The obligation of the board to challenge management
I think we all know that the board is supposed to have a majority of independent directors (at least in public companies) and to challenge the executives running the organization. That is what “oversight” means.
But the board is also supposed to work with those same executives, sharing their insights and experience to complement that of the CEO and his team.
Often, and I have seen this many times, the board finds it difficult to exercise what one might call professional skepticism in listening to the management team. As they look at the CEO and CFO, they see people just like them – one of their class, just perhaps a little younger.
Yet, professional skepticism is needed – and it is their legal obligation.
Recently, a good friend mine, Diane Frankle of Kaye Scholer, touched on this as she analyzed a case involving Yahoo! and the compensation of an executive. The case was Amalgamated Bank vs. Yahoo! Inc and was heard in the Delaware Chancery Court.
There are two important elements in her piece that I want to highlight: the obligation of the management team to provide the board with all the information they need to provide oversight, and the obligation of the board members not to accept management representations uncritically.
Here are the relevant excerpts (although I recommend reading her entire piece):
- Officers have a risk of personal liability for a breach of the duty of care without exculpation. …………. Officers have a duty to comply with board directives and to provide the board with information they need to perform their fiduciary roles. This precept then argues for officers obtaining board authority for important decisions, after providing to the directors all relevant information reasonably available. Going it alone can create significant risk of liability for officers.
- Directors who accept management’s statements uncritically, particularly with respect to executive compensation or employment actions, risk scrutiny and possible liability. The court notes that here the involvement of the Committee and the Board on the hiring and firing of de Castro was “tangential and episodic.” The court explains that a board “cannot mindlessly swallow information, particularly in the area of executive compensation.” The board must exercise business judgment. Where there is a lot of money at stake, and the provisions are out of the norm, directors protect themselves by asking questions and understanding the provisions they are approving, rather than simply relying on management. In cases involving executive compensation, hiring and firing, a board or committee may need to exercise more scrutiny than usual about the decisions being made, given possible self-interest of the executives. Lack of curiosity on obvious points, such as a candidate’s identity and credentials, or the financial impact of a complex compensation scheme, gives rise to concerns that the directors simply abdicated their responsibilities in a critical area.
I have often been concerned about what amounts to redaction of the information that is provided to the board. It is generally colored by the CEO or other top executive – presented in a way that supports his/her position, rather than with the intent of providing the board members with all the information they need to make informed decisions.
Even the choice of the CEO as to who will be present or absent as information is presented and discussed can inappropriately bias a decision.
Of course, I am not at attorney (Diane is) and would not presume to make authoritative interpretations.
But, I can see how the risk to the board – and to management – may be more than they think.
Both need to be informed that there is personal as well as collective risk.
If others (such as the CAE or CRO) see officers or board members failing either to provide the board with all relevant information reasonably available, or failing to exercise professional skepticism when presented with information by the CEO/CFO, is there not a duty to ‘ring the bell’?
I welcome your thoughts and views.
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Norman Marks on Governance, Risk Management, and Audit 
In theory yes, but in practice obviously in many organisations I wonder how long the CAE or the CRO would remain employed if this was carried out? Particularly if the information not provided was due to a deliberate attempt to withhold information by someone senior in the organisation and / or someone on the board was not in a position to offer up professional skepticism (for whatever reason) ie appointment of board members is not always totally dictated by for example competency factors. Whilst good to be obviously aware of such risks the way the bell is rung would obviously need to be carefully considered cognisant of the particular circumstances and the potential consequences. It goes without saying you are touching on one of the main challenges any CAE or CRO has operating fully effectively. In the end most end up making a choice to adapt within the particular limitations they may face within their organisations or some end up resigning in frustration or from being “sidelined”. Rgs
I can think of one routine procedure when the information provided to directors, and their questioning of it, is very important – payment approval. The vast majority of payments made by an organisation will not require director approval but payments which are large in comparison to the size of the organisation should have such approval. It is a vital control that these payments are presented with appropriate evidence, such as original invoices, orders and approval documents, not just a copy of a remittance note. The director needs to understand that the/she is approving the payment based on this evidence and not on the basis of all the other approval signatures inevitably on the documentation. In other words approval should not be on the basis that, ‘Senior management have approved this then so can I’. I’ve known directors refer payments back with the request for more information, and IA should encourage them to do this.
Perhaps the CAE should routinely brief all new directors?
David, the one that I had in mind above all others is the selection of objectives and strategies to get there. The board approves management’s recommendation, but do they understand all the options – including those favored by other executives but not the CEO? Do they receive all the relevant information, or is it limited to what supports the CEO’s position?
