The second set of meetings in the World Affairs Council of Atlanta’s Global Strategic Leadership Forum series focused on the new challenges facing the boards of directors of contemporary global companies. Setting the stage for the Forum’s discussions was the recognition of the huge changes that have taken place as a result of globalization in tandem with the world financial crisis and economic slow-down. The premise of the Forum was that the expanding and complex issues facing global companies today require a re-examination of the wide set of risks generated by global expansion and the complicated and dynamic matrix of the regulatory environment. These developments have dramatically impacted the relationship between the board and the chief executive officer as they determine strategic direction for the company – a role that is increasingly becoming a joint responsibility.
The general consensus of the Forum’s participants was that in today’s business environment, a global company board needs to ask itself if it is doing all it can and should to evaluate the complicated new risks facing the company, while ensuring that the goals for growth and profitability remain a critical focus. Complicating this escalating level of risk are the increasingly onerous and complex regulatory frameworks, imposed not only by the United States, but by other sovereign jurisdictions. The Forum participants confirmed that many of these regulations have global reach and the Board of Directors has specific oversight responsibility, thus vastly increasing the amount of information that must be examined at the Board level.
Dealing with the wide range of risks and the complex regulations governing corporate actions is significantly changing the traditional relationship between the Board and the CEO. The main issue is the degree to which these issues should become joint responsibilities between the two. It has also made the role of the lead director or independent chair or chair/CEO vastly more important and demanding, and has complicated the relationships between the board leadership and the management that are at the heart of corporate governance.
Regulatory Environment: The Expanded Challenges
One of the greatest risks companies face is in the area of regulation. Government intervention in business activities generally comes unexpectedly and is hardest to address. Each government has its own rules, so that there is a “localization” of rules that must be understood and managed. Local, regional, and national jurisdictions have different policies and often conflicting rules. Whether in global sourcing, manufacturing, or selling, cross-jurisdictional compliance becomes very complicated. In each jurisdiction, the company also must consider the actions of its employees and those of its entire supply chain in complying with regulations that could impact the company and the board.
The Foreign Corrupt Practices Act (FCPA) and later, the United Kingdom Bribery Law and the Dodd-Frank legislation, have had major impacts on a number of global companies. Even when the offence occurs in a small country and is instigated by one employee, the board must be informed or at least ensure that there are detailed and audited processes in place to address potentially devastating economic and reputational consequences. In the recent Wal-Mart case, there is a chance that certain executives in Arkansas knew what was occurring in their operations in Mexico. This could lead to severe consequences for management and directors.
In recent cases, it is clear that the culture in certain international environments allows or even encourages wrong-doing from the FCPA point of view. It is sometimes difficult to discern or even obtain a pre-ruling by the Department of Justice about what is permissible and what is illegal. However, self-reporting to the Justice Department is one way to address a possible violation. While this can, as in the case of Morgan Stanley in China, pre-empt the legal action, the process can be burdensome and expensive. Nevertheless, companies should look to cases like the Morgan Stanley one for guidance. The company did have robust, comprehensive regulations in place and showed that they had done everything they could to abide by the law. However, even self-reporting in good faith can still result in large fines.
Whatever the complaints may be about the costs of regulatory compliance, the Department of Justice sometimes will want to make a point and demonstrate that the costs of non-compliance are greater. The resources of the Justice Department are vast and taking them on can be very expensive. At the state and national level, politicians can also be involved as they try to demonstrate how “tough” they are on corporate wrong-doing. The role of the board members is to ensure that reporting procedures are in place, to keep informed, and raise a red flag if they think that management is not addressing a given issue properly.
There is a great impact of these regulations on America’s ability to compete. Some competitors, like China, do not play by the same rules. In markets where American companies face the Chinese in direct competition, the American companies may be inhibited and may even decide to exit the country. Nevertheless, the United Kingdom, knowing the potential impact on its own competitiveness, passed the U.K. Bribery Act, a law arguably even tougher than FCPA. The regulations of Dodd-Frank include significant bounties for whistle-blowers who are incentivized to go outside the corporate systems of reporting and use outside or third-party channels to report a possible violation. We do not yet know the extent of the impact of what some would call “bounty hunters,” but the risk is significant. Global “ambulance chasers” are already active. Whatever the motivation of these reporters of alleged wrong-doing, the risks are serious.
