The Important Role of Corporate Governance

July 30, 2020 Updated: July 30, 2020

Commentary

Building a successful company or organization takes many years, and the best way to safeguard that hard work is to establish an accomplished and reliable board of directors.

Experienced business professionals find board spots an appealing opportunity to share knowledge they’ve gained throughout a successful career.

Serving on a board of directors and providing corporate governance to both for-profit and non-profit entities is critical to the proper functioning of our economic system. When you join a corporate board, you become accountable to a variety of constituents and assume fiduciary duty and liability. Depending upon the type of corporate entity, these constituents may include shareholders, stakeholders, customers, employees, government regulatory agencies, and the community at large.

As a member of a board of directors, you may ask yourself, “How do I fulfill the enormous responsibility to all of these disparate groups.” First, the only way new board members can be successful is if they receive a thoughtful orientation process. Without an effective orientation process, how can any individual be prepared to exercise his or her fiduciary duty?

In addition to the orientation process, one tool often overlooked by boards of directors is industry metrics. Depending on your company or organization, and the areas you’re aiming to monitor, the board may want to focus on certain business metrics in particular that drive performance and also assess the financial health of the entity.

Risk Management and Corporate Governance

Managing risks is the most important role of corporate governance. Risk management is defined as “the process of identifying, assessing and controlling organizational threats, such as the threat to capital and earnings.” These threats or risks can stem from a wide variety of sources including financial uncertainty, legal liabilities, strategic management errors, accidents, and natural disasters. For those entities operating within a regulated industry, risk also includes regulatory risk from both state and federal regulators.

The risk management committee is the most influential and powerful of all board committees, and future board chairs often have served as chair of the risk management committee prior to becoming board chair. The board usually doesn’t take a direct role in managing risks on a day-to-day basis. The board’s role is limited to oversight of management and corporate issues that affect risk.

Providing corporate governance throughout an entire business cycle is a challenging task. The board needs to ensure that management has positioned the entity to succeed during both good and bad economic times.

Has management created the right balance sheet structure regarding leverage? Negotiated flexible loan covenant terms? Provided the right cost structure regarding fixed and variable costs, and a flexible human resource plan that can be adjusted quickly if necessary? Accumulated both equity and liquidity reserves to support the company throughout the business cycle? Designed a flexible dividend policy, and been cautious with capital investments that require long recapture periods?

Effective board governance demands leadership, and no time is that more critical than during economic downturns.

Board and Management Relationship

The once comfortable relationship between management and the board of directors has been strained from abuse by both management and the board. Numerous entities have failed or lost their competitive advantage because those entrusted with fiduciary duties have placed their personal interests ahead of the best interests of the various constituents they took an oath to protect.

The first part of the 21st century has witnessed several trends with respect to relationships between management and the board that have been upended by numerous corporate scandals. Boards have assumed a new role from that of ceremonial gatherings to a high performing team. Boards are requesting a deeper involvement in corporate strategy, which oftentimes conflicts with how management views its responsibility. Boards are being forced into becoming more serious about the quality of board composition. Directors without enough industry or relevant functional experience find it difficult to ask the right questions regarding strategy and performance.

Significant damage has been done to management and board relationships in the past two decades. It’s incumbent on both parties to learn from these past experiences and create a healthier environment where trust and respect are afforded each group. The role of these two groups are intertwined, and all constituents benefit from a working relationship that captures the best practices of management and the board.

If you make the decision to become a board member, check your personal agenda at the door. Additionally, when discharging your fiduciary duty, trust your gut as your instincts are usually “spot on.” Effective board governance demands independent thinking and actions in order to ensure the long-term viability of any corporate entity.

I have always been surprised by how many years it takes to build a successful company or organization and how quickly one person in a key position can destroy that entity. More often than not, it traces back to a failure of the board of directors to exercise its fiduciary duty.

Donald Hatt spent more than 40 years in executive roles within the financial services industry and served on numerous for-profit and non-profit boards of directors including the role of chairperson. He is an Air Force veteran and has both undergraduate and graduate degrees in business.