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.
At a mainstage panel during NACD’s 2016 Global Board Leaders’ Summit on September 19, directors, economists, and former regulators discussed the potential regulatory, economic, and geopolitical implications of the coming election and reflected on how corporate directors and executive teams should adjust to greater levels of ambiguity. One of the panelists, Nicholas M. (Nick) Donofrio, director of Advanced Micro Devices Inc., BNY Mellon Corp., Delphi Automotive PLC, Liberty Mutual Co., the MITRE Corp., and NACD, and the former head of innovation at IBM, characterized today’s external environment as “lumpier and more abrupt than even a few years ago,” forcing companies and their boards to be always on alert and to act quickly in response to change.
The panelists offered a range of projections to help corporate directors assess the business impact of the upcoming elections. They emphasized that aside from a new occupant of the White House, the elections also have the potential to drive significant changes in Congress, major regulatory agencies, and the judicial system. The discussion centered on four major questions of importance for companies and the boards that oversee them.
How likely is a major reform of the tax code?
Reform of the corporate tax code is long overdue, said former U.S. Senator Olympia J. Snowe, director of Aetna, Inc. and the Bipartisan Policy Center. For years, companies have learned to accept the “permanent temporary tax code,” and the resulting policy uncertainty has made investment and capital allocation decisions more challenging. Snowe suggested that even if House and/or Senate control switches from one party to another, it is unlikely that Democratic and Republican congressional leaders will be able to transcend their fundamental differences about taxation and break the current gridlock. Most likely, she believes, the incoming president will use the power of the pen to tweak the current tax code through executive orders.
Should we expect continued regulatory activism?
Troy A. Paredes, director of Electronifie and former Commissioner of the U.S. Securities & Exchange Commission (SEC), shared his concern that “the tidal wave of regulations” seen in the past few years won’t slow down, and it will force companies to commit more time and resources to compliance. “Elections are always major inflection points,” he said, that either sustain or reset the policy priorities of the SEC and other key regulatory bodies such as the Commodity Futures Trading Commission, Federal Trade Commission, and Federal Communications Commission. Meanwhile, Paredes urged directors to be alert as to whether Mary Jo White, the current chair of the SEC, will have enough time in her remaining tenure to finish rule-making on key corporate governance matters covered in Dodd-Frank.
Will our political system address skill shortages in the labor market?
Nick Donofrio offered a mixed view of how the country is addressing the looming crisis in the labor market where current skill sets do not align with the future industry needs. “Our political institutions are too polarized to take meaningful action,” he said. However, it’s crucial that the United States build a digitally competent and productive labor force that can be employed to deliver high-tech manufacturing. “We cannot afford to only create [financial] value in this country, but we must also [manufacture] value here. That means returning much more research and development and production to American soil.” In the absence of government investment, he’s optimistic that the private sector will step up to address this critical challenge and find innovative ways to reskill displaced workers.
How will the United States make itself more competitive globally?
Harry Broadman, a seasoned economist and the CEO and managing partner of Proa Global Partners LLC, reminded the audience that the United States faced a similar set of challenges to its global competitiveness in the 1980s when Japan was projected to become the world’s economic leader. A major difference today may be the backlash against free trade, which could jeopardize the adoption of the Trans-Pacific Partnership and threaten the underpinnings of the European Union. Broadman underlined that it will be critical for U.S. policymakers to remove barriers to foreign investments from high-growth emerging market companies that will contribute to quality job growth. This new generation of enterprises is important to the future of global business, which will no longer be dominated by firms headquartered in the West.
He and other panelists also spoke extensively about the importance of major investments in public infrastructure. America’s crumbling highways, bridges, ports, and technology infrastructure significantly impede further productivity growth, which Broadman believes is the country’s major Achilles’ heel.
The rate and complexity of change in the marketplace is greater than ever before—and not showing any signs of slowing. From innovation and disruptive technologies to regulatory activity and stakeholder scrutiny, companies are constantly presented with new risks and challenges. As NACD’s new Chair Reatha Clark King observed, writer William Gibson captured the inflection point most corporate boards find themselves approaching: the future is here, it’s just not evenly distributed. As these changes force global economic shifts, it is necessary for those in the boardroom to understand and prepare for the future structure of directorship now.
This week, NACD held the second in a series of exploratory meetings in Chicago to discuss how the boardroom can define and prepare for the challenges and opportunities expected in the next five to seven years. This meeting series—held in New York City, Chicago, and Los Angeles—will culminate in the kickoff of NACD Directorship 2020 at the 2013 NACD Board Leadership Conference. An effort to provide directors with a clear vision of what their roles will resemble in the future, NACD Directorship 2020 will extend from educational programs and roundtable exchanges to publications, all shaped by feedback from these events.
At the Langham Hotel in Chicago, more than 100 directors attended the afternoon session to discuss two topics: the future state of communications between the board and C-suite and how to select performance metrics that will generate sustainable organizational profit. Sessions were led by NACD President and CEO Ken Daly; Akamai Technologies Lead Director and Audit Committee Chairman Martin Coyne; NACD Chair King; and former Bell and Howell CEO, current NACD Director, and Northwestern University Professor Bill White. During the highly interactive sessions, each table was given a specific set of questions to discuss and provide thoughts among their peers. Takeaways from the event include:
Directorship is a part-time job with full time accountability. Inherent in the board/C-suite relationship is an information imbalance. However, with the right culture and board leadership, the board and senior management can easily communicate expectations and necessary information.
A CEO’s leadership style can serve as an indicator that the risk of information asymmetry has become too high. Directors establish a level of trust with the CEO and management to allow for board access to other members of the senior team, as well as site visits to see the company’s operations.
With an expanding board agenda, process and expectation setting are critical. The board should clearly communicate to management the types and format of information that need to be presented.
An empowered lead director or non-executive chair can help mitigate the risk of information imbalance. By facilitating communication channels and work between the independent directors and the CEO, this leadership position can break down some of the road blocks that may develop between the C-suite and directors. The relationship between the CEO and lead director or chair should be transparent.
Culture is critical in effective dialogue between the board and senior management. With the right culture, directors can be sure they are aware of the risks that are keeping the CEO up at night.
Sharing information via performance metrics, which are focused on what directors need to know, can bridge gaps in information flow. Ultimately, the board has to make winning decisions which are informed by data.
Today, directors balance short-term shareholder expectations with generating long-term sustainable profit. The role of the stakeholder, though, is more significant than ever before and expected to grow. In the future, directors will have to be increasingly focused on balancing shareholder return with stakeholder concerns.
It may be difficult for the board to address and to communicate with every stakeholder. The board should identify which stakeholders are critical to the strategic plans, and target communications to those groups.
Balance also extends to leading versus lagging indicators. The board should first approve the right strategy and set goals accordingly. Leading indicators will drive ensuing performance—but lagging indicators are also necessary to provide the right feedback loop.
Innovation is important to the success of any company. How innovation is defined, though, is largely dependent on the company, and should be rooted in the corporate strategy. For some, innovation will manifest in processes, products, or both.
The next NACD Directorship 2020 event will be held Sept. 10 in Los Angeles. Between events, NACD’s blog will feature viewpoints and research from our NACD Directorship 2020 partners—Broadridge, KPMG, Marsh & McLennan Cos., and PwC—that will take a deeper look into the emerging issues and trends that will redefine directorship.