Governance: A Practical Integrated Approach

In the wake of the failures in corporate governance that led to the global downturn, CIMA believes that businesses should integrate long-term sustainability into their core activities. In setting the ethical direction of an organisation the tone must come from the top - that is from the executive and non-executive board directors.  A key responsibility of the non-executive directors is to uphold values that put the long-term future of an enterprise above short-term profits. This also entails management providing non-executive directors with the most relevant and accurate management information available, data which would help the board identify if the company is cutting corners ethically to get quick returns.

 

CIMA’s report, Enterprise Governance: Restoring Boardroom Leadership, looks at what boards need to do to be more effective – and how management can support them in that task.  In the wake of the biggest and most damaging failure of corporate leadership of recent times, there is a growing public expectation for organisations to operate ethically and responsibly as leaders look to restore trust in the corporate world.

 

Integrated model

The report presents a practical, integrated model which shows all the key factors that support board effectiveness. People, behavioural issues and risk management are considered as well as supporting frameworks, processes and structures. In light of recent failures, there is a particular focus on how organisations can create a culture of ‘effective challenge’ where boards are encouraged to scrutinise management proposals.

 

“Public expectations of corporate behaviour are now, understandably greater than ever before,” observes Charles Tilley, CIMA Chief Executive. “Both boards and executive management need to combine a commitment to the highest ethical standards and the long-term sustainability of their businesses with a keen awareness of the public interest dimension of what they do.”

 

“Our new report provides a practical framework to help in this task. We place much emphasis on a constructive, but challenging relationship between boards and their management.  This does not mean a cosy complacent one!  But we would argue that a board can only be as effective and as healthy as the underlying business that it governs.”   CIMA’s boardroom leadership model suggests key ingredients to create a climate in which constructive challenge of the CEO is possible.

 

  • High quality management information.
  • Diversity in skills, perspectives and experience.
  • Mutual respect among players. There needs to be an understanding and acceptance on all sides that constructive challenge is vital. 
  • Robust processes and frameworks to support strategic development. It is difficult to challenge strategy if the board agenda does not allocate enough time to discuss strategy. Boards may find other devices useful, such as designating someone to play devil’s advocate for a particular discussion.

 

Challenging management

In the Harvard Business School white paper, Perspectives from the Boardroom – 2009, a board director recounted how he dealt with the management team. “When [the management team] walked in and sat down around the edge of the room, I said: ‘Folks, we’re very aware of all the work you’ve done. We’ve had a great review of all that, but there is an enormous amount of information here.’”

 

“‘You all, we know, have made very significant decisions to get to the conclusions you’ve come to. We suspect they are the right decisions, but the only way we will know and be able to put our judgment on that is if you’ll permit us the opportunity to test you in many ways during the next couple of days of discussions, so that we can get through the same small knotholes and decisions you did in the same way that you did. And you’re going to need to be patient with us.’”

 

Although there may be acceptance that a challenge culture is positive, it is not easy to define, create or maintain. The following questions need to be considered:

 

  • What does a constructive challenge look like in practice?
  • How can a company assess its effectiveness?
  • Are there best practice examples of a constructive challenge that prevented costly mistakes?
  • How much time should be spent on challenging proposals?
  • When does a challenge become counterproductive?
  • How can a company demonstrate to stakeholders that it has an effective challenge culture?

 

Talent development

Much attention has been devoted in the corporate governance debate to executive remuneration. Less attention has been paid to the nurturing of long-term talent and succession planning. Yet this is a critical function of the board that can significantly affect the continuing success of an organisation.

 

In our initial enterprise governance work in 2002-2003, we found evidence that succession planning was a relevant factor in success or failure. UK retailer Marks and Spencer experienced serious boardroom upheavals and strategic difficulties, partly as a result of its board’s failure to address succession issues. Tesco, on the other hand, took senior level succession planning seriously. The transition between its chief executives worked well and the company’s performance benefited as a result.

 

Long-term talent and succession planning – both on the board and in senior management – needs dedicated attention.

 

Frameworks, processes and structures

It is important to recognise the frameworks, processes and structures that support effective boardroom leadership.

 

  • Roles and responsibilities. There must be clear definitions of the roles of key players, including those of the chairman and the Neds, along with structures such as boards and board committees. Key processes should include board evaluation. This is well covered in traditional corporate governance codes.

