Running any enterprise involves risk, which can only be avoided by choosing to do nothing — and still then unexpected events can occur.
In many business situations the greater the risk the greater the potential return to the enterprise. The challenge is to balance risk with acceptable reward. In other words, boards need to understand the exposure of their companies to risk, determine how those risks are faced and ensure that they are handled appropriately.
Corporate governance involves creating business value while managing risk. Risk management — not minimisation — should be the theme. Boards have the responsibility to recognise, understand, and accept risks inherent in their corporate strategies.
Many boards delegate such responsibilities to the audit committee, which is indeed recommended by several exchange listing rules.
Critical strategic risk, however, is another matter. At Enron, the board failed to understand that the company had moved beyond being a supplier of energy to a business trading in financial derivatives.
In effect, Enron had become a financial institution with a different risk profile from that of an energy supplier. Moreover, external directors seemed to be unaware of the high risk that their executive directors were taking.
Closer home, Kenya has recently suffered a great deal of institutional failures ranging from state corporations to financial institutions both public and private.
There is a host of examples such as Mumias Sugar Company, Cooper Motor Corporation, Kenya Airways, Uchumi Supermarkets, Nakumatt Holdings, Imperial Bank, Chase Bank, and Dubai Bank. The failures of these firms can be attributed to poor corporate governance practices and structures as well as weak management.
The policies, procedures and systems affecting the way the institutions were directed and managed fell short of expected standards.
Stewardship and fiduciary obligations appear to have taken a rear seat instead of being at the centre stage.
Sophisticated investors around the world focus on the nature and extend of risk in companies and industries in which they invest.
Companies recognised for having professional enterprise risk management and transparent reporting are respected and remain attractive for investment considerations. They have a competitive edge, their shares command a premium over those of competitors, and their overall cost of capital is likely to be lower.
There is need for a paradigm shift and this should be to put enterprise risk management at the centre stage. A host of corporate governance codes and company law now call for boards to give assurances that systems are in place to handle corporate risk in their regular corporate governance reports to shareholders.
Directors need to understand where value is added within the business, at which points the company is critically exposed to risk, and where the most sensitive areas are in which the very survival of the business could be threatened.
Boards need to face up to those risks and to develop relevant strategies and policies and ensure that they are mainstreamed in the company.
Ibrahim Kitoo is Advocate of the High Court of Kenya.