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Boards don’t uncover misdeeds; that is what regulators, accounting firms are for

Boards don’t uncover misdeeds; that is what regulators, accounting firms are for
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First Published: Mon, Jan 19 2009. 01 15 AM IST

Updated: Mon, Jan 19 2009. 02 33 PM IST
How culpable are boards of directors in the current economic crisis?
—Hugo Beit, New York
Without a doubt and with perfect hindsight, some boards could have acted more boldly in their attempts to avert the current meltdown. But the real fallacy about corporate governance in this crisis does not involve what boards did and didn’t do. It involves what was expected of them.
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Not that we’re board apologists. Over the past three years, our columns have taken boards to task several times. But in this case we think boards have a right to defend themselves against the scolding cries of “Where were they?”
The answer: In most cases, they were where they were supposed to be, doing their jobs—within the limitations of reality. Look, shareholder activists may want board members to act like the superheroes of detailed company operations—like combined forensic accountants/cops.
But let’s get real. Most boards meet one or two days a month and are comprised of individuals who hold demanding full-time jobs elsewhere.
Given those circumstances, it’s absurd to believe that board members—even the most experienced and best-intentioned among them—can uncover systemic flaws or acts of malfeasance, particularly at complex financial institutions. That’s what regulators, outside accounting firms and internal control systems are for: to help boards ferret out excessive risk and wrongdoing.
Boards serve another purpose. Their job is to hire and fire the CEO based on his performance and values, the quality of his team, and the coherence of his business model. When boards are operating as they should, their members are engaged in a vigorous, candid dialogue with the CEO and his top lieutenants about strategic direction and whether the company has the right talent to implement its key initiatives at the right speed. And they’re spending time in the guts of the organization talking to “regular” employees, looking for signs that the CEO’s vision is understood and shared, and that company values mean more to the organization than just lip service proffered for the board’s entertainment. They’re protecting shareholders not by wielding their calculators, but by deploying their good judgment.
Unfortunately, even good boards using good judgement didn’t stand much of a chance against the newfangled financial instruments that sparked the current crisis. You can just imagine how the meetings went. Financial wizards showed up with gee-whiz presentations that demonstrated how they could capitalize on the “home ownership society” by packaging mortgages in a way that passed risk to others. They told their boards that consumer credit was rapidly increasing but the models were predicting only modest losses, and assured them that, with low interest rates, huge private equity loans were somehow different in this cycle from those in the past.
“Don’t worry,” they surely told their boards, “we have the downside covered”.
Obviously they didn’t. Should the board have known that? No, but the CEO and his direct reports ought to have. And if they didn’t, the board should have at least sensed that “knowledge gap” in their bones—and, indeed, that’s where boards merit some flak for the current situation.
Surely some financial institutions’ board members should have pressed their CEOs and executive teams harder about their risk assessment systems and demanded to know how risk managers were being rewarded. Instead, too many boards waited until the media started asking questions before forcing their CEOs out of the door. In the future, perhaps boards won’t wait for the “ratification” of negative publicity before they act.
But that can only happen when boards have the right kind of people serving on them—members who, in only a very limited time, can exercise good judgment and act with courage. Members who have a special ear: who can hear a presentation from any given executive and, with probing, differentiate between an executive who overpromises and one who under-delivers, between an executive who is a glib salesman and one they would bet their own money on. Members who have skin in the game, understand the company and care about it deeply.
If there are to be governance lessons from this crisis—aside from the need for realistic expectations—let that be among them.
The list of guilty parties involved in bringing about the current economic situation is long indeed, and boards do belong on it. Just don’t put them near the top. It’s giving them too much credit for a job they couldn’t do.
Write to Jack & Suzy
Jack and Suzy are eager to hear about your career dilemmas and challenges at work, and look forward to answering some of your questions in future columns. Jack and Suzy Welch are the authors of the international best-seller, Winning. Their latest book is Winning: The Answers: Confronting 74 of the Toughest Questions in Business Today. Mint readers can email them questions at winning@livemint.com Please include your name, occupation and city. Only select questions will be answered.
©2009/NYT Syndicate
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First Published: Mon, Jan 19 2009. 01 15 AM IST