The total failure of the corporate strategies of the major financial institutions has resulted in the recent financial chaos and required unprecedented state intervention to ensure the continued survival of the global financial order and has raised questions about the adequacy of corporate governance of financial institutions. The current crisis has also revealed that the existence of non-executive directors on the board of directors has proven to be inadequate protection, particularly as many lack the specialist knowledge to effectively challenge their executive colleagues.
Although the credibility of the corporate governance framework is constantly being questioned as a result of the current financial turmoil, it is quite critical to dismiss the transitory excitement brought about by the crisis and remain rational. All stakeholders, including boards and shareholders, must accept their roles and responsibilities in what happened and learn critical lessons from this crisis to avoid repeating the same mistakes in the future.
In response to the current economic crisis, many governments around the world have responded immediately, focusing mainly on fiscal and monetary measures to mitigate the impact of the recession. While policymakers are under short-term pressure to act quickly, they are fully aware that the revised policy framework needs to be designed for the long term and subject to proper consultation and discussion. Company boards must consider their own individual responses to the crisis.
A balanced governance response from boards will gain momentum and is likely to be beneficial, particularly as the recession continues to unfold. Such a response is likely to restore confidence in shareholders, other stakeholders and ensure survival and strong and sustained repositioning at the operational level. The misfortune of some corporations has left important lessons for directors on corporate governance of all types of organizations in all business sectors.
The board should be comprised of individuals with varied and diversified skills, experience, and knowledge that reflect the challenges facing today’s business. Directors must possess at least adequate experience to understand the fundamentals of the company’s business and potential risks. Seasoned directors with prior experience in past downturns can be a critical asset to today’s boardroom, particularly at this stage of the financial crisis. The board should establish a mechanism to periodically update its membership to reflect the environment and emerging risks.
The current crisis has highlighted the importance of the board taking full responsibility for risk, which must be recognized and embraced by the boards of companies in all sectors of the economy. After all, risk management is a key responsibility of the board, and risk is at the heart of the business activities of any business. Therefore, the board has a critical role to play in terms of quantifying the risks inherent in corporate strategies, defining and clarifying the company’s risk appetite, and ensuring that appropriate resources are allocated for the identification, prevention, and risk mitigation.
Oversight of risk is a collective responsibility of the board, and the full board should engage in meaningful discussions about the overall strategic risks associated with the business, taking into account the relationship between business strategy and risk. It is fair to suggest that the biggest failure of boards, regulators, and shareholders in the current crisis is that they failed to adequately assess and challenge the risk of overall business strategies.
It is necessary to establish a line of communication between executive management and the board to alert the board of significant risks in a timely manner. This could be achieved by ensuring that the head of the internal audit function has a joint reporting line with both the board of directors and the CEO. Current single line reporting practices to the CEO result in a conflict of interest and could negatively affect internal audit’s credibility as a boardroom risk monitoring tool.
The absence of CRO representation on the board could be interpreted as risk management subservient to the operating interests of the revenue-generating business units. Risk management should be high on the board’s agenda and should not be relegated to a specialized department or individual. The board should allocate sufficient time for risk management discussions.
The current crisis has highlighted a key governance principle that employees should not be rewarded for improper actions that take risks, and the board should ensure that the compensation scheme rewards long-term performance. While such a compensation package may vary from company to company, it is essential that boards define the rationale for their compensation scheme and take into account how compensation awards are viewed by the outside world. After all, the transparency of compensation is an important aspect of maintaining legitimacy and earning the trust of stakeholders, regulators, and the general public.