Economy: A Plan For All Seasons

The corollary to “the more things change, the more they stay the same” is that no one can accurately predict what is going to change next. Economic forecasts range from dire to optimistic, and the march of unexpected events continues without end in sight. Seemingly solid financial institutions have been shaken by unforeseen market conditions; merger and acquisition transactions that appeared certain have fallen apart; and everyone from presidents to Fed chairs are coming under scrutiny and facing criticism. Harsh consequences for behavior that once appeared forgivable is now the rule, not the exception.

In this current period of volatility, directors may be surprised at how quickly a company’s fortunes can change. They may find themselves in a difficult situation through no fault of their own or their board’s. It is of paramount importance in these circumstances for directors to remember that even in the most uncertain of times, the fundamentals of directorship continue to apply: directors must responsibly oversee company affairs. The business-judgment rule remains the standard for judicial review of their ordinary-course business decisions.

Although well known to most directors, like the Boy Scout motto, it bears repeating: In the broadest sense, it is the responsibility of directors to oversee the affairs of a company and it is management’s job to run the day-to-day operations. In times of market uncertainty, there are generally three main areas on which directors should focus their attention: the state of the company’s business, the quality and depth of the company’s management (including succession planning), and the company’s liquidity.

This Year’s Model

Paying careful attention to the overall state of the company’s business is central to a director’s responsibilities. Directors should, in response to changing economic conditions, evaluate the sustainability of the company’s business model. For example, the collapse of the subprime mortgage market caused significant collateral damage—some of which was foreseeable and much of which was not—to many companies in different industries. Financially disruptive events may occur with little warning. However, if a company’s management and board are aware of potential vulnerabilities arising from changing market conditions and are willing to adapt their business model and strategy, they may be able to reduce their exposure in time to avert a crisis.

Similarly, as economic conditions change, it is important that the board is certain that it has the appropriate management team in place to weather any crisis. Management’s qualifications and capabilities should be reassessed in terms of experience, expertise, commitment, leadership ability, and depth. Moreover, the board should make certain that the chief executive officer knows that he or she has the support of the board for the company’s strategic direction, if that is the case, or directors should communicate their concerns if there are any differering views on strategic direction.

An important part of this process is making sure that the board hears regularly from the chief executive officer’s direct reports so it has sufficient confidence in the entire management team. This should be an important component of the board’s succession planning process as well. These matters should be addressed during the board’s executive session, which should be on the agenda for each board meeting.

Minding the Store

Once directors have satisfied themselves that the business model and the chief executive officer’s strategy continue to be appropriate, and that the current management team is capable of effectively managing the company’s current circumstances, directors should be sure they understand the key elements of the company’s business performance. Directors should have a clear understanding of how revenue sources might react to changing conditions in the economy in general or their industry in particular. For example, directors should have a general understanding of the company’s customer base and whether it is changing in meaningful ways. Directors also should have a good overall sense of the company’s operating costs, including labor and goods sold, as well as selling, general, and administrative expenses. Directors should take a broad view of the company’s financial and market position in order to be able to ask management about potential vulnerabilities in performance, depending on different economic scenarios.