Managing risk and seizing opportunities require a new approach
Historical approaches to risk management are often no longer effective in this era of rapid business evolution. Risks are too numerous and need to be addressed more quickly. Potential impacts are greater and are often driven by technological advances that are neither broadly nor well understood. To discuss how boards are addressing innovation and disruption risk, Grant Thornton and NACD convened a roundtable of directors to get their frontline perspectives.
“A board may feel comfortable about its smoothly running operations and processes, but good enough is not enough in this era of disruption,” said Janet Malzone, Grant Thornton Midwest Audit Services leader and board member. “Boards have to think about proactively breaking things that don’t appear broken when a start-up you’ve never heard of can marry the right technology to the right business plan and turn an entire industry on its head in a matter of months. Further, increasing global activism around environmental, social and governance [ESG] issues demands a new level of board sensitivity and attention to those risks.”
10 questions directors should ask about innovation and disruption risk
- How is the board creating support for innovation and an appreciation for technology?
- What new ideas has management brought before the board to tap into directors’ expertise and is this approach embraced?
- How does the board encourage healthy debate and manage discomfort when asking challenging questions?
- What is the board’s view on the pros and cons of adopting a risk committee to address new areas of risk?
- How might periodic engagement with outside experts benefit the board and management in dealing with and understanding risk and innovation?
- How does the board ensure there is enough time on the agenda for robust discussions about the successful evolution of the business?
- What is the board doing to ensure management goes beyond a defensive posture to address risk?
- How is the board leveraging diversity to ensure a variety of viewpoints on risk?
- What are the key cultural traits of both the board and management that will foster or inhibit innovation?
- How is the board stoking its own curiosity in the continually changing digital environment?
Question the status quo
The news is rife with stories of large businesses being marginalized by competitors that innovate faster. The roundtable attendees were reminded that businesses can no longer settle for the status quo. In fact, that’s why many of them chose to participate. What happened to Eastman Kodak Co., BlackBerry, Borders Group and Palm can happen to any company. What happened there will occur with greater frequency to organizations lacking an appropriate focus on the opportunities and potentially disruptive forces of innovation and technology (think Airbnb, Uber and Lyft). Nor is disruption the only risk. Bad actors are also innovating. One person with a laptop can target your intellectual property, customer data or other critical information and, with just a few keystrokes, cause significant damage.
“The nature of disruption is different from in the past, often coming from technologies that most board members or management teams don’t have personal experience with.”
The traditional boardroom agenda may need to be disrupted to prioritize discussions around strategy and disruption. Such conversations between the board and management could be challenging, especially if they aren’t happening on a regular basis and at an appropriate level of depth. “The speed of disruption is accelerating,” said Malzone. “In addition, the nature of disruption is different from in the past, often coming from technologies that most board members or management teams don’t have personal experience with. This potential vacuum makes it more necessary than ever for boards and management to collaborate on strategy and investment, and to be proactive in gathering innovation insights.”
Jim Grogan agreed. He is an International Capital Investment Co. senior partner; an AMERCO, Cancer Treatment Centers of America and Drees Homes director; and an Encore Real Estate Fund advisory board member. “There are risks inherent in innovation, and boards need to consider them,” Grogan said. “But the real risk is not innovating. Boards should play a key role in making sure that innovation is adequately supported and regularly addressed at the board level, and whether budgets sufficiently support research and development, and other activities. Are policies at all levels supporting innovation? The board can’t and shouldn’t actively manage innovation. That’s the executive team’s job. But the board should be pushing management to ensure it is happening.”
“The real risk is not innovating. The board should be pushing management to ensure [innovation] is happening.”
Management can take part in disrupting the board’s regular agenda by raising new ideas — even if they’re not fully fleshed out — for examination and discussion with the board. In turn, directors should routinely inquire about potentially disruptive risks while bringing their personal experiences and insights to the table. Yet these agenda-busting discussions should not all be about risks. What is the upside? Where are the opportunities? What are the current market trends? Exploring both sides of the risk equation requires an open and inquisitive mindset.
“Board agility is critical,” said Joyce Cacho, president of Adinura Advisory Services, a director of Sunrise Banks and former director of Land O’Lakes. “In this era of innovation, we in the boardroom need to ask the difficult questions to ensure that our fiduciary responsibility, value creation and company strategy align.”
