Robin Murray Brown of Tyzack Partners investigates how risk avoidance and lack of diversification can cripple businesses.
Not so long ago Eastman Kodak’s stock was trading on the NYSE at $80+. Now, the shares have been delisted and are valued in cents following the company’s Chapter 11 bankruptcy protection filing in the US. It has been a spectacular fall from grace for a name with which most of us grew up, and which dominated the photographic film and camera market for over a century.
Blame for Kodak’s demise has been attributed to a culture in which cautious executives shied away from innovation and risk-taking and failed to adapt to the changes and opportunities thrown up by the emergence of new technology. But if cultural failures were the symptom, few can doubt that the root cause is to be found in questions of leadership.
Of course, Kodak doesn’t have a monopoly on leadership failure. It is a truism that the best people to lead companies during buoyant economic times may not necessarily be the right leaders in a downturn. This is as true for the executive leadership team as it is for non-executive and independent board members; and, as the global economic outlook shows auspicious if tentative signs of recovery, this will put pressure on boards looking to return to sustainable growth.
Recovery demands that new opportunities are identified and embraced and this will usually entail a degree of risk. When times are more difficult, is it – paradoxically – inevitable that business leaders become more risk-averse and cautious as they endeavour to ride out the storm? It has become noticeable recently that risk management is increasingly seen as a collective board responsibility. Far from being a sign of executive weakness, this seems to reflect a greater willingness by management teams to draw on the experience of their non-executive directors, much as they would on questions of strategy.
But if few of the statutory responsibilities of non-executive directors have changed during the recent downturn, it does seem that how they carry out their role, and how they address stakeholder expectations, has shifted. They now have to be more effective in balancing the exploitation of commercial opportunities with sensible risk management and the maintenance of shareholder value.
Accounting for risk
Firms that have an appetite and aptitude for change management will tend to do better in unpredictable times than those which simply batten down the hatches and cut costs, but keeping exposure to risk at a manageable level raises a number of issues. Boards must identify the principal risks to the business, agree on an acceptable risk-profile, and ensure that proper procedures are in place to operate within that context. And, since risk has moved up the boardroom agenda, non-executives must possess appropriate skills in order to navigate the company safely through an economic upturn.
This has direct implications for the make-up of the board itself. The corporate governance debate of recent years has given prominence to the theme of independence among non-executive directors. That focus has developed to include commitment and diversity.
As in the past, the process should start with an honest analysis, ideally led by the chairman but with external advice, of gaps in the board’s collective skills, knowledge and experience. It also needs to extend well beyond the historical practice of recruiting non-executives through the personal contacts and networks of existing board members. This will lead only to a limited field of candidates in the board’s own image, without clearly articulating or prioritising the fundamental professional requirements which are needed.
Boards also need to strike the right balance in terms of their non-executive directors’ commitments, and should be realistic about this when making an appointment. If a non-executive director feels they need to step down at a moment of crisis because they cannot devote sufficient time to their board duties, this can send alarming messages to the markets. Tellingly, three Eastman Kodak board members (one, a business school professor and White House advisor, the other two executives of a private equity firm) resigned within a week of each other following the company’s announcement that it might not survive 2012.
Equipped to survive
Although there is no standard prescription, there is a growing consensus that smaller and more independent and diverse boards are better equipped to steer companies through these difficult and increasingly complex market conditions. Where boards are too large, it can slow down the decision-making process and make it easier for directors who are ill-prepared, or uncommitted, to conceal themselves. Smaller boards often see improved overall dynamics between board members.
Long tenures of supposedly independent directors have also been much argued over. It may be fair comment that such directors risk losing their independence and their detachment from the executive team; but what is the penalty if boards lose their most knowledgeable directors at an arbitrary termination date? Audit committees, for example, need directors with substantial service on the board in order to understand the context of a company’s financial activities and help to avoid any future risks.
The answer to this conundrum almost certainly lies in boards ensuring that they have the breadth and depth of experience to meet a range of different business and economic situations. Diversity of independent directors has become one of the most important issues in the makeup of the board. At the current economic turning point, it is more important than ever for boards to diversify. Diversity encourages better debate and decision-making and helps to avoid the possibility of any ‘groupthink’ occuring. After effective competency-matching, it is invariably one of the distinguishing characteristics between successful boards and failing boards.
The development of the gender diversity debate epitomises this. In their 2010 report, management consultants McKinsey wrote that companies with a higher proportion of women on their executive committees were also the companies that had the best performance, providing strong evidence in favour of greater gender diversity in corporate top management. Yet fewer than 20 percent of large American companies have female board members and fewer than 15 percent of European listed companies have women on their boards. To many, this represents a squandered opportunity and European Commissioner Viviane Reding recently launched a public consultation on how to redress the gender inbalance within the EU’s boardrooms.
Many are sceptical of the capacity of political rhetoric or legislation to change the makeup of corporate boards. As the McKinsey report indicates, the commercial imperative will do just as well. Yes, it is frustrating that it has taken a long time for this realisation to be translated into action, but it is encouraging that an initiative such as the 30% Club in the UK, which aims to achieve 30 percent female representation on the boards of the top 100 listed companies by 2015, is a voluntary scheme, albeit one with some prominent (male and female) advocates.
Adapt and diversify
Although this is not a polemic in favour of board diversity, it seems likely that there will be many candidates from currently under-represented backgrounds who will have emerged from the global financial crisis with reputations and skills which should commend them to the most ambitious boards in Europe.
Many businesses which survive an economic downturn feel that they emerge leaner, fitter and better equipped than they were in the past. That may be true, but it is also all too easy for survival to breed complacency. Few of Eastman Kodak’s senior executives, not to mention analysts commenting on the company, would have looked at its performance just a few years ago and thought that this was a business on the brink of corporate failure. Chairmen and boards need to take a very honest look at themselves in order to answer the question: “Did the company survive because, or in spite, of us?” Successful boards are those that understand and reflect the markets they serve, but they also need to be able to adapt and diversify; and, critically, they need to do so more quickly and more effectively than their competitors.