The updated version of “21st Century Governance Principles for U.S. Public Companies” describes the board’s major areas of responsibility as “monitoring the CEO and other senior executives; overseeing the corporation’s strategy and processes for managing the enterprise, including succession planning; and monitoring the corporation’s risks and internal controls, including the ethical tone. Directors should employ healthy skepticism in meeting these responsibilities.”
The last sentence of the principle almost reads as an afterthought, but it states that directors should employ “healthy skepticism” in meeting their responsibilities. I never had enough appreciation for this “afterthought” until my experience as the corporate governance expert witness in a major Enron lawsuit. What makes the point interesting is that this is not a statement about numbers, risk management, or complex financial securities, but rather about human behavior and attitude. Indeed, it is possible to be highly intelligent, talented, knowledgeable and successful, but because of human behavior, fail to employ “healthy skepticism” in meeting responsibilities as a director.
So what does this have to do with Enron? By all accounts, in the late 1990s and 2000 Enron was, on the surface, a booming company with an executive management of business superstars. With such a backdrop of success, a natural human instinct might be for a director to reason that “star” management should not be seriously questioned or challenged and that the board should simply ratify management’s proposals. This, however, is contrary to the notion of “healthy skepticism.” Merriam-Webster’s online dictionary defines skepticism as an “attitude of doubt.” It is understandably difficult for a director to have an attitude of doubt when management’s track record is so stellar. However, directors need to understand that each decision they ratify is either one that creates or destroys value, irrespective of the past.
Healthy skepticism is when directors employ confidence in their ability to use common sense and wisdom in their decision-making processes, irrespective of whether the CEO is new to the board or is a known “superstar.” Healthy skepticism does not mean that directors question every facet of every decision, but simply that they employ their ability to discern and recognize when and how to contribute to a richer decision outcome with all eyes on the decision itself, and not to have undue bias towards the one proposing the decision.
What makes the Enron case particularly relevant today is that there may be many boards out there with directors of impeccable qualifications who enjoy a collective boardroom culture of “pedestal-type” respect for management. This is not healthy. Many of these boards might think that this is not their situation since they routinely ask “tough questions” and “challenge” management. However, in all the testimony I read, I did not find a single outside director on the Enron board in the 1997-2001 timeframe who felt he or she did not challenge management or ask tough questions. In short, there is no question in my mind that the Enron directors did challenge management and ask tough questions. On conclusion of such interaction and virtually without exception, however, the board or committee approved the management proposal. One director’s testimony brings the point home in reference to his role in the decisions on accounting policy before the Enron board: “I am not going to second guess on whether that was the right or wrong approach.”
The problem with this logic is that “healthy skepticism” requires that directors do exactly that (second guess), either in the quietness of their own mind, if that is what is “healthy” for the situation, or to speak up, question, and yes, perhaps even reject a management proposal.
So did a very high management proposal approval rate prove that Enron was a rubber stamp board? The answer is no, but it does provide supportive evidence. The nail in the coffin indicative of a rubber stamp board is when you combine a high management proposal approval rate with specific ratification of decisions that by all measures defy common sense. If the Enron board had employed “healthy skepticism” in meeting their responsibilities, they would have had enough trust and confidence in their judgment (in spite of “superstar” management) to reject decisions that defied common sense.
It is easy at this point to “Monday-morning quarterback”, but that does not mean we cannot learn from the past. If you are on a board of directors with talented, successful, personable, and knowledgeable people, and if your executive management team “can do no wrong”, then this message is especially meant for you: “Directors should employ healthy skepticism in meeting their responsibilities.”
James Tompkins is a director of the Corporate Governance Center at Kennesaw State University.