Practical suggestions for mitigating risks with boards of directors Featured

8:00pm EDT April 25, 2010

Risk management methodologies and techniques remain at the forefront in these challenging economic times.

Boards of directors are under increased pressure to identify and manage risks in a timely manner and quickly remediate any issues that may arise.

Active, involved board members possessing diverse skills can greatly assist firms in achieving risk mitigation. While securities laws mandate various director qualifications, including independence for audit committee members, there exists no specific requirement that boards contain directors with varied skill sets.

While this is not a requirement for boards, “a diverse board can allow directors to critically examine management assertions and shepherd the organization through crises that may arise,” says James P. Martin, managing director at Cendrowski Corporate Advisors.

Smart Business spoke with Martin about best practices for boards and their impact on risk mitigation.

What defines a great board member?

In my mind, a great board member is one who becomes genuinely immersed in the company, understanding not only its financials but also its operations and strategy. Many articles have been published encouraging board members to become more active participants in their firms.

However, for whatever reason, this is largely not the case. For instance, a recent study showed that more than 90 percent of directors have not interacted with employees outside executive ranks at firms they govern; more than 70 percent have not visited their firm’s production facilities.

By failing to do so, directors are depriving themselves of important insights into corporate policies, procedures and strategy. These insights might be particularly beneficial for smaller, private firms that really turn to board members for help and guidance. While it is important for all firms to have directors with a diverse array of skill sets, smaller firms especially benefit from diversity of ideas.

This diversity might afford a firm particular insight in the event of a crisis, such as the economic tsunami we’ve experienced over the past two years.

What does it mean to have a diverse board?

Board members must have diverse, but complementary, skill sets to effectively govern a firm and critically question information provided by management. While government and stock exchange regulations have mandated a financial expert on audit committees, boards should also include directors who are experts in operations, legal matters and risk management.

In possessing individuals with such diverse skill sets, boards will be better able to analyze management’s vision and plan for the future, as well as guide the company toward continued value creation for shareholders. Diverse skill sets should also be present on board committees in order to help incite healthy dialogue surrounding critical issues.

What recommendations do you have for those serving on audit committees?

The audit committee is one of the most — if not the most — important committees on the board. Its importance is paramount to the proper oversight of the company. However, the existence of an audit committee is not a sufficient condition for proper governance.

Enron, HealthSouth, Tyco and Adelphia Communications each had audit committees. Although audit committees today must include a financial expert and independent directors, I believe they also should include individuals with skills in areas other than accounting. For instance, a director with risk management expertise might be able to assist an audit committee in recognizing the warning signs of risks that lie ahead.

These risks can then be brought to and evaluated by the board as a whole.

What factors might influence a board’s ability to act on and evaluate information presented by management and internal committees?

Size is certainly one factor that affects board-level decision-making processes. When a board is too large, it sometimes becomes a case of too many cooks spoiling the broth. The larger the board, the more difficult it is for members to participate actively and engage in constructive discussions.

Many large companies have boards with 10 to 15 directors, while smaller, growth-oriented firms may have five or fewer members. There is, however, great variance in the size of boards that isn’t necessarily commensurate with the size of the underlying company. General Electric, for instance, has 16 directors. Apple Computer, a firm whose market capitalization is larger than GE’s, has only six directors, including CEO Steve Jobs.

While a large board allows directors to more concretely divide responsibilities, a large board can stifle meaningful dialogue. Smaller boards promote accountability and also help directors make swifter decisions in crises.

However, if a company has a small board, these individuals must hold a diverse array of skills in order to effectively shepherd the company. Small boards might also be more greatly influenced by persuasive CEOs seeking to impress their personal vision upon the company.

James P. Martin, CMA, CIA, CFE, CFD, CFFA, is a managing director of Cendrowski Corporate Advisors. Reach him at (866) 717-1607 or jpm@cendsel.com.