Consider possible solutions
What steps can a board take to ensure that the company has a clearly articulated strategy so that its full range of risks can be considered and addressed in a timely fashion? Where should accountability for the stated strategy sit within the board? A risk committee is one answer. Centralizing responsibility for risk issues within a single committee can help ensure accountability and confirm that attention is paid to the full range of risks the company faces. The risk committee can also help ease the pressure on the audit committee, which at most companies is charged with risk oversight. However, an accounting and advisory firm’s review of 2018 proxy statements of all S&P 500 companies found that only 11% had formed a risk committee. Considering that the Federal Reserve Board rules implementing Section 165 of the 2010 Dodd-Frank Act required many large financial institutions to form a risk committee, it is clear that the adoption of risk committees has been limited outside of the banking and finance sectors. Specifically, major companies that have adopted this structure include BNY Mellon, General Electric Co. and Wells Fargo & Co.
Other boards are pushing for the creation of a management-level committee comprising both company insiders and outside experts to bring different perspectives on how the business considers and addresses the strategic risks of innovation and disruption. These non-board-level committees may report directly to the board, and representatives may participate in board meetings to answer questions and ensure the board and management have proper context. “It’s a tightrope between management and governance that we walk daily,” said William Kraut, a director of Fly Time Media, InTest Corp., Marlboro Industries and NACD’s New Jersey Chapter. “Every decision is existential. I convinced the company to put together a technology committee of the management group but put myself on it so I could ask questions in the middle of the process, not when the report was coming out. By the time it gets to the board, it’s way too late.”
“It’s a tightrope between management and governance that we [board members] walk daily.”
No matter what structure the board chooses for supporting or augmenting its risk oversight responsibilities, enterprise-wide risks need to be addressed at the board level. That requires a group of directors with a range of skill sets. Increasingly, this also means a diverse board whose members have different backgrounds in terms of both demographics and experience.
3 key questions about risk committees
If your company is considering a risk committee, you need answers to these questions:
- Have you adequately defined your company’s risk positions? Right now, many companies with risk committees are in banking, financial services or insurance, and those risk committees are often focused on such issues as market risk, interest rate risk and investment risk. In other companies, the risk committee may need to address larger, more difficult issues such as risk tolerance and how to balance opportunities against inherent risks. If your company hasn’t done the work necessary to fully articulate these positions, a risk committee may lack focus and direction.
- How will your risk committee coordinate with management? A risk committee’s role is governance, not management. But without effective coordination between the board and management, governance will not be translated into effective policies or actions. General Motors Co.’s risk committee, for example, works closely with a management risk committee to help ensure the seamless translation of governance into effective action.
- How will your risk committee coordinate with the full board? On many boards, the audit committee serves as the de facto risk committee. You will need to clearly define the audit committee’s role, as well as when and how the audit and risk committees will share overlapping information. You will also need to determine when and how the risk committee should report to the board as a whole. Education will be a key role for the risk committee. When and how should the risk committee bring in outside experts for its own education or to share new perspectives with the board?
Value age diversity
A 2018 study by the Brookings Institute found that the demographic makeup of the United States will be “minority white” by 2045. Many large markets, including Texas and California, already are. Add to this fact that women play an increasingly dominant role in consumer decisions, and the vital role diversity should play in a board’s composition is clear.
“Failing to take diversity and inclusion seriously is burying your head in the sand,” Adinura Advisory Services’ Cacho said. “Basing innovation investment or M&A decisions, and board composition strategy on historic consumption pattern data and past investment criteria overlooks the predicted technology and demographic shifts in our country.”
“Failing to take diversity and inclusion seriously is burying your head in the sand.”
Differing generational and racial attitudes matter on fronts beyond consumer market preferences. Consider climate change. Women, minorities and Americans under the age of 40 are all more concerned than white males, on average, about the environment. That presents an increasing ESG risk for companies. A significant number of investment companies — including BlackRock, State Street Global Advisors and Vanguard — are now considering the effects of global warming and other ESG issues when making investment decisions, thus raising potential financial risk issues.
When it comes to confronting rapidly evolving risks such as cybersecurity, digital innovations including artificial intelligence, and broader technology-driven threats of disruption, board diversity in age and experience may matter most. Yet, according to PwC data, the average age of an S&P 500 independent director in 2018 was 63, up from 61 in 2007. Very few are younger than 50.
Youth is no guarantee of technological or business expertise, of course. The Zuckerbergs and Musks of the entrepreneurial world get the most attention, yet a study by the Harvard Business Review found that while the average age of founders who have won TechCrunch awards over the past decade was 31, and the average age of founders selected by Inc. magazine at the fastest-growing start-ups in 2015 was only 29, the average age for founders of all successful start-ups is 45.