Legal regimes and anti-corruption laws almost surely will not result in the responses that the U.S. and other governments want. Some corporate leaders and legal analysts believe that these severe regulatory regimes don’t work. What is needed is a more clearly defined and implemented set of corporate core values which employees and stakeholders will be encouraged and incentivized to accept and adopt. Whatever the system, some employees will still break the rules. In addition to whatever legal regime is in place, aggressive, transparent, and audited systems of compliance within companies are essential. Beyond the corporation, some alliances with non-governmental organizations (NGOs) as well as institutions like the World Bank can be beneficial both in supporting the company’s approach to the corruption issue internally, but also in its dealings with the relevant governmental entities in the global marketplace. Engagement with bodies like the World Economic Forum and Transparency International can underscore the need for ethical and transparent business transactions under the rule of law. These organizations can encourage and even put pressure on national governments to promulgate comprehensive reporting requirements and disclosure of company payments to government officials in the host governments.
Whatever responses large companies may have, small and middle-sized companies simply do not have the resources to pursue complicated legal processes in the realm of FCPA actions. This creates an even more complex dilemma in regard to American competitiveness and needed export growth.
The Chief Executive and the Board: Has the Relationship Changed? Should It?
The complexity of issues facing every global company has caused some change and expansion in the role of members of global boards of directors. However, there is strong disagreement among corporate executives about how much the board members should be involved in the management of the company. For some, the role of the board should be focused on the hiring and firing of the CEO and in reviewing and approving the strategy that has been developed by the management team. The board should represent the shareholders in monitoring and evaluating the performance of the executive team. For others, the risks associated with board service are increasing as companies move into more complicated regulatory and market environments. What seems very clear is that the board needs to be more involved in strategic design and compliance processes.
As a result of these new demands, in both cases, the role of the Lead Director has increased significantly in companies where the Chair and CEO titles are held by one person. The Lead Director has become a key partner with the Chair/CEO in ensuring that the company operates profitably and in a socially responsible way. The Lead Director serves as a sounding board for the CEO and a communications channel to the other board members. The issue is where to draw the line. The danger is that the job of the Lead Director or non-executive Chair becomes essentially a full-time job and blurs the actual responsibility of the CEO. There are a number of organizations in the United States, including Tapestry Networks, which are working on the issues associated with the role of the Lead Director.
Some CEOs communicate frequently, sometimes as often as three times a week, with the Lead Director or non-executive Chair. All boards should demand transparency from their executives and have access to managers at all levels. Communication with directors also occurs between meetings. Board committees also meet more frequently than in the past. The demands, therefore, of board service have increased substantially over time, especially in the past few years. However, it could be problematic if the increased role of the Lead Director and the board resulted in another corporate bureaucracy or the institutionalization of a “professional” board member. The challenge is to find a balance between the independent board members, including the Lead Director, and the corporate management team. There is no evidence yet that one model is preferable to another, but there seems to be no disagreement that the role of independent directors, however defined, is crucial.
Beyond governance, there is also the issue of the skills, knowledge, and access that board members need to bring to the board and to the company. In today’s global market, it is impossible to internationalize a board to an extent where all members possess all the regional, functional, business, and industry knowledge required to run a global company. What is possible is to have members of the board with the widest possible experience across regions and specific skill-based functions. Some companies also use an international advisory board, but these individuals often have limited or no knowledge of the company’s business and can only provide a broad perspective on the dynamics of a region.
The Requirements for Effective Leadership in an Expanding Risk Environment
Way beyond the notion of corporate social responsibility is the challenge to integrate the company’s core values into day to day operations and strategic design. The issues of governance in a global company today are volatile, uncertain, complex, and ambiguous, and management and board leadership must have vision, understanding, clarity, and the ability to adapt. Without these attributes, strategic judgment will be clouded at best and faulty at worst. The relationship between the board and the management team must be one of transparency that leads to trust. The greatest leadership skill lies in the ability to depolarize the most divisive issues and deal with the paradoxes. Great leaders can shrink from neither – nor should they.
The board and the executives must constantly re-prime the core values of the company by asking: “Who are we and what do we stand for?” With these questions answered, the company’s leaders must have the mental and moral ability to do what’s right and to follow through with commitments made to all stakeholders.
The New Global Environment – What Has Changed?
To set the table for the subsequent discussions, the dinner presentation provided an overview of the economic developments since 1991: the impact of globalization, the rise of importance of the emerging markets in terms of global GDP growth, and the world financial crisis. During the past 20 years, there has been a shift from OECD dominance, to the search for new sources of raw materials and manufacturing platforms, to the emergence of China and the other BRICS that had not previously characterized as growth markets themselves. By the 2000’s, the rates of GDP growth in a number of emerging markets had reached levels three times higher than those of the OECD. In many ways, 2009 was the tipping-point, at which the emerging markets, especially China, counted for more than 50% of world GDP and became the focus of international economic growth. In the emerging markets, improved economic management, favorable fiscal balances, productivity increases, trade surpluses, and high savings rates all contributed to this new market situation.
