Building a better board and the benefit of director self-assessments

Current realities are dulling the glamorous sheen. Being a director these days is hard work, complicated by ever-escalating scrutiny, controversy, and liability.

“In today’s world of unrelenting disruption and innovation, a company’s board plays a more active role than ever before in overseeing strategy and risk management amid digital and emerging technologies, industry convergence and workforce transformation, shifting consumer attitudes, increased climate risk, diminishing trust in organizations, political polarization, rising income inequality, and various other megatrends shaping the business environment,” is how EY’s Center for Board Matters assesses the situation in a new report, “Top Priorities for Boards in 2019.”

Embrace the ‘duality of strategy’

There is a recently amplified debate about the merits, or lack thereof, of quarterly earnings reporting. While investors prize regular, reliable disclosures, there is also pushback that the focus on short-term results—and the executive rewards for meeting and exceeding those expectations—undercuts long-term strategy, sustainability, and strategic opportunities.

The challenge faced by management and their directors is what EY refers to as the “duality of strategy,” the easier-said-than-done desire to demonstrate short-term performance while simultaneously investing in the future, even if the latter can dampen the former’s financial metrics.

The board’s role in helping management navigate and find balance within this tension is an especially critical one.

“You still need to file your quarterly reports with the Securities and Exchange Commission, and you still need to jump on earnings calls to provide some clarity,” says Steve Klemash, who leads the EY Center for Board Matters.

That traditional approach needs to be supplemented with a recognition of a company’s multiple stakeholders, “not just communicating to shareholders,” but also employees, communities, and society at large.

“Capitalism is not dead. It is alive and well. I think companies do a lot of good for society, they just don’t necessarily do a good enough job communicating all that because there’s so much of a focus on regulatory filings,” Klemash says. “Companies need take step back and think through how they’re communicating it externally.”

A focus on strategy

Boards should frequently revisit the company’s strategic plan, its key elements, and assumptions, EY says. One-off and annual board strategy sessions should be challenged, potentially replaced with more frequent opportunities to dig deep into both the problems and inherent potential of business units, products, and solutions.

This approach should include “critically evaluating underperforming assets or operations that are most at risk from emerging technologies and customer disruption.”

Boards should challenge whether reinvestment in existing businesses, products, or solutions makes sense or whether a new strategic path should be forged.

“Boards should take an informed and forward-thinking view of the company’s operating environment, industry, and business. They need to look for shifts in customer and employee behaviors and expectations, current and potential competitors, and how the company can ethically fulfill its purpose over time,” the report says.

“Everything’s coming at you in a much greater speed than it historically has,” Klemash says. “A lot of boards, historically, have had off-site strategy sessions where they would head into the end of the year with an economic outlook and maybe a look at next year’s plan in conjunction with a three-year plan. All that now is really being looked at at nearly every board meeting, and both short- and long-term strategy is updated in a more realistic time frame.”

He compared board thinking to a famous quote by Donald Rumsfeld, secretary of defense under both President Gerald Ford and George W. Bush: “There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know … It is the latter category that tend to be the difficult ones.”

“It is tough to really see the benefit of a significant investment in culture, and the returns on that, because it’s a longer-term result; but, at the end of the day, if you do well by the communities you operate in and you treat your employees well and you have a laser focus on customers, your shareholders are going to do fine.”

Steve Klemash, Leader, Board Matters, EY Center

“Boards really need to have, you know, some type of external data to routinely, objectively challenge their thinking on strategy,” Klemash says.

Boards should also “embrace an activist mindset and seek third-party data about future business, talent, revenue models, and transformation opportunities,” EY suggests. “This data will help the board constructively challenge biases, identify blind spots and unknown unknowns, and bring an objective perspective and new ideas to the strategic planning process.”

Transforming risk management

As companies look to transform their business models, leading boards are similarly transforming their governance of risk management. Enhanced board oversight coincides with the Committee of Sponsoring Organizations’ update of its enterprise risk management framework in June of 2017, the EY report notes.

“A board that brings expertise aligned to the company’s strategic goals and risks, and one that has the character and leadership needed to challenge management and seek external insights as appropriate, is foundational for effective risk oversight,” it says.

Among the key takeaways: Don’t be afraid to shake up the status quo.

Most boards outside of the financial services industry, for example, have historically charged their audit committee with oversight of the company’s ERM program. Boards that evaluate the effectiveness of this approach may find it is no longer the most effective strategy.

Regulators and audit committee members alike have voiced concerns that they are overloaded with action item-heavy agendas, even though their primary mandate is oversight of financial reporting.

