legislative branches that can impact the regulatory and geopolitical landscapes. If it’s possible that one or more assumptions might be rendered invalid, senior management should assess the ramifications to the strategy and business model.
3. Consider the implications of scenarios germane to the sectors in which the organization operates and prepare accordingly. Management should define plausible and extreme scenarios. The impact of various policy initiatives on the company’s markets, channels, customers, labor pool, supply chains, cost structure, discretionary spend, and business model should be considered. Scenario planning can be useful for formulating response and contingency plans. One major Japanese automaker spent three months following the 2016 election evaluating alternative scenarios resulting from Trump’s policies and their impact on U.S. and global sales. The company formulated contingency plans to pivot should a disruptive change occur, while also embracing the incoming administration as a market opportunity.
4. Prepare for more discretionary spending capacity. The Trump administration is looking to reduce the corporate tax rate significantly, make it easier for U.S. firms to repatriate profits earned and taxed abroad. It also seeks to eliminate the corporate alternative minimum tax and provide special deductions for firms engaged in domestic manufacturing. While these proposals have a long road to being passed, companies should consider how to deploy the hypothetical additional cash flow. Some examples include undertaking new investments, reigniting deferred projects, enhancing compensation to retain employees, and increase dividend rates, among other options.
5. Pay attention to sovereign risk. The primary objective of managing sovereign risk is to protect company investments from risks of impairment and sustain returns on investment (ROI). Investment impairments from confiscatory actions such as nationalization of the business or expropriation of assets may occur. ROI reductions may arise from discriminatory actions directed to the company, a targeted industry, or companies from certain countries in response to American policy. Actions could include additional taxation, price or production controls, and exchange controls. In addition, investment impairments and ROI reductions may occur due to circumstances such as violent political unrest or war. These risks must be addressed by understanding the driving forces of change in countries where the company does business and taking proactive steps to manage exposures.
When high risk of confiscation or discrimination emerges, your company might consider repatriation of cash to the extent allowed by controls and currency conditions. Look at managing down the investment by avoiding additional capital investments, cessation of inventory replenishment from abroad, and financing payroll and other operational functions through local cash flow. Initiating an exit by divesting assets is an option if a willing buyer is available. If necessary and feasible, moving tangible and nontangible assets out of harm’s way may be appropriate. Entering into joint ventures with local and foreign partners may reduce exposure to confiscation risk since the presence of nationals can take a multinational under the radar. If cost-effective, political risk insurance is another option covering the risks of confiscation, political violence, insurrection, civil unrest, and discrimination.
6. Diversify if revenue mix is dependent on government funding. Defense contractors can capitalize on defense spending and materials companies; heavy equipment manufacturers and construction contractors can focus on infrastructure spending opportunities. However, companies and nonprofit organizations with a high dependency on government contracts and federal funding may want to evaluate opportunities to deploy their core competencies in markets other than the public sector. It is not unreasonable to surmise that the new administration and the current Congress will restrain growth in budgets in areas that are not deemed a priority.
As priorities and policy direction become clearer over time, companies can firm up their responses to potential changes in the operating environment. Meanwhile, it is never too early to start thinking about alternatives. Directors should ensure that their companies’ boards are paying attention.
Dig into deeper insights from Protiviti by visiting their Board Perspectives piece on emerging geopolitical and regulatory challenges.