Why boards should face up to weak enterprise management

Corporate risk arises at every level in organisations. This can take the form of strategic, managerial, and operational risk. Running a business, indeed running almost every enterprise, involves risk.

In many business situations, the greater the risk, the greater the potential return to the enterprise. The challenge to boards is to balance risk with acceptable reward.

In other words, boards need to understand the exposure of their companies to risk, to determine how those risks are faced, and to ensure that they are handled appropriately. Corporate governance involves creating business value while managing risk.

Risk profile

Risk management not minimisation should be the theme. Boards have a specific and vital responsibility to recognise, understand, and accept the risk profile inherent in their corporate strategies — what some people call 'approving the company's risk appetite'.

The practice is that many boards delegate such responsibilities to the audit committee; and indeed this is 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 quite different risk profile from that of an energy supplier.

Moreover, the outside directors seemed to be unaware of the high risk that their executive directors were taking.

In the case of Northern Rock Bank, none of the non-executive directors were bankers.

The executive directors, placing more emphasis on revenue generation than risk management, traded in sub-prime mortgage products. The board failed to appreciate the risks involved.

A run on a British bank is very rare, but in September 2007 it happened to Northern Rock, the country's fifth-largest mortgage lender.

On Friday 14, September 2007, the Bank of England, acting as the 'lender of last resort', provided an emergency facility to prop up Northern Rock but to no avail.

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 whole host of examples like Mumias Sugar, Cooper Motor Corporation (CMC), Kenya Airways (now restructured), Uchumi Supermarkets, Nakumatt Holdings, Imperial Bank, Chase Bank, and Dubai Bank.

The failures can be rightfully attributed to weak or poor corporate governance practice and structures — and in a big way weak enterprise management.

The policies, procedures and systems affecting the way these institutions were directed, controlled or managed fell short of expected standards. Stewardship and fiduciary obligation appears to have brought up the rear instead of taking the centre stage.

Sophisticated investors around the world focus on the nature and extent of risk in the companies and industries in which they invest.

Companies that are recognised as having professional enterprise risk management and transparent risk reporting are respected and remain attractive for investment consideration.

Competitive edge

They have a competitive edge, their shares easily 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 laws 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 point the company is critically exposed to risk, where the most sensitive areas are and where the very survival of the business could be threatened.

Boards need to face up to those risks and develop relevant risk strategies and policies and ensure that they are mainstreamed throughout the company.

Kitoo is an advocate of the High Court of Kenya, specialising in corporate law and corporate governance