Boards of Directors and Risk Management in 2009

Boards of directors will need to respond to new challenges and pressures in 2009, including regulators’ increased focus on risk management policies and the public’s increasing demand for board and management accountability in the wake of accumulating financial losses.  Boards may need to reassess their agendas, committee structures, time commitments, director recruiting, and their role in monitoring performance, compliance, and risk management in light of these changes.  By proactively addressing the changing landscape, boards may be able to help shape the regulatory response towards measures that promote creation of long-term shareholder value. This paper, authored by Martin Lipton, Steven A. Rosenblum, and Karessa L. Cain, discusses how there are many significant issues facing boards of directors in 2009, but there is not be a “one size fits all” approach and each board should focus on the issues most relevant to their organization.

Key Issues Facing Boards in 2009

Risk management is the first key issue addressed.  The set of risks facing an entity is complex and changing, and the board of directors’ ability to effectively oversee the risk management function is critical to the success of the enterprise.  Boards need to look comprehensively at their organization’s risk profile and determine their appetite for risk.  In doing this, the board is responsible for informed oversight, not direct management of risk.  While risk management systems will vary across organizations, an effective system will identify the material risks an entity faces in a timely manner, implement appropriate risk management strategies that are responsive to the company’s risk profile and material risk exposures, integrate consideration of risk and risk management into business decision-making throughout the entity, and include policies and procedures to transmit information about material risks to management or the board.  The board should review the risk management system periodically.

Another key issue facing boards is executive compensation as these policies have been criticized for encouraging excessive risk-taking and contributing to financial instability at both entity and systemic levels.  Boards should review policies carefully, seeking to avoid policies that encourage excessive risk-taking and describing the impact of incentive structures on risk management in the Compensation Discussion and Analysis.

Short-termism and special interest groups are another key issue for boards due to the recent economic volatility and uncertainty.  Boards focusing too much on short-term issues may take excessive risks to generate positive short-term results or be reluctant to make investments requiring a long-term horizon.  However, boards that consider a long-term perspective and the interests of all stakeholders in setting the strategic direction and goals of an entity will better position their companies for long-term growth and value.  Other key issues addressed include CEO succession planning, takeover defense, director elections, direct lines of communication with shareholders, shareholder proposals, separation of the chairman and CEO positions, and considerations in the “zone of insolvency”.

Roles and Duties of the Board

Boards have a dual role as advisors to management and agents of the shareholders and must find the appropriate balance between advising as to strategy and monitoring compliance.  “Tone at the top” is one of the most important factors ensuring a board functions effectively and meets its responsibilities.  The board’s vision for the entity’s commitment to ethics should be transparent and communicated effectively as this tone shapes the entity’s culture and permeates the entity’s relationships.  The board should monitor management’s performance, receiving pertinent information and having discussions with management about important issues and developments. 

Another duty of the board is to implement compliance monitoring systems and take action if it becomes aware of any problems management is not dealing with appropriately.  The board has a key role in approving the entity’s long-term strategy and it should manage any pressures to focus too much on short-term stock price performance, keeping the best interests of shareholders in mind.  Crisis management is also an important duty of the board.  Boards need to be proactive in handling crises and can prepare for potential crises by staying attuned to their companies’ risk profiles and vulnerabilities.

Board Committees

An audit committee, compensation committee, and nominating and governance committee are all required by the NYSE of listed companies, but there are additional committees boards may want to establish to help meet ongoing governance needs such as a risk management committee.  While the audit committee may otherwise assume the role, risk management has sufficient scope and complexity in many entities that a separate risk management committee can allow for increased focus on risk management at the board level.  A dedicated committee will also be better suited to looking at the broad scope of risks the entity faces.  If a company does keep the role of risk management within the audit committee, it is a good idea to schedule time periodically to review risk management outside the context of its role in compliance with auditing and accounting standards.

Board Procedures

One board procedure encouraged is director education, where an annual retreat with senior executives and appropriate outside advisors could serve as a review or orientation of the company’s financial statements and disclosure policies, risk profile, strategy and long-range plans, budget, objectives and mission, succession planning, and current developments in corporate governance.  Another board procedure suggested in the realm of director compensation is use of restricted stock grants in lieu of option grants to better align director and shareholder interests, avoiding the perception that option grants might encourage directors to support more aggressive risk-taking by management to maximize option values.  Other board procedures discussed include executive sessions; charters, codes, guidelines, and checklists; confidentiality and the role of directors outside the boardroom; minutes; board, committee, and CEO evaluations; reliance on advisors; whistle-blowers; major transactions; and related party transactions.

The memorandum also discusses issues related to the composition and structure of the board, including independence and recruitment and nomination of director candidates, and director liability, including personal liability of directors and indemnification, exculpation and directors’ and officers’ insurance coverage.

Click to download full report.

Citation: Lipton, M., Rosenblum, S., & Cain, K. “Some Thoughts for Boards of Directors in 2009″ Dec. 8, 2008.