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.
This is the second post in a series addressing the short- and long-term impacts of the 2016 presidential election. Read the first post here.
Directors gathered to discuss the impact of the recent presidential election on November 16, 2016 with audit and risk professionals from accounting firm EisnerAmper. While immediate-term changes were pressing on the minds of directors, they also discussed strategies to address societal and business challenges that coalesced around the following topics.
Can Corporations Bring Back Modern Manufacturing Jobs?
Directors were skeptical that the type of manufacturing jobs that have fueled American economic growth since the end of the second World War would ever return—and asserted that changes in trade agreements may directly impact the ability to create jobs.
EisnerAmper Chief Risk Officer Peter Bible outlined how the developing administration of President-elect Donald Trump could affect the ability of American companies to export their goods. The Trans-Pacific Partnership (TPP) “is basically on hold now” said Bible. “He wants tariffs on China and Mexico, wants to renegotiate NAFTA, and reconsider the U.S.’s involvement in international trade agreement.” Bible also pointed out that the president can act unilaterally on trade agreements, thus negating congressional checks on trade decisions.
Jill Wittels, chair at eMagin Corp., voiced concern about the pace at which companies could replace factories to offset the impact of tariffs and build more jobs for Americans. “Imposing currency restrictions and tariffs on goods coming in from China, South America, or other parts of Asia would be highly disruptive,” Wittels said. “You don’t instantly create replacement factories in the U.S. at a comparable cost.”
Robert Klatell, chair of TTM Technologies, concurred. “Realistically speaking, there is not that much flexibility. We cannot create in the United States the scale of manufacturing that exists in China,” Klatell said. “We don’t have the people or the capital to do it. We’ve rarely had a government willing to support manufacturing the same way that China has in the past 10 to 15 years.”
William Leidsdorf, director at Icahn Enterprises, offered a different viewpoint. “I think you have to look at how Congress may change or water down the president’s decisions,” Leidsdorf said. Trump “is a businessman. He’s a pretty good negotiator. He’s going to go in [to the presidency] and say he’ll do a lot of things and then negotiate.”
Educating the Workforce
Re-educating the American workforce has been a ubiquitous topic at roundtables co-hosted by NACD throughout 2016. This event was no exception.
A vigorous discussion about the modern workforce was ignited when Carol Robbins, principal of financial services strategic advisory group CER Consulting, cited the invention of a garment-sewing robot as a groundbreaking technology likely to replace countless garment manufacturing workers around the world. Sharon Manewitz, principal and executive director at Manewitz Weiker Associates, a firm that consults with struggling companies, responded: “But who will make the robots? Will they be made here? We need corporate America to help educational institutions change the nature of education in America” to meet the demands of a knowledge-based economy.
The ability of the workforce to be retrained for modern jobs, and how automation will continue to disappear unskilled and lower-skilled positions, was discussed at length. Klatell, however, looked to the future. “Some people won’t make the transition, so we should be focusing on their children,” Klatell argued. “Hopefully, we can get their kids through school with a more meaningful education to make them more employable.”
Laurie Shahon, president of Wilton Capital Group, placed a board lens on some companies’ struggle to fill open positions in certain fields. “Human capital is an issue boards have to deal with,” Shahon said. “We see jobs available in financial services and other industries, but they can’t be filled because there aren’t sufficient qualified people to fill them.The board can and should present alternate cases in its strategy planning to address these changes.”
If Trump makes good on his campaign promises, deregulation is expected under the new administration and the forthcoming Republican majority congress. How long, though, can directors anticipate deregulated policies to last? Bible pointed out that the current administration might attempt to press through lingering Dodd-Frank provisions. However, he warned that deregulation could cause disruption. “These things are deeply rooted, with a lot of capital behind them,” Bible said. “You can’t just say ‘poof—gone.’ It’s impossible.” Practices that companies have implemented as a result of post-financial crisis legislation [such as the Dodd-Frank Act of 2012] are likely not to disappear as governance best practices because companies invested time, energy, and money to comply with them.
Meanwhile, directors in the room considered what impact deregulation might have on enforcement of the Foreign Corrupt Practices Act (FCPA) and other international business policies by the Department of Justice. Andrea Bonime-Blanc, founder of GEC Risk Advisory, reminded attendees that enforcement of the FCPA, the False Claims Act, and other laws has been on the rise lately. “People are asking, ‘What’s going to happen with FCPA enforcement?’” Bonime-Blanc asked. “Companies can’t just say ‘oh, let’s stop worrying about bribery.’”
Bible responded: “I believe that the FCPA will continue to be enforced as a worldwide standard, and that the new administration’s focus is going to be on executive compensation and on market regulation. I don’t think there will be an increase or a decrease in enforcement.” If anything, Bible indicated that directors should be concerned about the risk of tax repatriation from companies that have moved their headquarters offshore. “Is everyone familiar with how the overseas tax issue works?” Bible asked. “There is $2.6 trillion in money offshore, and $500 billion of that is held by tech companies. There are drives to get that money back into the U.S. economy that can be done without addressing the entire tax structure.”
Don’t Give Up on Culture of Inclusion
The social unrest incited or revealed by the vitriolic presidential election was discussed in the context of the culture of inclusion and tolerance that their companies have invested in building for decades. Aside of the moral imperative felt by many attendees, the disruption of hard-won corporate culture by internal or external actors could present a reputation risk to the company.
Wittels noted that a popular American shoe company had been endorsed by an incendiary website littered with forms of hate speech after a senior manager at the shoe company stated that it felt the country was moving in the right direction under the incoming president. While the company released statements strongly stating its commitment to principles of inclusion, “there are comments about boycott,” Wittels said. “This is a real reputational risk, and a risk with consumers, that could instantly in this communication age go viral and affect the bottom line.”
Klatell returned to the question of the board’s responsibility to ensure that the CEO, his direct reports, and management across the organization are responsible for maintaining a culture of respect, dignity, and inclusion. In the face of employees who may be looking to throw principles of inclusion out of the door, Klatell said: “I’d hope that most companies would stand up and say ‘No, this is what we stand for, and this is how we behave.’”
To see the full list of participants, please click here.