Boards Fail Often (more often than it seems)
We are passionate advocates for strong corporate governance. We believe good governance leads to organizational health and sustainability.
We get depressed when another large (frequently public) organization bites the dust or hits the skids. Whereas the press and many others seem to blame management, we frequently find ourselves asking ‘where was the Board of Directors?’.
Some of examples of corporate governance failures in organizations:
- Where was the Board of Volkswagen when the Company started cheating on emissions testing?
- Where was the Board of General Electric when it embarked on new costly directions that significantly impacted it’s growth, profitability, and shareholder value?
- Where was the Board of Wells Fargo when it created millions of false accounts on behalf of its customers without their consent?
- Where was the Board of Carillon when it took on new, unprofitable contracts and it’s debt soared to the point of corporate failure?
- Where was the Board of Uber? Equifax? Samsung?….?
What are the corporate governance lessons from these failures?
Three Reasons Why Boards Fail
When we analyze corporate governance lessons, we see three common reasons Boards fail:
- The Board didn’t know there was a current problem
- The Board didn’t know there was risk
- The Board approved direction and incentives that made cheating worthwhile.
1. The Board Didn’t Know There Was a Current Problem
A key challenge of corporate governance for any Board is knowing what it doesn’t know – the DK2 (don’t know what we don’t know) problem. It’s not an excuse – it’s part of the job.
How was the Board of Volkswagen supposed to know that it’s engineers were cheating on emissions tests. Who knows? But others in the VW organization knew. It’s likely that some suppliers knew. What was the whistleblower policy? Was the Board getting regular updates on whistleblower incidents? Was that one way to find out about a hidden problem?
2. The Board Didn’t Foresee a Problem – understanding the hidden risks
A primary role of every Board is to identify and mitigate risk. Here’s why so many Boards fail at it:
- They don’t understand the market (technology?!)
- They don’t understand the product (mortgage-backed securities?!)
- They believe everything management tells them (“business will never adopt the iPhone”)
- They get comfortable because everything seems to be going so well (“things could not be better”)
- They don’t understand that mitigating non-financial risk is a key part of their role (talking to the Lawyers and Auditors but not the IT, marketing or HR consultants)
3. The Board Didn’t Understand They Created the Problem – incenting ‘goofy behaviour’
Ok, this one’s a biggy. Think large financial or stock incentives for bottom line or market share performance. Then consider what kind of behaviour that might (and does) incent in management:
- Taking unnecessary risks like acquisitions, large contracts, expansion into new markets, lower pricing
- Cooking the books, accumulating false assets, ‘off-balance sheet’ transactions
- Hiding problems like staff turnover, whistleblower incidents, sexual harassment
- And many others
Incenting goofy behaviour may the most common cause of corporate failure over the past hundred years – the Board ok’ing a direction that empowered management to make serious errors in strategy and tactics.
Corporate Governance Lessons: Three Questions Directors Should Ask Before a Board Fails
Corporate governance is a tricky task. It fails more often than most Directors realize. If the penalties for enabling corporate failure were tougher perhaps more Boards would work harder and more creatively at stopping it. For those who want to try harder, here are three simple questions:
- What is management telling you about the business that you are accepting at face value?
- What is management being incented to accomplish and what are the various right and wrong ways they might be successful?
- How well does the composition of your Board reflect the risks and strategies of the business you are governing?