With the current unprecedented focus on corporate governance, good practice is now essential. The penalties for those companies and those directors which fail to recognise this fact are becoming increasingly severe. Although the range of subjects covered in AIG Europe’s fifth annual corporate governance seminar in January was wide, this was the message that came across clearly in many of the presentations.
“People are the weakest link in every organisation,” warned Chris O’Donoghue, director, The Risk Advisory Group, in his opening keynote speech. Discussing the hidden implications of managing an economic downturn, he stressed that meeting the challenges produces competitive advantage. “Recession is, and should be, a crisis for companies and, in a crisis, well-run companies often show their finest talents and skills.” A downturn multiplies commercial pressures, and predators tend to strike faster. “We have already seen the failure of a number of major companies. Were they bad businesses? Or had they just not planned and evaluated their risks properly?
As the number of laws and regulations increases, so too does uncertainty. And there are more and more ways of prosecuting directors as individuals for their part in a company’s failure. However, said O’Donoghue, it was terrifying how many directors, even of listed plcs, are unaware of the full scope of their duties and of the personal liabilities that they carry. As an example, he cited health and safety regulations that often require a senior person within a company to be responsible for compliance. “Every director of every UK company is at risk from the ‘responsible person’ syndrome.” With the Health & Safety Commission recommending that boards appoint one of their members to be responsible for this area, a failure could result in collective liability.
“In addition, the greater the expertise and qualifications of the director, the more he is at risk in terms of personal liability. The more he is paid, the more vulnerable he becomes.” O’Donoghue explained that the premium paid for the specialist skills of a director increases the expectation that he should apply that expertise and not have problems. He also pointed out that widely publicised suits against a company and its directors are career limiting for the directors concerned.
He cited the core risks as:
O’Donoghue stressed that risk is not a compliance issue, nor a layer of bureaucracy. “It should be fundamental to the management philosophy.” While the mindset in most organisations is to cut costs in a recession, few companies spend enough to be able to do so. Instead, they tend to look to save money by not spending it in the first place. However, said O’Donoghue, most companies now know that they need to increase their advertising spend in a recession in order to maintain or increase their market share. And they need more, not less, due diligence in a recession.
Discussing whether anticipating risk leads to stasis, he cited analysis of companies that had employed due diligence in respect of anticipated deals. 50% were able to proceed along the original lines; 45% changed the terms of the deal in some way in order to protect themselves, but still went ahead. In only 5% of cases did the company withdraw completely.
Not only should shareholders demand ‘good Turnbull’, he said, but competitors are already exploiting bad Turnbull. Although he described Turnbull as still being a ‘distress purchase’ for many companies, he warned that the Serious Fraud Office was already looking at a case where non-compliance with Turnbull was a feature.
O’Donoghue also stressed the benefit of appraising staff. “A fraud risk reduction programme brings real financial return, and vetting staff is the single biggest risk reduction strategy for companies.” Surveys show that 79% of fraud is undertaken by employees, and that nearly 50% of those convicted have been with their companies for over five years. Further, although junior employees account for by far the greater numbers of frauds (92%), fraud by senior managers, who are better at hiding it, costs companies far more.
He referred to a survey produced by American Fidelity at the end of 2001, in which the US company asked people to rate themselves: 25% said they were honest, 50% said they would take an opportunity for fraud if they thought they could get away with it, while 25% said they would actively go out and find ways of defrauding their companies.
O’Donoghue gave two alarming examples of his own company’s experience when checking employees. The first concerned a 25 year old broker who was employed by an investment bank. He had an 18 months gap in his CV during which he said he had been travelling round the world. However, it was discovered he had been charged and convicted for hiring a contract killer. In an even more worrying case, an applicant who had been provisionally accepted by a major bank was discovered to be a suspected terrorist masquerading as someone else. He is now being held in custody.
In summary, O’Donoghue said that the rewards for getting it right are greater in a recession than at other times. He advised companies to sack poor managers - “they increase your risk profile to an unacceptable level” - and to sell or reorganise subsidiaries that damage the risk profile. He pointed out that if you cannot transfer a risk, you have to manage it, to protect and add value to your organisation and to be more successful than your competitors.
Sue Copeman is editor, StrategicRISK
OFF-BALANCE-SHEET RISK FINANCING
Dr Deborah Pretty, Oxford Metrica, told seminar participants that many large corporations have huge amounts of off-balance-sheet risks in the form of contingent liabilities, and these impact on their share value. This is because substantial contingent liabilities create potential mis-allocation of capital, financial uncertainty, managerial distraction, impediments to restructuring and M&As, and higher cost of capital. Looking at some actual risk financing deals that had been arranged, it appeared that, on average, these produced a fairly immediate 15% increase in share values. However, Pretty stressed that, in order to achieve a value increase, shareholders must be made aware of the compelling business reasons for the deal.
Discussing the proposed UK codification of directors’ duties, Neil Fagan, Lovells, said that it would probably take the whole of this year for the Department of Trade & Industry to prepare a full draft bill to modernise company law. “One of the problems with codification is that it leads to the concept that, if it is within the code it is acceptable, and if it is without the code it is not.” The European Commission also published a green paper on corporate social responsibility in June 2001, with the message that long-term economic growth, social cohesion and environmental protection must go hand in hand.
Jon Edis-Bates of Edis-Bates Associates, speaking on “Fixing directors’ remuneration - a risky business” gave some extracts from the organisation’s survey report, Directions, published on 14 January.