The capital markets presented public company board directors with a variety of vexing issues in 2009. Most importantly, it underscored the need for board directors to have a much better understanding of a company’s liquidity and how the risk profile—which was developed by models that were range bound by historical scenarios—would behave under extraordinary conditions as came to pass. For that to happen, it has now become abundantly clear that directors need to engage in even more robust and candid discussions about selecting the appropriate capital structure for the company they serve. Among the many challenges faced last year, it was the derivatives crisis that showed in clear catastrophic fashion just how quickly capital structures, which had worked well for companies throughout the decade, can vanish at the least opportune time. The financial crisis cemented the need for the board’s engaging in real world and expertise driven “what-if” and “worst-case” scenarios on risks to solvency and liquidity on an ongoing basis.
As the rapid meltdowns at Bear Stearns and Lehman Brothers illustrate, companies with impaired liquidity may not always appreciate the severity of their distress despite the presence of expertise and experience inside the management team. Further testing of assumptions and healthy debate, which encourages a diversity of opinion is required now, or else the risk again is that by the time the true risks are recognized the market has discovered it as well, and has shuttered all available solutions.
“There are probably dozens of stories of situations where if somebody had just said, ‘I think we’ve got a problem here,’ insolvency could have been avoided,” observed Houlihan Lokey’s Richard De Rose, who together with Cynthia Jamison of Tatum LLC, the executive services and consulting firm focused on the office of the CFO, facilitated a recent Peer Exchange on Capital Markets at Directorship’s New York office.
More stories in The Director’s Guide to Capital Markets:
Fiduciary Duties in Turbulent Times
Assessing the Balance Between Debt and Equity
A CFO’s Perspective
Jamison, who in addition to serving as the national director of CFO Services at Tatum is a director at Tractor Supply and B&G Foods, points out that sometimes problems can stem from Generally Accepted Accounting Principals (GAAP) set since 1973 by the Financial Accounting Standards Board (FASB). “In my experience, the bigger the company the more likely they are not managing on a ‘cash flow’ basis. By focusing on the P&L and/or balance sheet, some items require GAAP presentation that may not completely portray the risk element from an operational perspective. Derivatives are a perfect example of this.”
Should corporations have chief risk officers and how should boards be educated?
“You cannot have a conversation about risk without strategy,” said Jamison. “If you’re going to have a conversation about risk it must be about strategy and one person needs to own that.”
Leslie Rahl, founder, Capital Market Risk Advisors, suggested that the “next great front” for financial firms and banks, in particular, “is for boards to figure out what its risk appetite and risk attitude is and how to communicate that to management.”
Directors need to do their own independent assessments, said Tonia Pankopf, a veteran research analyst and investment manager, and not always rely totally on company or management information “When you make an investment you talk to competitors, suppliers and customers. I review the materials presented to the board but also consult with other reliable sources of information when possible,” says Pankopf, who is managing partner of Pareto Advisors and a director of TICC Capital. “I may end up hiring a third party but there’s work I do on my own to be informed about the company and the industry.”
How should directors carry out their fiduciary responsibilities, asked Jeffrey M. Cunningham, the chairman, CEO, and editorial director of Directorship. De Rose noted that directors of solvent companies owe fiduciary duties of loyalty and care to the corporation and its stockholders. And when it comes to being held accountable for their decisions, “as long as you [the director] listened to advisers, and looked at every alternative you’d be protected by the business judgment role,” he said.
“Ask the real simple questions: what could go wrong?” suggested Rahl.
Noting that she serves exclusively on non-financial services company boards, Jamison said, “We ask management what keeps you up at night and if that happens, what is your tactical plan? When and if you march down that path who would you call? Who would you fire? The answers tend to get really crisp.” As for the CFO, Jamison says, “The CFO needs a strong defense. You need to have everything documented and to have considered all sorts of scenarios. The CFO really has to build the book.”
Added Jeffrey S. Sherman, senior vice president and general counsel at BD (Becton, Dickinson and Company), a medical technology company: “One question that should always be asked of management: is there anything you haven’t told the board that they should know?”
What’s the biggest risk in capital markets?
“I don’t believe we’re out of the crisis quite yet and that we’ve got another two to three years,” cautioned David Meachin, chairman and CEO of Cross Border Enterprises, an investment bank, and a director at Metha Energy Solutions and BTM Corp. Companies “continue to have a tough time getting the money that they need to borrow without risk,” said Sherman.
Pankopf replied that it’s the issue of liquidity and balancing the capital needs to fund ongoing operations and new investments” that is the greatest challenge. “Some companies that have sufficient liquidity can be opportunistic and use that liquidity to fund new areas of growth,” she said.
Meachin agreed that liquidity is and will be critical for the next two to three years: “The outside environment will continue to be a challenge and the board needs to be involved…The world will change again and you need to keep your eyes wide open.”
In the current environment, De Rose said, “directors need to be actively involved. Although your responsibility is to supervise rather than to micromanage, in order to supervise adequately, a director needs to have a thorough understanding of all aspects of the business and the challenges and risks associated with that business.