 

  • Agendas and tools. Boards must use time and the setting of board and subcommittee agendas constructively and with discipline to consider strategic issues. Boards can use strategic frameworks and tools to facilitate discussions. One framework is the CIMA Strategic ScorecardTM, which enables boards to focus on the key aspects of strategy, to ensure that they receive the necessary information and to ask the searching questions.

 

  • Information and reporting. The information that boards need and how they report in ways that drive good governance have been explored extensively in two CIMA programmes, ‘Report Leadership’ and ‘Improving Decision making in Organisations’. The institute is undertaking further work in this area to be published in a future report.
     
    This is also linked with calls for a new model of reporting to take into account long-term sustainability issues. According to the Prince of Wales’s Accounting for Sustainability Project: “The recent financial crisis has highlighted the need for capital market decision making to reflect longer-term considerations and has called into question the extent to which corporate reporting disclosures highlight systemic risks.” 

 

  • Risk awareness. Boards must properly understand risk, integrating it into strategic thinking and demonstrating a rigorous and consistent approach throughout the business cycle.
     
    The crucial point is the quality of the conversations that the board has about risk – it’s not about ticking boxes in a risk framework. Organisations need to manage risks reliably throughout the business cycle to deliver sustainable performance. Risk management practices became too lax during the boom years. This was apparent in the financial services industry, with misaligned performance incentives and inadequate risk models leading to excessive risk taking.
     
    Organisations tend to oscillate between under-scrutiny in good times and over-scrutiny in bad times. Sustainable performance requires reliable and consistent scrutiny over the course of the business cycle.

 

Greed and disaster myopia

“Greed reflects a failure of leadership,” writes Russell Palmer, former dean of Wharton Business School, in [email protected] “Turning your head to ignore the risk because you are making big earnings today certainly shows a lack of leadership.”

 

The tendency towards greed is reinforced by ‘disaster myopia’. This is the tendency to underestimate the probability of adverse outcomes that have not occurred in recent memory. A parallel example is the homeowner who has been burgled but whose vigilance drops as their memory fades. Disaster myopia was recognised as one of the factors responsible for the banking crisis by Andrew Haldane, executive director for financial stability at the Bank of England.

 

Conventional approaches to decision making exacerbate this weakness. Wim Van der Stede, CIMA professor of accounting and financial management at the London School of Economics and Political Science, describes the oscillation between over and under scrutiny as a possible by product of the ‘management by exception’ approach that most companies practise.

 

“[Management by exception] directs attention primarily, if not exclusively, to problem areas, assuming that all is well where and when performance meets or beats expectations.” he explains. “There tends to be an asymmetry in the attention paid to good versus poor performance – that is, there is more vigour to combat contractions than there is healthy scepticism or sensible restraint during expansions or towards unusually strong performance.”

 

An illustration of the imbalanced performance scrutiny cycle is that it is less common for firms to investigate unusual profits than unusual losses. Yet, as Van der Stede points out, unusual profits often provide hints of impending disasters. Unusually high profits might indicate that managers have been too aggressive, taking too much risk or focusing excessively on short-term goals, particularly where there is lax scrutiny.

 

‘Superstar’ managers should perhaps be assumed to be excessive risk takers, except where proved otherwise (Woods, 2009). Boards should celebrate stellar performance only once they have cast a searching eye over how it has been achieved.   

 

Key conclusions

  • Boards need an integrated approach to effective leadership. 
  • Directors must incorporate behavioural and structural factors. 
  • More attention must be paid to psychological factors contributing to board performance: creating a challenge culture, succession planning and effective risk governance. 
  • There must be rigorous, regular and systematic board evaluation. The model proposed by this report could provide a useful input to the board evaluation process. 
  • The board’s relationship with external stakeholders, particularly shareholders, is crucial. By focusing on its own effectiveness and contributions to the long-term sustainability of the organisation, a board will serve those stakeholders.

 

About the Author

Gillian Lees is an enterprise governance specialist within the knowledge unit in CIMA’s communications department. She was heavily involved in the IFAC/CIMA enterprise governance project as well as CIMA’s initiative to develop the CIMA Strategic ScorecardTM. Her particular interest is how boards can oversee strategy and risk effectively.

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