Impact of CEO’s Influence Over the Board on Risk Management – Part 3
“The board is there to “stress test” strategic proposals, and ensure, by way of considered challenge, that they are based on proper research, analysis, and commercial sense”.
The dash for growth and a show of some semblance of achievement, in the context of a feeble board on the one hand and a dominant Chief Executive Officer, is one of the consequences. This is made manifest through ill-judged and hurried expansion, often through acquisitions. Although a bigger portion of all acquisitions hardly succeed in delivering promised returns, a dominant Chief Executive Officer, often frustrated by his inability to grow a company organically, may push severely through the ranks of the board members for their buy in of the expansionary drive though the returns may not be vindicated by any empirical evidence. Such moves have been recorded to have destroyed stakeholders’ value.
When a board approves plans which indicate no link to the mission of the company or plans which indicate but a blurred link, plans whose value creation is no closer to comprehension and understanding, then there is a governance problem.
A prudent board ought to have a “No go zone philosophy”. This simply explains that where any undertaking proposed by the Chief Executive Officer, be it recruitment, promotion, procurement, award of tender and so on does not indicate how such an undertaking is linked to the mission of the company, then it is a “No go zone”. Period. This should become a litmus test. This is a speed governor to personal ambition and glory at the expense of stakeholders.
An ineffective board increases the likelihood of poor strategic thinking and decision making. The board is there to “stress test” strategic proposals, and ensure, by way of considered challenge, that they are based on proper research, analysis, and commercial sense. The board must ensure also that proper risk assessments have been undertaken. This is especially vital when a company intends to expand into new products, jurisdiction and forming subsidiaries.
Value destruction can be avoided by ensuring appropriate due diligence has been carried out, that acquisitions make commercial logic, that the price is not excessive and that thought has been put on post acquisition planning. If such scrutiny is not in place, then, there is a danger that the company will embark on a downward spiral leading to a disaster.
“He can now sway the board’s decision on contracts and appointments not only of senior managers but also external auditors. This influence over the board by the Chief Executive Officer is described as “board capture”.
The corporate world has witnessed Chief Executives push and lobby for approval to invest money in order to capitalise a brand new company while the parent company itself is under-capitalised and walking on the decreasing liquidity and reserving metrics path. I have come across a company that was on the verge of rating agency downgrade with an outlook which is negative spending money to capitalise a new “subsidiary” that is shockingly slanted to do the same business as the parent company though located in a different jurisdiction.
It was not clear when this new venture would break even when the board approved the new company capitalisation move. This was malignant. Board members who grant approvals in a chorus fashion betray their calling to creating and preserving value.
Studies have been conducted to investigate the role of the Chief Executive Officer in the director selection process and its impact. This study was motivated by growing interest in director selection among institutional investors and other corporate governance activists, as well as recent theoretical work modelling the balance of power between the Chief Executive and the rest of the board.
Evidence found was consistent with the proposition that directors are less likely to monitor performance progressively when the Chief Executive Officer is involved in the director selection process. In light of this, a company is likely to appoint non-executive directors who have conflict of interest and less likely to appoint independent directors under such conditions. A possible interpretation of this evidence is that influence in the director selection process is a mechanism used by a dominant Chief Executive Officer to curb the performance pressure that arises from monitoring by the board.
More broadly the results illustrated how the influence of the Chief Executive Officer serves as an important determinant of the governance structure of the firm. The worst scenario is when the Chief Executive Officer even influences which director should belong to which committee to make his life easier. When this happens, one should be sure that the board cannot exercise its directing and leading role over the Chief Executive Officer and his team. This breeds a situation whereby there is no adequate control environment.
An ineffective board gives a way to a dominant Chief Executive Officer’s influential position even on matters that should be reserved for the board to decide. The board proceeds to approve poor strategies such as ill-judged acquisition, financing, and over-expansion which might be there to serve the greed and excessive pride of a single person. This ends with corporate ruin.
When a Chief Executive wields undue influence over the board and in particular some vocal lobbyist directors, the board can support a non-performing Chief Executive Officer during a removal bid. The board now becomes a colonnade, a shield, a breastplate. The board insulates him against reproach to the extent that the Chief Executive Officer becomes “the company” and starts craving for veneration.
He can now sway the board’s decision on contracts and appointments not only of senior managers but also external auditors. This influence over the board by the Chief Executive Officer is described as “board capture”. He can even induce the formation of “the caucus” within the board, a grapevine association akin to a “coalition of the willing” that solicits and enlists the support from its allies outside a duly summoned board meeting. In the psychological state, the ability to engage in constructive discussions and deliberations is weakened. This way, the ego of the Chief Executive Officer becomes more pronounced and influences the culture of domineering that permeates through the ranks of the company.
Nevertheless, this malady is curable. The remedy is a robust governance structure, with an independent board led by a strong and adept chairman which can assess the Chief Executive’s performance in running the company. The board must spell out very clearly on matters reserved for the board. An effective board can act as a brake on poor decision making.
A competent audit committee must ensure that sound internal controls and risk management are implemented and that bookkeeping and financial reporting give a true indicator of the financial health of the company. The compensation packages must focus on long time achievement and do not reward failures. This can be achieved by reducing incentives that tend to increase short term earnings at the expense of long term health of the company.
It must be noted that good pieces of legislation will do little to prevent failure of a company as it cannot address the underlying causes it cannot prevent the company from pursuing flawed strategies or making poor investments. Nor will it reign an overly ambitious and greedy Chief Executive Officer. Only a strong board can do that and good corporate governance must hinge on both the law and best practices.
by Amani Mbuja Tuntufye, ERMCP, CERG