If nothing else, IA can audit the completeness and accuracy (a controls focus is fine) of the board package.
I instigated a similar audit looking at major projects which went to the board for approval. If I remember correctly it recommended;
>formal identification of risks and their management
>possible alternative scenarios (covers your point about other options)
>results of financial modelling, which highlights the factors critical to success
>scrutiny by an independent accountant of the financial case, which should detect missing costs and unrealistic income (partially covers your point about receiving all information).
How was that received?
I don’t remember receiving opposition to our proposals so the reports recommendations will have been agreed with implementation dates. I can’t remember the results of any follow-up audit. (One of my regrets as CAE is that I didn’t have a policy of routine follow-up audits). Scrutiny by an independent accountant was certainly carried out, but I think financial modelling fell by the wayside.
Incidentally, internal audit used financial modelling as an audit technique. We purchased a copy of @RISK and applied it in the audit of a new business to determine the factors presenting the highest risk to its success.
The ideas that Norman rises are guided towards quality in decision making, is my feeling. Most decisions made by the board are by nature strategic decisions, that will pave the future of the company/organization. There are two teams that need to be partly united to ensure that the best possible decisions are made. The executive management team tends to be a very united team, partly depending on the leadership qualities of the CEO. The board needs to be a “less united” team with members holding personal wisdom and integrity – being able to take a birds-eye view of issues, possible problem solutions and not the least, possible trade-offs. The board needs to see all the biases that might exist in the executive team’s proposals (read Daniel Kahnemann’s “Thinking Fast and Slow”).
I’ve taken an open 4w course (MOOC) in Decision Making at Stanford Univ. lead by Carl Spetzler. (http://strategicdecisions.stanford.edu/individual-participants/courses/decision-quality.php) The necessary steps in decision making is like a chain with the weakest link being most critical. The last link (which I didn’t think much about before) is execution. A major reason why companies fail – lack of executing a good strategy.
When I visited Carl Spetzler’s Strategic Decisions Group, I see his just issued a new book now in March. It is shown on this page which illustrates the decision making process: http://www.sdg.com/wp-content/uploads/2016/01/Decision-Makers-Rights.pdf
Many companies have introduced decision analysis as a part of their culture or DNA (which should be reviewed by the IAE), such as Unilever and Chevron.
Click to access Andrew-Evans.pdf
If we executive humans don’t learn to make better decisions under risk and uncertainty, artificial intelligence (AI) soon will.
Both teams, Executive and Board, should have the same view of what constitutes Decision Quality.
Or, what do you think?
Kind regards/ Per
Having just sent off my comments, I see that CGMA has just issued a report on decision making in our new, complex, age called “Joining the Dots”. looks great – full of ideas.
Click to access Joining%20The%20Dots%20-%20Report.pdf
All the best/per
For Per:
The ideas that Norman rises are guided towards quality in decision making, is my feeling. Most decisions made by the board are by nature strategic decisions, that will pave the future of the company/organization. There are two teams that need to be partly united to ensure that the best possible decisions are made. The executive management team tends to be a very united team, partly depending on the leadership qualities of the CEO. The board needs to be a “less united” team with members holding personal wisdom and integrity – being able to take a birds-eye view of issues, possible problem solutions and not the least, possible trade-offs. The board needs to see all the biases that might exist in the executive team’s proposals (read Daniel Kahnemann’s “Thinking Fast and Slow”).
I’ve taken an open 4w course (MOOC) in Decision Making at Stanford Univ. lead by Carl Spetzler. (http://strategicdecisions.stanford.edu/individual-participants/courses/decision-quality.php) The necessary steps in decision making is like a chain with the weakest link being most critical. The last link (which I didn’t think much about before) is execution. A major reason why companies fail – lack of executing a good strategy.
When I visited Carl Spetzler’s Strategic Decisions Group, I see his just issued a new book now in March. It is shown on this page which illustrates the decision making process: http://www.sdg.com/wp-content/uploads/2016/01/Decision-Makers-Rights.pdf
Many companies have introduced decision analysis as a part of their culture or DNA (which should be reviewed by the IAE), such as Unilever and Chevron.
Click to access Andrew-Evans.pdf
If we executive humans don’t learn to make better decisions under risk and uncertainty, artificial intelligence (AI) soon will.
Both teams, Executive and Board, should have the same view of what constitutes Decision Quality.
Or, what do you think?
Kind regards/ Per