Calls for boards to challenge management more robustly sound good in theory. But finding the balance between probing executive views and maintaining relations is hard in practice.
Boards that aggressively challenge executives, treat management information like homework that needs checking, or play “gotcha” to catch out people, can do irreparable damage. Inevitably, management becomes guarded and less communicative with the board.
Equally, boards that are too polite or unwilling to call out management – and keep the blowtorch on issues until they are satisfied – can destroy stakeholder value. Worse, such boards become cheerleaders for the organisation and blinded to management shortcomings.
The Australian Prudential Regulation Authority (APRA) emphasised the importance of boards challenging management in its 2018 Final Report of the Prudential Inquiry of the Commonwealth Bank of Australia – widely considered a governance landmark.
APRA wrote on CBA’s governance: “For much of the period under review, the Board did not demonstrate rigour of oversight and challenge to CBA management. The tone at the top was unclear. The Board did not have the right balance of both summarised and detailed reporting in these risk areas, and nor did it, until recently, insist on improvement.”
The Financial Services Royal Commission picked up on APRA’s finding on CBA and added in its Final Report: “The evidence before the Commission showed that too often, boards did not get the right information about emerging non-financial risks; did not do enough to seek further or better information where what they had was clearly deficient; and did not do enough with the information they had to oversee and challenge management’s approach to these risks.”
APRA’s report implied that boards must deep digger in their organisation – a view that could lead to some boards taking on a quasi-management role as their oversight expands. That risks blurring the lines between boards and management, reducing board independence.
Therein lies the issue: investors and the governance community stress the value of board independence in challenging management and holding it accountable. But the regulatory view could reduce independence if boards get too involved in management issues.
Directors are caught in the middle. Anecdotally, boards of ASX 200 companies are spending greater time probing information, examining financial and non-financial risks, and testing organisation culture. That should lead to extra debate with executives – a good sign if the board’s challenge is constructive and delivered appropriately.
Frank Cooper AO FAICD, a non-executive director of South32 and Woodside Petroleum, Chair of the Insurance Commission of WA, and Division Council president of AICD WA, says the starting point for boards challenging management is to establish a mutuality of interest.
“Good boards and executive teams recognise that while their interests are not identical, they are strongly aligned. It’s not one side against the other; everybody is pulling in the same direction and wants the best possible result for the organisation and its stakeholders.”
Directors must focus on the problem rather than the person, says Cooper. “I try to stick to the issue and work collaboratively with management to help them solve a problem. I try not to let personalities cloud my judgement in finding the best answer to an issue".
“In essence, I’m asking management to break down an issue and show me how it got to the result. For example, assumptions behind a forecast might be discussed. If they are not able to satisfy me, we will usually agree that there is something that needs more work.”
Cooper carefully considers the framing of questions before presenting them to management. “My starting point is that the organisations I govern have high-quality executive teams who know what they are doing. My question to executives is often along the lines of: ‘help me understand how you satisfied yourself on this issue’. I’m not suggesting they are right or wrong; I just want to understand how they arrived at their view and whether I understand it. It’s how I try to get beyond just accepting an assurance to understanding why the executive is satisfied and being comfortable whether that is sufficient.”
He believes this approach is more constructive than “challenging” management in a confrontational sense. “In essence, I’m asking management to break down an issue and show me how it got to the result. For example, assumptions behind a forecast might be discussed. If they are not able to satisfy me, we will usually agree that there is something that needs more work. In my experience, good executive teams appreciate boards that constructively test or expand their thinking.”
Cooper likes to give management sufficient notice of any material issues. “I (make a) note out of board papers to give them the opportunity for a considered response at the meeting rather than just drop it on them during board meetings. I try to have no surprises on the basis that the more time management has to consider an issue, the better their response and hopefully the board is then in a better position to make the right decision.”
Cooper tries not to dismiss the perspective of directors with left-field views. “I have seen boards get frustrated when there is a director with a nit-picking focus on what looks like minutiae, and it can cause boardroom tension. Occasionally, it’s that director who saves the board’s skin. Good boards take time to understand why a director is uncomfortable with an issue, even if the other directors do not see it as a problem.”
An effective board meeting, says Cooper, should have creative tension. “The last thing you want is boards being too polite, afraid to ask seemingly basic questions and every director nodding in agreement as group-think sets in. The value of diversity is having directors with different skills and perspectives coming together to test complex issues – and not being afraid to raise them with management or pursue the matter if they are not satisfied with the answer.
Industry experience critical
Dr Sarah Ryan, a non-executive director of Woodside Petroleum, Viva Energy Australia, MPC Kinetic and Akastor ASA, a Norwegian oil-services investor, says industry experience on boards is the key to challenging management constructively.
“I spent my entire executive career in the global energy sector, so am comfortable with the technical aspects, numbers, risks and assumptions. When you spend decades in an industry, you know when things don’t make sense or smell bad, and are confident to back your judgement.”
