At a board meeting of a multinational corporation, the question of whether to invest $50 million in a project in a Middle Eastern country was discussed. The president of the company subsidiary seeking the board's approval insisted that the country was a safe place to invest because of its recent history of economic and political stability. Satisfied with the president's assurances, the board approved the investment--a decision they later came to regret.
As it turns out, the interests of some of those involved were not directly aligned with those of the company. The corporate underwriters has incentives to promote the deal internally so that they could meet their production targets. And while the underwriters sought the views of the country risk manager charged with vetting the transaction, a large portion of that analysis was deleted from the final version that went to the corporate risk manager for approval before being given to the president. To make matters worse, the country in question was not as stable as it was portrayed, and the company's investment was tied up in costly legal limbo that has had damaging implications for the company's brand and reputation.
As illustrated by this example, companies often rely exclusively on their own risk management processes, which they believe are bulletproof but may in fact be riddled with holes, inconsistencies and contradictions. Without data or insight of its own, the board was too reliant on the company's assessment to make an effective decision and fulfill its duty to protect the interests of the company and its shareholders.
If the board had been better educated about the economic, social, political and media situation in that country, it may have been able to identify the errors in the assessment they received. They may have forced the company to conduct more thorough due diligence before taking a vote, rejected the request outright or made the approval conditional on receipt of the company's plans to mitigate and address the potential risks.
As company operations and holdings expand to all corners of the globe, decision makers often pay too little attention to specific country risks and other matters of crucial importance. Boards of directors are particularly vulnerable to this oversight due mainly to a lack of direct insight into a particular country-which leads to an inability to discern fact from fiction-and not knowing the right questions to ask of corporate management.
How can boards make better decisions with respect to country risks? One place to start is in the composition of the board itself. Too often, board members are selected from a small group of high-profile, well-connected, prestigious individuals who may not have relevant experience in foreign investments or operations and who may want to avoid appearing ignorant about a subject of discussion. Company management should emphasize experience and knowledge when selecting board members. That said, it is difficult, if not impossible, to find individuals who have direct and timely experience in every country that may be an investment target for a large corporation.
Another solution is for boards to press companies to regularly update their own risk management procedures and insist on instituting appropriate checks and balances. Given the competing interests that may influence an internal risk management team, a better solution is to look outside of the company's country risk management function (if it has one) and insist that either the company hire an independent third party assessor or, ideally, do so themselves. A qualified outsider can conduct regular risk management audits that test the system, provide insights into the target country that incorporate political, economic and social risk, and provide board members with unbiased information, empowering them to ask the right questions.
Unfortunately, even when a problem is identified, boards are sometimes reluctant to confront management. Candor often gets lost in the politeness of board proceedings, and boards are too often focused on building consensus, which inhibits due diligence and proper risk management. By remaining polite and silent, boards can do more than contribute to monetary losses; they may unwittingly cause reputational risk, often with long-lasting and severe consequences. Therefore, board members must exercise their responsibilities with renewed vigor and with a solid base of knowledge and insight. If that had been the case with the company investing in the Middle East, the outcome could have been much different.
The Boardroom Vacuum
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