Boards can’t get stuck in the forest

Looking back over more than three decades of working with or sitting on boards, the extent of various issues faced by today’s board directors – and the stakes involved – have never been greater.

In my earliest days as a director, there was no such thing as the two-strike rule. There had never been a prudential inquiry that called out the adequacy of board oversight of non-financial risks. Threats related to cyber-attacks and global warming were rarely – if ever – discussed around the boardroom table.

And influential commentators weren’t calling board members “dills”, “supine” and “bedwetters” – well not on the public record anyway. 

Much has changed.

While these shifts seem seismic – and have required change – the fundamental role between a board and management team hasn't varied all that much.

Non-executive directors are still part-time people that meet with management on a periodic basis and have specific obligations to oversee, monitor and report on certain matters. They still need to exercise commercial judgment in allocating capital or approving strategic initiatives.

But although the fundamental role hasn’t changed, it is actually at the centre of today’s biggest point of challenge around modern boards amid an emerging tendency from commentators and regulators to blur the responsibilities of a company’s management team and its board.

This is particularly prevalent when an organisation is facing difficult reputation or performance matters. When things go wrong – as they inevitably do – then the question increasingly being asked is: “Where was the board in all this?”

While this seems like an obvious question given the board’s oversight responsibilities, the problem is a premise that directors are heavily involved in day to day operations so they should be able to ensure nothing goes wrong.

I’m not the first director to point out that, not only is this unrealistic, it also misunderstands directors’ duties under the law and their place in corporate governance.

Unlike full-time employees, non-executive directors cannot and should not be across operational minutiae. Doing so would undermine the independence they must bring to their oversight role in holding management to account and protecting the interests of shareholders.

This doesn’t mean directors bear no responsibility for wrongdoing. Directors must take accountability for misconduct in their organisations and be transparent about their actions in response. Neither does it mean directors should simply accept whatever the management team puts forward. Directors must challenge and interrogate the information they are provided to test its veracity, logic and assumptions.

But if non-executive directors are intimately involved in day-to-day decisions, it means they would no longer be able to challenge management statements and assumptions, because they would have helped form them.

Put another way, board directors must not get stuck in the forest. They must have enough information to offer impartial insights and have good mechanisms to oversee, monitor and govern progress.

In achieving this, there are two areas exercising many modern board directors’ minds: the role of directors in an organisation’s culture and how directors can best engage management, particularly when dealing with large strategic challenges.

While a company’s culture is quite an intangible concept and hard to measure, there is no doubt in my mind it plays a huge role in an organisation’s performance.

As we’ve seen all too often over the years, a company’s culture often comes under heavy criticism when things go wrong.

And while it has long been theorised that culture is set at the top – from the executive management team – a question that seems to be asked more often these days is what role board directors play in setting the culture and, indeed, a growing school of thought that boards should take responsibility for setting it.

For the reasons outlined, I believe its inherently difficult for directors to set a culture. But it’s critical to understand and be able to monitor it.

As a board, you can form impressions, and a good indication is how clearly an organisation can articulate its DNA – what’s its purpose, values, remuneration framework, and behavioural gateways people must go through before they participate in incentive reward schemes. All of these are useful indicators and influencers of culture.

But if you really want to know what’s happening, you need to do a deeper dive.

And the deepest dive I’ve ever done was the process we conducted in the second half of last year at Westpac for our Culture, Governance and Accountability Self-Assessment, as required of several regulated entities by APRA.

Overall, Westpac’s self-assessment process was thorough and valuable, albeit at times confronting.

Well before APRA requested the self-assessment, the Westpac board had already been conducting our own analyses, following the first self-assessment by Commonwealth Bank and throughout the Financial Services Royal Commission.

But when APRA made the formal request, this stepped up. Almost 100 one-on-one interviews were conducted with senior executives covering off structures, policies, processes and culture, supported by focus groups and a broad survey across more than 1300 Westpac people. Some 65,000 documents were referenced and a number of detailed case studies undertaken.

On the positive side, the analysis found that the company’s governance structures, in totality, are appropriate, and the bank has a strong bias to balance sheet strength and the management of financial risks. It also found a culture that is highly analytical and consultative. On the negative, the bias to strength diluted the group’s focus on non-financial risks while the analytical and consultative culture has created undue complexity and reduced the focus on implementation and execution. 

While the self-assessment confirmed that there is no need for radical change in the overall governance structure, it found a real need to change how the structure works.

From my perspective, the most useful part of the exercise was that it affirmed some of the themes both the chief executive and board had been discussing. These are now being worked on.

While it may not be appropriate for all companies to undertake a self-assessment of this magnitude, I believe it was a useful exercise for the board to comprehensively understand the organisation’s culture – which is important to be as effective as possible in oversight, particularly when it comes to striking the right balance when challenging management and in seeking to determine milestones and deliverables for key projects.

One of the major lessons I’ve learnt as a director is that just because an issue you’ve raised doesn’t appear on management’s agenda in the way you intended, it doesn't necessarily mean it’s been overlooked.

The key here is not only to be persistent, but to keep framing the question differently so it resonates more effectively with the thought processes and culture of the organisation. I’ve found that bringing diverse perspectives in this way can provide a helpful new lens through which management considers strategic issues.

While there is no doubt that modern boards are operating in a more complex environment, it’s important to remember that their fundamental role remains the same.

And so long as we can continue to learn from the events around us, and evolve our approach as the environment shifts, Australia’s corporate governance framework will continue to hold its place as the envy of many markets around the world.   

_{This is an edited version of a speech delivered today by Ewen Crouch at the Governance Institute of Australia’s 2019 national conference.}