With the principle of the rule of law and democratic governance under siege in numerous parts of the world, corporate board members are increasingly considering how global events are creating mounting risks to both their businesses and the bottom line.
These actions are taking place in jurisdictions that have long been high risk for companies. The Democratic Republic of the Congo, Venezuela, and Myanmar, for example, have for some time presented operational challenges as a result of poor governance. In recent years, however, countries thought of as bulwarks for the rule of law have also begun to present challenges for businesses. Some argue that these include the United States, a country that traditionally has been known as a powerful advocate for the rule of law and democratic values and the long-time guarantor of the system of global governance, and the United Kingdom, where the legal and regulatory uncertainty caused by Brexit has seen many investment decisions put on hold.
Just in the last few weeks actions taken by the United States with rule-of-law implications have given some in the business community great pause. US actions regarding Chinese telecom company ZTE Corp. have raised questions as to whether a law enforcement action against a corporate entity can be used as a point of leverage in an international trade negotiation. Notwithstanding policy arguments for and against, the US’s withdrawal from the Iran agreement and pending re-imposition of secondary sanctions create significant uncertainty both for international businesses making investment decisions in Iran, and with respect to the US’s long-term commitments to international agreements. Many also note that America’s executive in chief has imposed considerable pressure on elements of the Federal government whose independence has long underpinned the rule of law in the United States, from individual judges and the judiciary to members of Congress, to law enforcement and the Federal Bureau of Investigation. This pressure has at times taken the form of quite personal attacks that set a concerning precedent, including for businesses that must ask whether they could become a target for a president who dislikes what they may be doing.
It is no secret that businesses do well in jurisdictions where the rule of law is strong: where contracts are enforceable, where fair judicial decisions are rendered without unreasonable delay, where assets aren’t arbitrarily seized or contracts arbitrarily renegotiated, where laws and regulations are transparent and applied fairly, where bribes need not be paid for discretionary actions by government. These are environments where businesses thrive. Indeed, as a 2015 Report by law firm Hogan Lovells and the Bingham Centre for the Rule of Law makes clear, there is a strong correlation between foreign direct investment in a country and the existence of a sound rule of law.
Businesses also do well where basic principles of the rule of law and associated norms are embedded. The separation of powers, the existence of a resilient and independent law enforcement system, and basic respect for truth and fact-based decision making are all important contributors to business success.
Finally, the existence of a strong rule of law correlates with broader societal thriving, making for an invigorated source for customers, employees, partners, and suppliers.
Given this reality, it is imperative that boards be sensitive to the range of rule-of-law issues that impact their businesses, even in jurisdictions where they least expect it. This means considering specific risk factors involving rule of law, above and beyond more generic political risk factors, whenever contemplating entry into new jurisdictions. The same can be said for assessing merger and acquisition or joint venture prospects, even in places where rule of law issues aren’t on the front page of newspapers every day. Indeed, a broad range of rule of law risk factors should be included in standard risk matrices so that business-critical issues such as prospects for the enforceability of contracts, or the ability to get a fair and timely judicial decision, or the independence of law enforcement are specifically considered when assessing risk. Existing governance and compliance frameworks can readily be adapted to reflect rule of law issues, alongside human rights and other risk issues. Rule of law matters should be included on the agenda of board meetings when appropriate.
In addition, boards should consider their companies’ own self-interest in the existence of a strong rule of law, and decide what their role might be in encouraging better governance, both within the companies themselves and in the environments where they operate. Many high-profile businesses have stepped up in recent months to publicly support such issues as countering climate change (as occurred when the US withdrew from the Paris Climate Agreement last year, which precipitated an outpouring of commitments by businesses to meet the goals set out), or in response to gun violence (as with Dick’s Sporting Goods following the Parkland school shooting), for instance.