To compete in this changed environment, many companies shifted their strategic focus to the new, growing economic powerhouses not only for sources of production, but also for strategic positioning in the growth markets themselves. One global consumer products company has built 19 of its last 20 production plants in emerging market settings and several companies have selected Shanghai, Hong Kong, or Singapore for the headquarters of their Emerging Markets management teams. This kind of re-location is happening because so many U.S. companies now have the majority or even a substantial majority of their revenues being generated outside North America.
The Impact on Multinational Enterprises and Their Boards
The new strategic focus has impacted American-based multi-national enterprises (MNEs) as they began more earnestly in the last two decades or so to seek new opportunities for investment in areas outside their traditional market arenas. In taking on these more challenging markets, boards are now engaged in the careful review and critique of the corporate strategy. In addition, U.S. companies’ concerns about compliance, especially the demands of the Foreign Corrupt Practices Act, have increased significantly. These concerns, for years most often controlled and monitored by management, now are being considered at the board level because of the legal risks involved. In addition, global U.S.-based companies must take the taxation policies of the American government into consideration when determining where expansion investments will be made. This is an issue of both corporate and national policy concern. Finally, board members must be more cognizant than ever of potential “black swan” events that could require sophisticated crisis management plans. In addition to the traditional Audit Committee, some companies have added a Risk Committee and both of these committees generally meet independently from the Chairman/CEO.
The complexity of the strategic considerations for MNEs also impacts the selection of the board of directors itself. Whereas in past years most board members were selected by the CEO, now the selection is done primarily by the independent directors with input from the CEO. Today, the independent board members are in the majority. Another big change with regard to the boards is that it is now far more difficult to find CEOs who are willing to be on another company’s board. This is a big change that diminishes the input of active CEOs who have the most current operational experience in the global marketplace. Boards also are far more focused on CEO compensation issues and have increased concerns about succession planning, not only at the CEO level but across a wider set of corporate officers. In this context, the role of the Lead Director has significantly increased in companies in which the Chair and CEO roles are held by one person.
Building the Right Board
Building the right board requires the right skill set across the members and a full analysis of the strengths and weaknesses of the current board. Over time, boards have moved from being largely ceremonial to being deeply engaged in specialized aspects of the company’s operations. In today’s environment, board members need a global perspective, independence, and, if possible, a deep knowledge of the context of at least some individual countries. Special skills and experience in information technologies and sustainability are also desirable. In the new board context, diversity means not only ethnic and gender diversity, but diversity of country and regional knowledge and specific business functional expertise. To achieve these diverse characteristics, it may take the engagement of a professional board search firm. Whatever the process, the CEO and the Lead Director should get to know the potential new board member very well to ensure that the right chemistry and knowledge set is there. In any case, board members must be knowledgeable about what the company does and make visits to facilities outside the United States. Assessment of board members’ performance, not often a strong point in most board governance processes, must be increased.
The demands on board members are increasing dramatically with expanded time requirements and, through by-laws, physical presence at board meetings. One leading board member suggested that today board membership of a global company can take up to 30 days per year. Moreover, board meetings of global companies are often held in distant cities where the company has significant investment or strategic potential. Another experienced participant reported that many companies are adding advisory boards or committees to their corporate governance architecture in order to expand the board’s knowledge base on issues of particular concern to the company and with which the official board members have no deep expertise.
What is the nature of the largest global companies based in the United States? Are these large companies still entirely “American” if they are involved in markets all over the world? Where does sovereignty start and stop? Whatever the answers may be, there is still a national dynamic in the company’s decision-making. Even with the many complaints about burdensome regulations and U.S. corporate tax rate questions, how many boards actually are seriously considering moving their headquarters off-shore? Many believe that to address these issues, CEOs should be much more vocal in expressing opinions and advocating positions that support American competitiveness and that there needs to be a more engaged dialogue between the American executives and the federal government leadership.
While there will be differences of scope and complexity when comparing Fortune 500 companies to, for example, the Russell 2000, the risks inherent in emerging and global markets will be equally challenging. One participant pointed out that the legal and administrative costs to smaller companies are very difficult to handle and that the pressure on these companies is “unconscionable” and as a result, U.S. competitiveness is hurt.
