No Risk of Agreement Panel Discussion: Ruth Bender, Murray Steele and Toby Thompson June 2009 TT
Hello my name is Toby Thompson. I am here today with Dr Ruth Bender, Senior Lecturer in Finance and Accounting and Murray Steele, Senior Lecturer in Strategic Management. We are talking about risk on the board. Ruth, can risk be managed? RB Yes, provided you mean by risk and what you mean by managed. TT Go on then. RB OK, well companies have got to take risk on the basis that if you never take a risk, you are never going to make any money. So the issue is how much risk do we want to take? Which means you have to decide what your risk appetite is and there are all sorts of issues with that because people see risk differently. TT Is that the individual’s risk appetite, or the company’s risk appetite? RB In theory it should be the company’s risk appetite, that is what the combined code says. But the company, the board is made up of individuals and every individual sees the same thing with a different level of riskiness depending how familiar they are with it. And so it ends up being what the different individuals do. TT But Murray, haven’t we seen too much appetite for risk because we are in a terrible situation right now, economically? MS Well I tend to agree with Ruth. I think you can manage risk to a certain extent, but you can never utterly eradicate it, sometimes there are politicians who think you can completely eradicate it. I think we are in a situation because people took risks, but let’s face it they have been taking risks for the previous sixteen years of fantastic economic growth. Yes, we have had two bad years and I am not saying it isn’t dreadful for lots of people – companies and individuals who are losing their jobs – but risk management wasn’t too high on the agenda in the previous years. And I think that risk management can be brilliantly managed with the benefit of hindsight. TT So we should put this into perspective, the current financial crisis, it comes along anyway? What comes around, goes around? MS I would say that you could argue that it is part of the cycle, it just happens to be a bigger kind of spasm in the cycle – the biggest one we have ever Ruth Bender, Murray Steele, Toby Thompson
seen probably. RB Can I disagree with my learned colleague here? TT Go on, please. RB Yeah, I will accept it is cyclical and yeah, I will agree that people lost the eye on it, but I don’t think that means that you can’t do it. I think what happened was the whole system was geared more than ever to encourage people to take risks, and that is the problem that happened. I don’t think you can just say well, its cyclical, it’s always going to happen. MS I agree. And I think a lot of the regulatory framework and the political framework said, I have abolished boom and bust; we need a light touch regulatory framework; the City is the star of the UK economy; go for it guys; etc, etc, etc. I am sure there were some people who were saying let’s just be cautious and there are a lot of companies at the moment who are doing pretty nicely thank you, who have got on the balance sheet and are finding their competitors very slowly crawling towards them saying please buy me because we were perhaps a little more profligate during these wonderful boom years. So there are people at the moment profiting from the lack of risk management that has previously taken place. But I fully expect to see in my lifetime the same cycle happening again. I suspect that we won’t see the same kind of variation; the top and the bottom of the cycle that we have seen this time because it is one of the biggest that we have seen since the 1930s. But banks will have to start lending again, they will have to start taking risk. A bank’s job is basically risk and return, so they don’t make any money unless they start taking risks. So their current policy of not lending money is a bit of dumb one for a bank because ultimately they are going to have to start taking risks. Now the question is how do they manage it? At the moment they are managing it by basically saying I am going to keep all the money and not do anything until my balance sheet recovers, then I am going to start lending it out again in little, little bits. But I think that you will find that competition – one of the greatest economic factors in the world – will screw that for some of the banks. TT So the market is a reality which you can’t get away from and the financiers rule the organisation. RB Oh, that is a little bit vicious Toby. Let’s take that a bit at a time. Yes, the market works but it works very inefficiently and there were people at the same time, as Murray says, at the same time there were banks and financial institutions taking shed loads of very aggressive risk – even when they knew it was wrong. Wasn’t it Chuck Prince who said ‘the music is playing, we will carry on dancing’ even when he knew things were going downhill. But there were still organisations who looked at it and one of Page 2
