The substantial amount of time that we spend with directors provides a reasonable barometer on governance issues. And for a while now, we’ve noted rising pressure surrounding the intersection of risk and strategy.
The 2008 financial meltdown made evident to boards everywhere that risks they don’t understand can hurt them. Risk—how to define it, corral it, manage it—has been on directors’ minds nonstop since then. Which risks are critical to monitor? How should each be measured? Is there a risk in being too risk averse? Meanwhile, the concept of risk has broadened—financial risk, operational risk, safety risk, reputational risk, technological risk, talent risk—and keeping tabs can feel like a Sisyphean game of Whac-A-Mole.
Put the mallet down. Directors and CEOs know that if risks appear ubiquitous, that is because taking risks is the very definition of doing business: putting capital and assets on the line for the chance to make a profit. Risk shouldn’t be a dirty word; it is a critical element of good strategy.
That conclusion, though, is leading directors to another discomfiting realization: they’re not necessarily happy with how strategic oversight is functioning at their companies, either.
We’ve heard several directors bemoan how a decade has passed without much evolution in how their board handles strategy. Many boards, understandably, lost years entangled in regulatory issues post Sarbanes-Oxley. Then, just as they got compliance under control, they were hit with the 2008 financial crisis and went on risk patrol.
There’s no comfortable prescript for getting back on track with strategy. Boards, individual directors and CEOs have widely varying opinions on how strategy oversight should work. Where does oversight end and interference with management begin? How can the prerogatives be shared? Such boundary issues are sensitive, but they’re worth resolving so that boards can be strategically productive for management.
Last year Korn/Ferry interviewed several lead directors in top 100 companies about their work. They were eager to talk about evolving the board’s role in strategy. This highlighted one of the benefits of a lead director—examining the board/ management interface. A board that is properly engaged in strategy helps management identify unwarranted risks and advises it on risks to take. The best practices will vary and evolve, but it is clear that directors want to be peers in the strategy process.
The danger of segregating risk from strategy is that boards can develop risk myopia—focusing too much on what can go wrong, instead of how to win. Leading boards already sense this, and it is probably the main reason that so few have carved out separate risk committees. When Korn/Ferry examined governance during the 2010 proxy season, we found that only seven of the top 100 U.S. companies by market cap had separate risk committees. Nearly all were financial services firms responding to regulation.
Which brings us to the potential risk/strategy issue emerging in 2011. Corporations have been holding on to their liquid assets—to the tune of $1.93 trillion by the end of the third quarter last year, according to the Federal Reserve Board. What is that cash doing for companies? Insulating them against unknown negative risks for sure. Reassuring investors, maybe. It’s likely contributing to lagging employment rates and a sluggish economic recovery as well. Boards are starting to question the opportunity cost of keeping assets under-deployed.
Will companies make strategic attacks, or keep licking their wounds? In other words, will boards approach 2011 from a risk mindset, or a strategic one? The atmosphere we sense in the boardroom points strongly in one direction: Focus on strategic oversight and risk oversight will follow.
Steve Mader is the vice chairman and managing director of Board Services at Korn/Ferry International. He can be reached at firstname.lastname@example.org.