Still, the average age of the innovators most likely to disrupt business is probably more than 20 years younger than the average age of board members. That disconnect should ring alarm bells.
Prize the technologically savvy board member
“We need ‘people people’ who can go beyond the ones and zeros — those who understand the implications of technology on what we’re trying to accomplish as a business. People with the experience to do the interpretation the board needs and people who give us the proper context,” said Jeannie Diefenderfer, founder and CEO of courageNpurpose, a board and leadership strategy consulting firm. She also chairs the nominating and governance committee at Windstream Holdings, serves as a director at Sedona Systems and is a trustee at Tufts University. “The challenge often is that the majority of board members are not given the education to be technologically aware. That’s what it takes to move beyond a reactive, defensive strategy to one that leverages potential advantages and opportunities. How do we leapfrog our competitors and go straight to an SAAS [software-as-a-service] model? A lot of what we do can be sold or bought as a service using technology.”
“We need ‘people people’ who … understand the implications of technology on what we’re trying to accomplish as a business.”
“Risk is just one side of the coin,” said Mike Desmond, a Grant Thornton Audit Services partner. “Opportunity is the other. The more attuned your board members are not just to what could go wrong but also to what’s possible, the better job they can do guiding the appropriate strategy. Truly managing risks means balancing what you could lose against what you have to gain. Your board needs to understand the upside, too.”
Younger business leaders, who are digital natives, have leveraged technology to strategic advantage and may intuitively understand the intersection of tools with new and existing business models. They can provide boards with just that kind of insight. A study published in the Spring 2019 issue of MIT Sloan Management Review found that among companies with more than $1 billion in revenues, only 24% had digitally savvy boards. But those businesses with technology-minded boards significantly outperformed others on key metrics such as revenue growth, return on assets and market cap growth.
“When we use the phrase ‘digitally savvy,’ it’s about being able to understand technology’s capabilities and its timely application across the whole business — a holistic view.”
Matt Loeb is a former CEO of ISACA and a research fellow at MIT’s Center for Information Research, which produced the research on digitally savvy directors. He serves on the boards of the Center for Cyber Safety and Education and the American Society of Association Executives, and is a trustee for Excelsior College. “You need people who can understand technology as it applies not only to what the business model is today, but also to how to evolve the business model of tomorrow,” he said. “When we use the phrase ‘digitally savvy,’ it’s about being able to understand technology’s capabilities and its timely application across the whole business — products, marketing, financial, talent — a holistic view. And the more people we have that can do this, the better off we are. Even people who are good at it have blind spots and gaps.”
Loeb said it’s vital that the board and management are willing to discuss issues when they may not be comfortable with the subject matter — like the potential impact and application of emerging and disruptive technologies — when neither the board or management has immediate answers and may need external help to understand and address the issues.
“Anyone who pushes back on having the dialogue should be a first sign of concern,” Loeb advised.
“You don’t have to be an expert. But you have to be able to intellectually engage.”
Stay curious
Regardless of age, ongoing intellectual commitment and curiosity are vital characteristics for all board members. No board member can be an expert on every risk, but every board member can master the basics necessary to push back, ask questions and challenge assumptions, even when — perhaps especially when — that makes management uncomfortable. “You don’t have to be an expert,” said Christopher Y. Clark, publisher and director of partner relations at NACD. “But you have to be able to intellectually engage. If you have 12 people around the table and only two of them are talking, that’s not a good balance.”
Desmond concurred. “We’re in an era where potential digital disruption is one of the greatest risks facing most organizations. No company can afford to get too comfortable. It is a board member’s duty to be a little disruptive and push conversations where they need to go.
“It is a board member’s duty to be a little disruptive and push conversations where they need to go.”
Risks are proliferating in both type and magnitude, and some of them, like potential digital disruption, are existential. It is imperative that boards develop a clear, accountable plan to address these risks. “Board diversity is absolutely a must-have,” advised Grant Thornton’s Malzone. “A risk committee might be part of the solution. Ad hoc committees might be part of the solution. Teaming board members with key management initiatives might be part of the solution. Most likely, some or all of these will combine to best suit your unique circumstances. But it all starts with the right board, and the right board starts with the right, broad mix of experience, demographics and expertise.”
Traditional approaches to risk management are no longer enough. From technology to diversity to board structure and composition, boards need a new approach to risk.
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