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the financial companies I was working with, they looked at something and they said we can see there is a lot of money in that, but on the other hand there is way too much risk in that and we are just staying well clear. So I think different organisations looked at the market, but still set their risk appetites differently. TT How much of that is an individual thing? As a non executive director, for instance, is that something that is to do with you, your courage, your authenticity and your conviction to speak up based on your conscience? Or is that more of a market or a contextual thing? RB I think it is a lot to do with the individuals and I think the point you raised, the conviction to speak up, is particularly important because you have examples. Again in the research that I did a couple of years ago, there was one example of a company – not a finance company – where the executives were absolutely gung ho to do a particular transaction and the non executives said no, we can understand why you want to do it, but we are looking at it in a more objective way are saying this could be so bad; there is upside, but the downside would kill the company. And they said you need to find a different way round it. But what was really impressive there was that the non executives actually have the guts to stand up in the board room and say no we do understand this totally, we just think you have made the wrong call and we are backing our judgement. One of the difficult things for a non executive, because you always have less information than the executives don’t you? So one of the difficult things for a non executive is to get the full picture and then say, right I understand it, but this is my judgement. TT Murray, you are a non exec; isn’t the idea of a non exec kind of the grit in the oyster? You have got to be a little bit annoying and stand up say wait a minute, why are you doing that? Isn’t that part of the role? MS Its combination of what you said; it’s the market knowledge, which Ruth says you can never have the same as the executive no matter how you try, but you should try. Then its having the courage or the guts to push the question. To me the perfect definition of the role of the non executive, which would cover risk management precisely – the role of the non executive is to ensure that the company is properly run, but not to run it. So as a good non exec, what you have to do is ensure that there are appropriate processes of risk management in place and that they are actually being adhered to. Now, just to highlight some of risks with this, pre all of the current financial crisis and pre all of the problems, which company do you think was the absolute perfect example of having all the corporate governance risk management and regulatory frameworks? It had every one you could possibly have – and the answer is Enron. Enron had every single Page 3
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governance framework, risk management, ethics policy – you name it, it had the perfect list. Kennerly loved corporate governance. And that is pre the financial crisis and look what happened to it. And I think everyone got caught up in the hubris of this fantastic new type company – being fantastically successful, full of extremely clever people, making shed loads of money. It only ever announced record profits until it went bust. So I think the point about the non exec, they have a critical role in managing risk and that gets you back again the fundamental role of the non exec which is to support the upside and limit the downside. And it all comes back to the questions that they ask using their experience. Now as a non exec, there are times when I have to start off thinking I am worried about this, the risks are too great in this; if I was an executive I wouldn’t do it. But then I question the executives and they give me answers; and they give me some other answers and after a period of time I think OK these guys have satisfied me that they have thought of most of the risks. I think it is unreasonable to expect them to have thought of all of the risks. One of the companies that I sit on the board of at the moment, it’s in Lithuania and its right next door to Latvia and they are looking at a massive devaluation of currency. If the same thing happens to Lithuania our risks just multiply. But the two guys who run the company have said we have thought about this, here is what is going to happen and here is plan B. So I am relatively comfortable saying we should carry on with the development of the business and carry on with our investment plans. TT But couldn’t you say, Ruth, that is one of the problems? That Murray is may male, pale and stale? Sorry to say that, but that is diversity or a gender thing? How much is that relevant to the whole risk management on boards? RB Certainly, if I ignore the male, pale and stale bit, certainly there is a lot of evidence that talks about the testosterone oestrogen thing and says that women have a different attitude to it. There is also a lot of evidence that says that if you have just one woman on the board, one individual on a board with a different view to everybody else, that is a very uncomfortable position to be. Psychologically if there are two or three outliers you get a much better position on it. But I think the whole thing comes back to culture. Murray was talking about Enron, when I lecture on ethics as my example of a perfect code of conduct, I use the Enron one. Like you said, it’s a really good code of conduct. But when I am talking to non executives, over and over again, when you say to them what is the biggest risk that you face as a non executive, they always talk about the culture of the company. And what they are talking about is not tone at the top, but tone from the top and how you have got to get out and see what there is, but also to encourage the view. If I give you a very practical example, one of the companies I was talking to – it’s not a finance company, it’s a company where there is a Page 4