In this regard, business can serve as a champion of good governance and the rule of law, advocating for improving the standards of governance where appropriate, and initiating collective efforts with like-minded companies with shared interests in stronger rule of law. Chambers of Commerce and other trade associations can be powerful voices when it comes to advocating for a strong rule of law that encourages foreign investment and secures stable business environments. Directors can urge the associations they are involved in to initiate efforts to support the rule of law, helping to bring to bear the influence and credibility of the business community to move the needle, in a positive way, on the quality of governance and the rule of law. Further, there are business-driven associations that provide a platform for collaboration to support the rule of law.
With the rule of law being challenged in so many countries around the world, businesses have both a strong interest in and ability to contribute to fostering a strong rule of law everywhere. Businesses, and their directors, should be part of the urgent work to publicize and mitigate what it is we as a global community will lose if the rule of law is undermined.
Ulysses Smith is a US-based lawyer and director of the Business and the Rule of Law Program at the Bingham Centre for the Rule of Law. All thoughts are his own and do not necessarily reflect those of NACD.
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.
Peter Bible, standing, discusses geopolitical risk.
“I put the future of risk in two buckets,” Bible said. “First, there are black swans. They are things that are embedded [in the business environment and society at large], and when they come to light they are so disruptive they are devastating. Brexit was embedded in the way people felt in the United Kingdom. Our own election was an upheaval of sentiment. The other thing is the butterfly effect where some movement somewhere around the world can disrupt what you’re doing. That’s how you have to think about geopolitical risk.”
Here, strategy and risk oversight can enable a company to better weather disruptions that arise from changes in a country’s leadership or regulatory agenda. As one director observed, part of the trick is to be able to look out on the horizon, realizing that it’s impossible to have the foresight to identify every disruptor that can threaten the business.
“Get to know the business unit heads,” one participant suggested. “It gives you a feel for what they think the strategic risks and opportunities are—it changes how the board is reacting to strategy and risk.”
“When we first approached enterprise risk management,” another participant offered, “the whole board owned risk management and we reached to an outside firm for help. When the firm interviewed management and the board, the risk factors each group identified didn’t match up. People view the world from where they sit. So, we sat down with management and developed a top ten list that we could all bite into. Reconcile the risks as best you can and figure out how to move forward.”
Lacking a well-rounded worldview can be especially damaging for multinational companies, which need to consider risks that are unique to each country in which they operate. “I think we in the United States don’t take time to understand how different countries operate both as a country and as a culture,” one director remarked. “Think about benefits for employees. Most of those countries have national healthcare, so automatically you have a different cost structure of how your business looks in that country. And that can either lower or raise your company’s risk profile. As you get into other parts of the world, the nuances are very different and sometimes we think the rest of the world operates as we do. That’s a part that we as a culture need to understand. Think global act local needs to be implemented more in corporate strategies.”
Bible then refocused the conversation to focus on how the current regulatory environment stands to create both risks and opportunities. “There is a deregulation movement underway and many businesses are hurt by this because they make their money based on current regulations. If 75 percent of the regulations that are currently on the books are going to come off, what does that do to your business model? What regulations do you depend on for progress?”
One participant brought up Uber Technologies as an ideal case in point. The taxi industry is heavily regulated; however, Uber is allowed to follow its own set of rules. Another participant observed that having a Federal Communications Commission chair with an anticompetitive stance is going to be highly disruptive for telecommunications companies. For example, some critics argue that removing some net neutrality protections will lead to companies having to pay fees to broadband providers for faster download speeds to ensure that their goods and services can easily reach consumers. This could be especially detrimental to startup telecommunications companies and smaller Internet service providers which don’t have the financial resources of larger, more established companies.
While regulation compliance can be expensive and time consuming, one attendee noted that not all regulations are bad. “Identify which regulations benefit you and your competitors; it’s a good inventory to have,” Bible said in closing. “A lot of things are on the table right now and the potential to have your business hurt by deregulation is definitely there.
Click here for highlights from the portion of this roundtable discussion that focused on the business implications of social media and artificial intelligence.