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How to Revamp Corporate Governance During Crisis

How to Revamp Corporate Governance During Crisis

The complete failure of corporate strategies of major financial institutions has resulted in the recent financial mayhem and called for unprecedented state intervention to guarantee the continued survival of the global financial order and has raised doubt over the adequacy of corporate governance of financial institutions. The current crisis has also revealed that the existence of non-executive directors on the board has proven to be an inadequate safeguard, particularly as many lack expert knowledge to effectively challenge their executive colleagues.

Although the corporate governance framework credibility is constantly being questioned as a result of current financial turmoil, it is rather critical to discard transitional emotion brought about by the crisis and remains rational. All stakeholders, including boards and shareholders, ought to accept their roles and responsibilities in what has happened, and learn critical lessons from this crisis to avoid repeating same mistakes in the future.

In response to the current economic crisis, many governments across the world have responded immediately, mainly focusing on fiscal and monetary measures with the view to lessen the impact of the downturn. Although policy makers are under short-term pressure to act swiftly, they are fully aware that revised policy framework should be designed for the long-term and subjected to adequate consultation and debate. The boards of companies should consider their own individual responses to the crisis.

A balance governance response from boards will gain momentum and is likely to be beneficial, particularly as the downturn continues to unfold. Such a response is likely to restore the confidence in shareholders, other stakeholders and will ensure the survival and sustained solid repositioning at the operational level. The misfortune of some corporations has provided important lessons for directors on corporate governance of all types of organizations across all business sectors.

The board should be composed of people with the varied and diversified skills, experience and knowledge which reflect the challenges facing today’s enterprise. Directors have to at least possess the right expertise to understand the fundamentals of the company’s business and potential risks. Experienced directors with prior experience of previous downturns may be a critical asset to today’s boardroom particularly at this stage of the financial crisis. The board should establish a mechanism for periodically refreshing its membership to reflect the environment and emerging risks.

The current crisis has highlighted the criticality of the board taking full responsibility of risk, which should be acknowledged and embraced by the boards of companies in all sectors of the economy. After all, risk management is a key board responsibility and risk is centered at the heart of entrepreneurial activities of any business. The board has therefore a pivotal role to play in terms of quantifying the risks inherent in corporate strategies, defining and clarifying the company risk appetite, and making certain that appropriate resources are allocated to risk identification, prevention, and mitigation.

Risk oversight is a collective board responsibility, and the full board needs to be engaged in significant discussions of the overall strategic risks associated with the business, bearing in mind the relationship between business strategy and risk. It is fair to suggest that the biggest failure of boards, regulators and shareholders in the current crisis is that they did not properly evaluate and challenge the risk of overall business strategies.

A communication line needs to be established between the executive management and the board to alert the board of significant risks on a timely basis. This could be achieved by ensuring that the head of internal audit function has a joint reporting line to both the board and the Chief Executive Officer CEO. Current practices of sole reporting line to the CEO result in conflict of interest and could adversely impact the credibility of internal audit as a boardroom tool of risk oversight.

The absence of a chief risk officer representation on the board could be interpreted as that risk management is subservient to the operational interests of revenue-generating business units. Risk management should be placed high on the agenda of the board and is not relegated to a specialist department or individual. Sufficient time should be allocated by the board for risk management discussions.

A key governance principle has been highlighted by the current crisis that employees should not be rewarded for improper risks-taking actions, and the board should ensure that compensation scheme rewards long-term performance. Whilst such compensation package may vary from company to another, it is essential that boards define the rationale for their compensation scheme and take into account the way compensation awards are viewed by the outside world. After all, compensation transparency is an important aspect of retaining legitimacy and gaining the trust and confidence in stakeholders, regulators and the wider public.