What Directors Should Know About ... Managing Risk

Do bankers know how to manage risk? Did the boards of Lehman Brothers or AIG recognize that a financial crisis was impending? Did they ensure their companies were strong and could preserve shareholder’s equity when the crisis occurred? If that’s the objective against which you judge their risk management performance, then the answer for them, and those that failed with them, must be no.

Boards manage risk. It’s their only job. The measures used to judge their performance are the strength of the company and the value of their stock. So what happened? Part of the reason for failure was their approach to managing risk.

Computers don’t manage risk—People manage risk

Banks rely on computers to “manage risk.” So do many others. But computers can only use an algorithm to massage data, compare the results to a benchmark, and report whether the data deviates from the benchmark. When the characteristics of the situation extend beyond the assumptions of the algorithm, then the data is worthless and worse, misleading. You experienced the result. Computer programs don’t manage risk. Humans manage risk.

Managing risk is a forward-looking, intuitive process done by a human brain on the basis of its knowledge, imagination, capacity for solving complex problems, tolerance for ambiguity, ability to see ourselves in the world around us, paranoia, and previous experience. And the deeper the paranoia, and more painful the experience, the better. Managing risk takes place against a set of objectives. It looks in all directions. It takes time. It becomes suspicious when, “everyone is doing it,” or “it looks too good to be true.” It isn’t loyal to old friends for loyalty sake. It’s best done in a group where the experience is diverse (but relevant) and where the members can freely discuss their views, and challenge the views of each other. Some call this kind of group a Board of Directors.

The directors of Enron failed in their duty to shareholders. Kurt Eichenwald’s book, Conspiracy of Fools: A True Story, told the tale. The stories of what happened at Bear Sterns, AIG, Fanny Mae, Freddie Mac, and Washington Mutual have yet to be written. Will those stories reveal that their directors failed as well?

Let’s stop right there. It’s not my intent to criticize. I don’t know that the boards of Enron, Lehman Brothers, or AIG were the fat cats and uncaring people that some have portrayed them to be. I doubt they were. What I do know is that the expectations placed on directors changed dramatically with the demise of Enron and the introduction of Sarbanes-Oxley. And the challenge for boards ever since has been to find a means to effectively meet those expectations.

How can they do that?

They can start by recognizing that boards are risk mangers, and that risk management is their only job.

1. Risk management is an organized process in which Directors (not computers) routinely examine major risks critical to the business. Those risks are simple and straight forward. Moreover, most everyone knows them. The just don’t take the time to execute them well; the risk in the CEO and the CEO’s management of the business, the risk in the strategic plan at time of formulation and execution, the risk in the senior management team, the risk in the composition of the board, and the risk in the creation and presentation of financial information. Boards are the last stop in the risk management process, the endpoint in the company’s Enterprise Risk Management program.

2. Make risk management a proactive process in which Directors, like smoke detectors, are always sampling the air and checking for bad smells. They never go off the air. They are always listening, watching, and analyzing the results for events or situations of that could stop or deter their company from reaching its objectives. That’s the definition of risk, “An event or situation of that could stop or deter the company from reaching its objectives.”

3. Engage the company’s internal auditor to be the board’s eyes, ears, (and nose,) reporting directly to the board; operating with the board’s direction. The job is simply too big for ten, drop-in-directors, to do the investigation themselves.
4. Change the relationship between the Board, the internal Auditor, and the CEO. The preservation of the corporation and shareholder’s equity requires a team effort. There is no room for egos or petty jealousies.

What Should I know about CEO Evaluation

Background

CEO evaluation is not an end in itself. It is a major step in managing leadership risk, and building and maintaining excellent leadership that propels the organization into the top 20 percent.

Stephen R. Covey said, "I am personally convinced that one person can be a change catalyst, a transformer in any situation, and organization. Such an individual is yeast that can leaven an entire loaf. It requires vision, initiative, patience, respect, persistence, courage, and faith to be a transforming leader.

Leaders, whether we call them CEOs or Executive Directors, are the catalyst of any organization’s performance, whether significant change is required or not. They are the catalyst for the vision that ignites the enthusiasm of employees, clients, funders and other stakeholders. They are the pathfinders that guide the accomplishment of the vision. They are the pillars that provide resilience when the going gets tough.

For owners, the presence of strong leadership is the most convincing measure of the Board’s capacity to act on their behalf.

The challenge for Directors

Directors manage risk

The most significant challenge for any Board is to ensure that the organization’s leader is the right catalyst, the right pathfinder, and the right pillar for the time and the situation. A significant part of the challenge is finding internal candidates who fit or can grow into the profile. The Board manages leadership risk and ensures the right leadership is in place?

How Directors manage the risk

For more on this topic go to my website

Drop-In Directors

Being a Director is like buying a house—and not being allowed to go inside to look around. Would you buy a house if the only way you could see what was inside was to look through the windows? That’s, in a sense, what every Director is required to do.

Directors aren’t around day-to-day, unlike the CEO and senior management. They can’t observe events as they unfold. Instead, they “drop in” to attend six to eight Board meetings a year that last from two to ten hours, and they review information prepared by the CEO.

How can Directors fulfill their responsibilities for monitoring and supervising the CEO? How can you be held accountable for the reputation and financial well-being of the enterprise you serve when you’re only an outsider looking in? What windows do you look through to gather and assess the information you need to “buy the right house”? That’s the challenge faced by all Directors, from non- profits to major corporations.

To bridge the time and knowledge gap, effective Boards rely on their capabilities as risk managers. They specify the information they want to see through ten risk windows that give the Board an almost compete view of the inside of the house. By examining the CEO’s management through each risk window, the Board can monitor and supervise the CEO, contribute to the CEO’s decisions, and fulfill its mandate of preserving the reputation and financial well-being of the enterprise.

Risk management is a key skill for Directors. Fortunately, it’s a skill at which you’re probably already proficient. You’ve been identifying and managing risk for most of your life. With experience you’ve learned to apply it to complex situations like buying a house, considering a promotion, or making an investment. You assess the risk, weigh your options, and consider the consequences. With each decision, you become more skilled and confident in your ability.

For more information on the risk windows and how to use them, visit our website at www.GovernanceTools.com.

Confidence at the Board Table

The value others see in us as Directors is what we contribute to the combined wisdom of the board, and to the success of our organization. It takes confidence to be a contributor.

You may have reached this site looking for information that would help you contribute, with confidence, at your next board meeting. Were you looking for Strategic planning? Board evaluation? There are lots of websites that talk about how to create a strategic plan, or the importance of board evaluation. Good for you for working to be prepared.

But is the confidence you are looking for, built from knowing the mechanics of strategic planning or board evaluation? Will knowing how to prepare a plan, help you with the questions you will have to answer when the board is asked to approve the plan?

Do you believe this plan is the best for our organization? Do you believe this plan can be successfully executed? Do you believe that risks in this plan are acceptable? Will you vote “yes”?

While knowing how to prepare a plan is valuable, Directors are concerned first about risk, not mechanics.
1. Boards manage the risk in management’s proposal and actions
2. Directors contribute by bringing their experience with risk situations to the board’s discussion.
3. Your value to the board discussion is your ability to identify and manage risk.

Risk management is a Director’s fundamental skill. Knowing risk management is the foundation for director confidence. When you see yourself first as a risk manager, then the rest of your role as a Director becomes obvious and makes sense. It’s the dividing line between the role of the Directors and the role of the CEO.

This site will help you build your skills as a risk manager and build your confidence at your board table. It’s designed around specific topics such as strategic planning or board evaluation.