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lot of very heavy equipment – the non executives said we had a complete board change a few years ago and we who came in, every time we do a site visit to anywhere, on principle the first thing we do is we go down to the factory floor and we talk to the foreman and the people about what are you doing with health and safety on this machinery. TT So you sound the culture out? RB That is it absolutely. He said we are showing that as far as we are concerned this is the most important thing in our company; that we try to minimise this health and safety risk and the way we can do it is by talking about it. Not just at board level, but right the way down, and getting a feeling for the culture throughout the company about how that risk is being addressed and how other risks are being addressed. TT Quite a super human role for an executive to do. Is that gender issue, is that diversity issue, a bit of red herring? Is that too simplistic to think of it in that way? MS I believe it is. I got involved in a debate some years ago inside – it was then called the DTI, I think it is now called Mandelson’s BERR department. RB Its BIS now, it changed from BERR last week. MS BIS, well it was better than when it was called PENIS I remember, I forget what PENIS stood for – it was only for about five minutes and the government realised that they had made a bit of an error. And there was a bit of a battle going on inside the DTI and Patricia Hewitt was running the DTI and she wrote a pamphlet called Building Better Boards: The Argument for Diversity and it was one dimensional. It was just about women on boards and it was a pathetic argument. I had to review the thing and I reviewed it for the corporate governance people and the thing went through, and it sank without trace fortunately. I know some excellent women non executive directors, I know some women who would make excellent non executive directors who have been good non executive directors before. I know some women who would come in and wouldn’t say boo to a goose. I know men who sit on boards that wouldn’t know if a balance sheet was upside down or downside up if you put it in front of them, but might ask some very good questions. So personally I don’t believe there is a specific gender thing to this. Now in diversity terms, it depends on the context. If I am sitting on the board of a fast moving consumer retail business and 85% of the customer base is there and all of the board are men, I am going to be a bit worried. If they are all male, stale, 55 plus and accountants, I would like to see two or three women who are symptomatic of the customer base sitting on that board. Page 5
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I don’t even think it is horses for courses. One of the big issues this comes down to with NEDs is do you need to have prior experience, or do you just have to be a good NED? And the answer is a bit of a mixture of both. I think there are people who can be good NEDs regardless of industry experience because they happen to be very good at grasping a situation quickly; the financial aspects, the marketing aspects … TT Which is down to them, it’s their character? MS Which is them and their character and their experience and they can go in there and they can sum things up fairly rapidly and figure out what the five or six big issues are and what the five or six key questions are they should be asking until they get satisfactory answers. But from the cultural point of view as well, one of dangers of being a non exec is that you can actually push the question too far, until you become almost destabilising of the harmony of the board. Although sometimes to take your male, stale and pale, your boards do become too harmonious and don’t want to challenge each other, which is why you are bringing in fresh non execs. The non execs should never be afraid of walking away. If a non exec is doing it for the fees then that means you are not independent. And independence in all of this is a hugely prized characteristic. The one thing this government has done – and I am not a natural great supporter of what this government has done – but they have promoted independent non execs in the corporate sector, in the health sector, in school trustee boards, in charities. They have really pushed quite well independent directors. And I think if you have got that independence you are more likely to be asking questions about risk than if you haven’t. My colleague has just sighed exasperatedly and beautifully as ever. TT It does open the issue of remuneration on boards and risk management too, but we haven’t got time for that. Ruth Bender, Murray Steele, thank you very much indeed. You may have some comments and issues regarding this debate. Do please leave them in the comments box below this window. Thank you very much. Page 6