The pressure Wall Street places on companies to meet arbitrarily defined goals in this environment is staggering and can drive even decent ethical people to skate along the edge of reporting integrity. As directors, we are the shareholder’s last backstop to ensure integrity in this process. I believe the SEC is increasingly viewing it that way. It challenges us all to build a knowledge base that elevates the full board discussion on these issues.
On December 16, 2009, the SEC amended its rules governing executive compensation and corporate governance disclosures in proxy statements. Among other things, the amendments require new disclosure about the effect of compensation policies on risk taking, director qualifications, board oversight of risk, and independence of compensation consultants. The new rules also require that reporting companies engage their directors in discussions about risk oversight, among other topics.
This direction indicates a regulatory thrust in acknowledging a full understanding of risk and financial performance as the core of enterprise risk management. The ideas contained in this area are meant to provide both a common sense approach to financial discussions as well as an encouragement to elevate your level of financial understanding, even if you don’t serve on the audit committee.
When Lehman Brothers raised dividends in the first quarter of 2009 and bought back shares, the whole board had to vote. This was approved 9 months before its failure. What questions should board members have been asking about leverage and debt? Lehman’s leverage before bankruptcy was an irresponsible 30 to 1.
Ford’s saavy cash management by former CFO, Don Leclair, and CEO, Alan Mulally, began in late 2006. Prior to the recession, the company loaded up on $23 billion in debt at a time when credit was cheap. This was both “brave and prescient.” Their decisions not only helped Ford to gain market share for the first time since 1995, moving its stock to a near five-year high, but generated tremendous public goodwill in their avoidance of bailouts and bankruptcy protection.
Some companies grow too fast and don’t finance the growth effectively. Asking questions about how growth is being financed is one that all board members should consider.
Having the confidence to seek second opinions can strengthen decision making. According to Warren Buffet, as published in his latest annual Berkshire Hathaway shareholders letter, “Don’t ask the barber whether you need a haircut.” Directors should be aware that banker’s incentives to complete deals are high – it’s an all-or-nothing game. Without a deal, bankers don’t get paid. Improper incentives can make advice suspect. Whether hiring counsel for independent directors or additional bankers, this is common sense intuition put into action.
James L Orsini, EVP, director of finance and operations at Saatchi & Saatchi, New York, defines a perfect starting point for enhancing financial discussion: “If directors are going to invest time in financial understanding, I strongly feel the best use of their time is in learning more about how cash flows through an organization and how the corporate treasury functions.”
Net income should always convert to cash and at some point that ends up on a bank statement, which is extremely difficult to manipulate. That’s why bank reconciliations are so important to auditors. Being able to ask questions about the build-up of receivables or ones that are aging too long, leads to better board understanding and discussion.
Understand how your company’s gross margin compares to your competitors. If they exceed industry standards, ask why. Are inventory levels tracking with accounts receivables? Is there additional data to demonstrate that goods are being shipped? If there is a significant jump in account receivables, how many accounts contributed to this increase? Were any special discounts or unusual return policies provided? What were the payment terms? Becoming more well-versed in balance sheet language and questions, will help to ensure your common sense questions on financial matters are addressed.
Building your financial understanding will continually sharpen your insight. Consider participating in audit committee conversations to increase your performance as a director. Audit firms provide board member education.
As a corporate director, the removal of “silo” thinking is important. There is a shared responsibility for results around the table. To that end, for those who do not serve on the audit committee, you still have a greater responsibility today to be able to converse on topics that are outside of your field and know how to ask good questions that will have a positive impact on the quality of financial board conversations.
Stuart R. Levine, the founder, chairman and CEO of Stuart Levine & Associates, is a director of Broadridge Financial Solutions, and chairman of the governance and nominating committee and lead director for D’Addario & Company. He serves on the Advisory Council: The Directorship/NYSE Boardroom Guide for the New Director.