Risk Appetite and Risk Management: The Role of the Board
One of the most daunting challenges to board members is the understanding and management of risk. Risk is the responsibility of every board member. The nature of company risk extends to uncertainty in all its forms. While the range and complexity of risks facing companies has increased as they move into the emerging markets, risk is by no means restricted to those areas; the situation in the Eurozone and the Great Recession are but two examples. A board should be careful not to do too much managing of risk to the point of strangling growth. Scenario planning should be utilized to evaluate risk, and also to push management and the board to look at other risk factors that have not been thought about in more conventional risk management reporting and analysis. Thinking about worse case scenarios is hard for management and for boards, but it is important work that should be detailed and specific. The difficulty is in quantifying these risks. At the very least, the board must ensure that it is asking the right questions of the management team.
Beyond the set of risks directly related to a company’s activities is systemic risk: risks that are unpredictable, even mysterious, and that cannot be addressed through even the most sophisticated internal analytic. In this circumstance, the board must think more broadly about resilience rather than only about cataloging the risks themselves. In this wider assessment, the company must ascertain the capital reserves, internal capacity, and key relationships that can prepare them for risks that impact many or all sectors in the world economy, not just their own. An example of such a systemic risk would be a pandemic, for example SARS or avian influenza, which has the potential of shutting down travel or the ability of employees to get to work. Complicating the picture are the wide range of geo-political and economic risks, accelerated by instant global communication, that can impact all sectors in a given country or even world-wide.
A second broad area of systemic concern is cyber-attacks and the dangers these pose to the operations of the company. Global companies are connecting to major communications systems all over the world. This expansion has greatly increased the risk of significant harm that hackers can do in disruption of operations and the stealing of intellectual property. These attacks can come from low-level pranksters, thieves, organized crime, terrorist, anarchists, or even national governments. Beyond operational vulnerabilities, is the question of where and under what protection systems should the corporate data be processed and stored.
In 2008, during the recession, one large company cut 35% out its cost structure and laid off 40,000 people. This not only allowed the company to maintain profits, but also to be in a position to recover and re-hire 18 months later. It is very difficult for management to examine the worse-case or “black swan” scenarios, but they must make plans for preventive action to deal with these potential situations. Most banks now have these scenarios and analytical processes in place; corporations must do the same. To address the wide range of risk issues, some boards now designate specific board meetings to look specifically at risk and risk mitigation plans presented by management. In both company-specific and systemic risk, the board should differentiate between what they can and cannot control or manage. Another caution is that boards must not focus only on the “red zones” in the risk color mapping, but on the “green” areas where, in fact, some of the most damaging developments have occurred.
As documented in the 2002 book Commanding Heights, throughout the 1990’s and 2000’s, India, China, Russia, and Brazil opened up. Government regulation was out and free markets were in. Now, the pendulum has swung and government regulation is moving back in. So, the biggest risks are often the ones governments are imposing. Government protectionist trade barriers can significantly distort markets and constitutes a risk in itself.
In assessing risk, there is still no substitute for going back to fundamentals, core competencies, and common sense. The first task is to look at a country’s market potential and balance this against a thorough assessment of that country’s risk profile. Against these fundamentals, the company must balance the risks associated with resources the company may be seeking in the new market and the resources it is deploying. Whatever the risks, the global market reality is that there are a huge number of people that are moving out of poverty and into the middle class. For example, while China will soon have the world’s largest GDP (in PPP terms), it is still one-third of the GDP of the U.S. in per capita terms. The board needs to ask the right questions and be balanced in its approach to risk management.
There are a number of recommendations for board selection in the current risk environment. While board members are selected for a variety of reasons, some should be recruited who have deep understanding of financial accounting and knowledge of risk management. Board members must not only understand the business of the company, but understand the risks associated with it. While understanding risk is essential, too narrow a focus on risk avoidance can easily stifle growth. Risk mitigation, rather than avoidance, should be the goal. Boards must be aware that it is easier to say “no” to an investment or strategic initiative than to say “yes.” It is precisely the American capacity to accept risk, and even failure, that puts American companies in a strong competitive position in the global economy. Finally, risk assessment should be balanced with strategic opportunity and examined with both short and long term horizons. Board discussions of risk are often segmented, but actually should be reviewed across all business strategic and operational discussions. Increasingly, the board must be involved in analysis as well as the formulation and implementation of mitigating strategies. For management, risk assessment should be a regular part of any strategic or operational discussion.