Risk and the Board

It’s not a game; how corporate boards analyze and respond to risk is critical in a crisis.

Board committee work these days is anything but boring. While many boards typically meet four times a year, in a crisis, boards and their respective committees must meet and communicate far more frequently. And while financial matters in prior meetings may have focused mainly on company income statements, crisis management demands a deep focus on the balance sheet. Is there enough cash flow to meet short-term obligations? Are there debt obligations that can be renegotiated or refinanced?

Finances aside, corporate leaders should be looking for ways to act, not just react, and boards should encourage executive management to actively seek out opportunities. During turbulent market periods and economic recessions, there are always opportunities for new talent, new partnerships, and new consolidations. While we are all trying to imagine a new normal, we also are given a rare chance to reimagine operations and technology solutions through creative problem-solving.

During a crisis, getting a multitude of perspectives on strategic decisions is more important than ever. Often, critical decisions occurring in boardrooms are vetted initially in a committee structure. Risk committee agenda items permeate throughout the entire organization, and frequent disclosures of regulatory and other material risks are required and discussed in management discussion and analysis (MD&A) reporting. The overlap that exists between the risk and the audit committees has increased as risk disclosures continue to expand, meaning risk matters often end up on multiple agendas. The regular discussion of risk in each committee and among the broader board of directors is critical to the understanding of a business’ growth strategy, scenario analysis, and mitigation plan. As businesses retool, recover, and rebuild in a crisis, they need a playbook of potential paths forward. This is easier with the comprehensive and collaborative ownership of risk matters throughout the organization all the way up to board oversight.

The AICPA and N.C. State University’s Poole College of Management collaborate each year in publishing an annual look at the state of enterprise risk management. In the 2020 findings published in April, they observed:

• Over 80 percent of large organizations and public companies have management-level risk committees.
• Most respondents (59 percent) believe the volume and complexity of risks is increasing extensively over time.
• But only 24 percent of the organizations’ board of directors substantively discuss top risk exposures in a formal manner when they discuss the organization’s strategic plan.

Of the 563 survey respondents, which included public, private, and not-for-profit entities, only about 54 percent had assigned risk oversight to a separate committee. Lacking a separate risk committee, risk matters are generally assigned to the audit committee for review, with the HR and compensation committee dealing with talent risk and second-tier succession matters.

By necessity, crisis management board work often focuses on short-term emergency decision-making. It should also highlight risk measures and contingency planning initiatives that have been successful, as well as evaluate and strengthen those that need improvement. As each board committee meets on critical matters, here are some of the most prominent risk areas to be discussed:

OPERATIONAL

The pandemic has highlighted the real risk of not having a distributed supply chain with multiple third-party relationships. Companies and their boards should be evaluating overseas suppliers of raw materials, manufacturing plants, distribution arrangements, and everything in between.

CYBER

Has management been communicating the dangers of cyber threats? Hacking and phishing are rising risks as cyber criminals try to take advantage of increasingly distributed workforces and many newly remote workers—potentially sharing devices with family members—which may leave personal and business data vulnerable.

LIQUIDITY

You’ve no doubt read about the retail bankruptcies filed for J. Crew, J.C. Penney, and Neiman Marcus. There will be many more illiquid organizations forced to consolidate locations or stop doing business altogether despite government response programs to stem the impact of COVID-19. Bankruptcy doesn’t work in all cases, and it can leave employees without pensions unless you carefully construct the filing. Scenario planning is critical in these uncertain times. Boards should expect, or request if necessary, frequent updates on plans to evaluate and strengthen access to capital and refinance debt given current low interest rates. Boards should also evaluate any share buyback programs in place and, if necessary, terminate them.

FINANCIAL

Many industry-wide company valuations have declined and it’s unclear how long they may be depressed. Evaluating revenue stream scenarios is necessary, along with frequent reviewing of client/customer touchpoints. Companies will be reporting balance sheet impairments or new reserve requirements. Many companies should also renegotiate and rethink leases as they reconstruct office layouts that are conducive to social distancing and account for more remote workers. Boards should be made aware that regulatory agencies are calling for specific disclosures about the effects coronavirus is having on companies.

TALENT

The Department of Labor reported the U.S. unemployment rate hit 19.5 percent in April when adjusted for errors. Besides being the highest rate since the Great Depression, more than 20.5 million jobs vanished in the worst monthly loss on record. Whether these job losses are temporary or permanent is still to be seen. Still, companies must devise plans to reskill and upskill employees. While this has been on the radar for some time, the move to virtual work environments highlights the need for workstreams dedicated to enhanced training and retooling.

HR and compensation committees should be evaluating incentive compensation structures, including considering executive pay cuts and retention packages for key succession personnel. At the same time, the marketplace may be offering an opportunity to go after previously unavailable talent.

M&A

Bain & Company’s 2020 Global Private Equity Report lists 2019 cash-ready reserves at $2.5 trillion. The challenge in getting this money off the sidelines and invested in new deals is that due diligence will be tougher than normal if all activity is done virtually and digitally. After all, meeting company leaders and evaluating culture and values has generally been done through in-person conversations. In addition, deal structures may change depending on the target industry and any reliance on overseas supply chains. I suspect only companies with liquidity reserves and already targeted M&A opportunities may be in the marketplace in the near-term. However, with company valuations depressed, boards may want to explore previously unavailable acquisition targets.

Major economic events require teams to come together. A board that is engaged and informed can strengthen its committee structure and its ability to do the planning and evaluative work necessary to mitigate risks. Ensuring your board and its committees are evaluating and responding to risks as quickly and with as much information as possible puts your organization in the best position to be responsive and transformative.