Ryan says directors who do not have deep industry experience in their organisation also add value. “Directors from accounting, law or corporate finance, for example, have important skills and add to board diversity. But if you want to determine the actual risks and culture of the organisation, it is sometimes useful to enquire deeply of management on the technical and operational details of the organisation. For this, you need directors on the board who live and breathe the industry.”
In some board roles, Ryan works with the executive team on structured “deep dive” sessions. “I’ll meet with the geoscience team on key exploration projects and we’ll pull out the maps and discuss the geophysics. I love it and believe the management team values having a board that wants to understand their issues and share its knowledge, as required.”
She says the key is helping management lead itself to a solution. “I’ll ask an executive to take me through an issue and I’ll provide feedback where necessary. The goal is to provide a different insight rather than take a bruising approach. I find management really appreciates it when you give a view it has not considered and it encourages new thinking.”
Ryan says planned board interaction with the executive team, middle management and front-line staff helps it understand the organisation’s pulse. In one board role, directors have lunch with workers in a canteen during a site visit, each leading a separate table.
“Each director chats with workers about their role and experience of the company, to get a better sense of its culture. We try to avoid site tours becoming a form of board tourism where you look at the main assets, hear from the usual people and don’t get much insight.”
Ryan and her fellow directors have met with indigenous employee groups and their company’s university graduates over lunch. “Directors who want to ask probing questions need to spend more time outside the boardroom. That needs to be done transparently and in a way that the board adds real value to the executive team and the organisation.”
Also important is knowing when to ease off on an issue, says Ryan. “If I’m not satisfied on an issue, I’ll keep asking questions. But you have to accept that in some instances, the board might not share your concern. What you should never do, in my opinion, is form alliances with other directors or insist it is minuted in board papers. If you think it’s a serious problem that the board and executive refuse to acknowledge, you have to be prepared to resign from a directorship.”
Understand the board’s role
Steven Cole, FAICD, chairman of Neometals, Perth Markets and the Queen Elizabeth II Medical Trust, and a non-executive director of Matrix Composites & Engineering, says inexperienced directors can misunderstand the board’s role and inappropriately challenge management.
“The board’s role is to be part of a team, support management and give wise counsel. Directors, of course, should be probing, constructively challenge the executive team on issues where required, and call out inappropriate behaviour. But the board is not a headmaster with a cane that spends its time trying to pick up errors in management’s work and dish out punishment.”
Cole has seen the problems of an adversarial board/management approach first-hand. “Over the years, I’ve been on a board where one or two directors act like rottweilers and want to challenge management’s view on virtually everything. Sometimes, a director might have a combative style or has not yet made a transition from his or her executive role to governance. In other cases, the directors are ‘grandstanding’ and trying to score points by unnecessary aggression in dealing with management’s reports and responses to issues raised by the board.”
Cole, a governance expert and instructor, says boards should identify the causes of adversarial relationships and consider the issues through a risk-management lens.
“Essentially, it’s about boards addressing issues at the front end through effective governance structures and practices, rather than at the back end where directors and management risk becoming polarised in their views on issues, especially once positions are taken and information is presented.”
This approach is based on the board and management agreeing on the organisation’s strategy, risk appetite and tolerance, key risks, and the information the board needs to perform its duties and responsibilities. “Everybody needs to get on the same page,” says Cole. “If the board feels it’s not getting the information that it needs or was agreed, or lacks confidence in it, it needs to take action. The key is taking a holistic rather than fragmented approach to how information is presented to the board. Poor information and communication is often the cause of a deterioration in board/management relations.”
Cole says a board might doubt management’s capacity or lack faith in it. Directors could be concerned about the depth of experience and diversity in management, the accuracy of information or presentation of unconscious bias.
“The key is that boards are proactive rather than reactive if they have concerns with management,” says Cole. “When directors let these doubts linger for too long, inevitably an adversial relationship between board and management forms. Executives start to detest board meetings, guard information and discount the board’s view. It becomes harder for the board to challenge management views because it starts to appear to become personal. If the board senses that management is not up to the job, it needs to make changes, rather than keep fighting the CEO and executive team.”
Cole says it is good practice for boards to end each meeting with an “in-camera” or closed session where executives leave the room. “It’s better to raise any concerns about management in this session rather than have directors talking in the background, losing confidence in the CEO and attacking management every time it presents something to the board.”
Ultimately, the key is an executive team that welcomes being tested by the board, says Cole. “In my experience, the best executive teams want board input, they engage with directors, share information and value being challenged by the board. They don’t want directors who agree with everything they say. They value the opportunity of working with people that encourage a high level of thinking, can pull apart ideas, add value and are not afraid to hold others accountable. They are accepting of board meetings that are a little uncomfortable at times because of productive debate.”