While some boards are forming new committees, others are creating ad hoc committees to address key strategy and risk management issues. At a minimum, the full board is taking greater ownership for the oversight of strategic and operational risks while the audit committee continues its focus on financial reporting and compliance-related matters.

Boards are also challenging audit functions to update their risk assessment process through the use of predictive analytics and the leveraging of technology tools.

Successful boards, in EY’s assessment, are also enhancing their approach to critical enterprise risks by obtaining third-party research and analysis to better understand the changes and disruptions occurring within their industry.

These resources are also leveraged by directors to validate risk mitigation and when “considering strategic opportunities in areas such as culture, workforce transformation, the environment, geopolitics, and regulation, along with the ever-evolving cyber-security and data privacy landscape.”

Culture as a strategic asset

A company’s culture must be a strategic asset.

The board should have a strong pulse on how executive, mid-level and lower-level management demonstrate and communicate the company’s values, the EY report says. “Intangible assets” now average 52 percent of an organization’s market value (up to 90 percent in some sectors), and part of that capital can be attributed to a company’s workforce.

“A lot of boards look at return on invested capital and machinery, and equipment and property, but you almost need to take a step back and say, what’s my return on invested talent? How are our talent needs being challenged? How are you educating and training your employees and how are they reinventing themselves?” Klemash says.

Boards understand the need to oversee talent and culture more closely to boost the company’s performance and enhance its reputation.

“Boards are looking beyond the C-suite to better understand and oversee talent issues and culture across the organization,” the report says. “This is especially true following reports in the past year of high-profile managerial behavioral issues, toxic work environments, and the unintended consequences of certain business models.”

The report adds that a company’s culture must be viewed as a strategic asset. Companies should understand how a company’s programs promote culture and drive the right behaviors and actions.”

This typically requires directors to review culture across the organization and look at talent-related performance metrics, including attrition rates, diversity and inclusion metrics, whistleblower hotline activity, themes from employee onboarding and exit interviews, and code of conduct violations.

“We’re spending a lot of time with boards on culture, but unfortunately, they’re looking at it more as something that has turned into a liability with the ‘Me Too’ movement, unintended consequences of business models, and what have you,” Klemash says.

The positive results of corporate culture can be more difficult to quantify.

“Unfortunately, it’s a soft asset. It’s intangible. It is tough to really see the benefit of a significant investment in culture, and the returns on that, because it’s a longer-term result,” he adds. “But at the end of the day, if you do well by the communities you operate in and you treat your employees well and you have a laser focus on customers, your shareholders are going to do fine.”

Strengthening communication with stakeholders

Evolving companies are finding that a growing range of stakeholders—corporate leaders and employees, customers and suppliers, communities and investors—are increasingly focused on “the broader purpose of the corporation.”

“These diverse stakeholders increasingly seek greater insights into how companies are strategizing for business sustainability, including addressing environmental and social matters that impact long-term value,” EY says. “Companies are paying attention. There is growing evidence of a significant shift in corporate efforts to increase engagement with stakeholders and enhance disclosures and other communications.”

Continue to enhance board performance

An important piece of advice from EY: “Boards should rigorously and continuously examine and evaluate their performance.”

While most boards still formally evaluate performance annually, leading boards do so more regularly. More frequent evaluation enables directors to conduct a deep evaluation into one or more of the multiple aspects of overall board performance. It also encourages more candid, real-time feedback that can be quickly acted upon, improving information flow, decision making, dynamics, and performance.

A fundamental question is whether the current directors have, collectively and individually, all the experience, background, perspective, foresight, integrity, and communication skills needed to consistently exercise their many complex duties and responsibilities.

Boards should ask whether adding a new committee or establishing an ad hoc committee may enhance oversight capabilities, whether committee membership should be refreshed, and whether reallocation or expansion of duties and responsibilities can improve performance.

Directors, EY says, must also actively seek information and perspectives on their own, through peers, former colleagues, self-inquiry, and self-education.

Klemash recalled a recent conversation with a board member who explained that cyber-security mitigation is placed into the audit committee.

“There’s three or four of us who find ourselves asking all the questions on cyber-, so we decided to form an ad hoc committee,” the director said. “It’s not going to be formally announced anywhere, we just want to make sure we’re staying ahead of the game. We are going to meet three or four times a year, just on cyber.”

“Were seeing more of that,” Klemash adds. “Many directors are very, very focused on improvement. I would say it’s another form of continuous improvement, because they’re really trying to make sure that they are getting as much objective data as possible.”