This article, authored by John Buchanan, discusses how the economic crisis is impacting the future of corporate governance.  While there are many players at fault for their contributions to the economic crisis, “many observers fault boards – the most important line of defense against corporate breakdowns – for a fundamental failure of oversight”. Boards are responsible for ensuring senior leadership has applied due diligence to their decisions and for asking what risks the company is exposed to as a result of those decisions. However, though boards have these responsibilities, boards in general “do not believe they are getting enough of the right kinds of information in order for them to effectively execute their responsibility of risk oversight”. The “post-crisis transformation of corporate governance” will be driven by risk assessment and management. Boards will need to assess management’s ability to reduce risk and determine if management is thinking broadly and carefully enough about risk. With this increased focus on management and business fundamentals, boards will also see increased demands on their time.

Roles between boards and management will be redefined with this increase in board oversight. “‘Top management will spend more of their time as stewards of risk,’ says Mark Goodburn, vice chairman at KPMG in New York. In addition, senior executives will have to articulate, both internally and externally, the implications of such risks in order to satisfy an increased demand for transparency and the need to benchmark against other companies.” Senior management will need to understand not just big-picture evaluations, but more details of their businesses. Management will also need to challenge their assumptions and decisions and cultivate an environment where challenging assumptions is acceptable to promote the long-term betterment of the company. Other changes that will likely occur include more frequent separation of the roles of CEO and chairman and decreased time for CEOs to sit on other companies’ boards, which may decrease their ability to benchmark their own organizations.

While there is need for changes in corporate governance, there is also worry that the government will limit and control compensation of senior management and otherwise regulate corporate governance, which could be detrimental to businesses and the public. Boards and top management are attempting to self-regulate their compensation structures to avoid congressional oversight. With the shifting balance of power between the board and senior management, executive compensation will be reassessed with boards likely imposing tougher pay-for-performance metrics and measurement and introducing clawback provisions on executive compensation. Many hope that aggressive, voluntary self-regulation by businesses will help avoid government intervention in this area.

One positive outcome of the economic crisis may be a fundamental paradigm shift from concern over short-term earnings to a focus on more meaningful measurements focused on market viability, long-term sustainability, and consistent profitability. A contributing factor to the economic crisis was that “outsized risks propelled enormous short-term revenues that fed top-executive compensation packages based on such near-term performance”. “The addiction to ever-better quarterly reporting fed the appetite for excessive risk that pushed the global economy to a dangerous precipice, says Steve Wagner, managing partner at the Deloitte Center for Corporate Governance in Boston, who adds that ‘driving short-term earning based on greater risk-taking is not consistent with long-term shareholder value’.” A more long-term focus by senior management in their decision-making could positively alter how business is conducted.

This abstract is based on the article “After the Storm” by John Buchanan in The Conference Board Review, March/April 2009.  Please contact the Conference Board Review or the author for a copy.

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ERM Enterprise Risk Management Initiative 2009-03-31