GUEST EDITORIAL

September 2002

Corporate Boards and Business Oversight

By H. Stephen Grace, Jr.

As legislative and regulatory bodies advocate greater punishment for corporate lawbreakers, including jail time, the public and regulators alike have been asking what can be done about prevention—reducing the occurrence of these negative events. While it is true that increased punishment may deter individuals tempted to break the law, effective preventive measures keep the negative events from ever occurring, and avoid the time and expense of determining whether a law has been broken.

Certainly, some attention has focused on prevention, examining the roles and responsibilities of the various parties involved in the corporate governance process. Very little attention has been focused on corporate boards’ responsibility for business oversight, however, a responsibility that is distinctly different from oversight of the financial reporting process. This lack of attention exists in spite of boards’ ultimate responsibility for business oversight: the understanding, approval, and monitoring of the strategic and operational aspects of the business. The board, in addressing their responsibilities, must put in place processes for assessing strategic and operating decisions. The resulting oversight is a deterrent to inappropriate or illegal actions, and an integral component of the system of checks necessary to ensure the viability of the corporate governance process.

Effective business oversight requires an involved board, armed with information well beyond financial statements, exercising oversight and, ultimately, control. An excellent example of such a board is GM, which, under the leadership of John Smale and the other outside directors, led the call for a major change in the senior management at GM in the early 1990s. Jack Welch has praised boards with members who will challenge their CEO, just as bankers Lou Preston and Walter Wriston challenged his proposed acquisition of Kidder Peabody. Or, as Percy Barnevik has said, an involved board is one “able to access all relevant information, discuss matters openly, form an opinion, and act to influence management.”

Effective business oversight is not merely a concept but a well-recognized responsibility of boards for which they must be held accountable.

It requires a board with its own control system for oversight of capital expenditures that tracks and challenges significant variances and asks probing questions that can uncover operating expenses that have been improperly booked as capital expenditures. It requires a board that has basic guidelines and control processes for monitoring cash and noncash payments to executives and related individuals to identify improper payments. The breakdown in the oversight of the financial reporting process is a part of the failure to develop effective oversight of fundamental businesses processes. Together with strong internal and external auditing functions, effective oversight not only mitigates financial and operational irregularities, but also establishes a corporate culture concerned with making strategic and operating decisions that benefit all stakeholders.

The involved, informed board that exercises effective oversight provides the foundation for the checks and balances necessary for successful corporate governance. The board and its committees—corporate governance, nominating, audit, compensation, and others—in their interaction with senior management, the internal auditor, and the external auditor, define the roles, responsibilities, and relationships among the key parties, in the governance process. The checks and balances that emerge not only form the foundation of the firm’s corporate governance, but also address an important lesson from the history of political governance. The evolution of political governance, from monarchies and dictatorships to democracies, demonstrates that governing structures that consolidate power and authority into fewer hands, while conceptually attractive in terms of potential effectiveness, have consistently failed to meet certain conceptual ideals. The words of Lord Acton, “Power tends to corrupt, and absolute power corrupts absolutely,” capture mankind’s experience under monarchies and dictatorships. Sadly, Acton’s observation has been borne out in today’s business arena. A board diligent in its oversight and committed to effective checks and balances is the best prevention for the breakdowns in integrity that history has shown to be inevitable.

Business oversight is not a friendly responsibility. Business oversight is complex, but it need not be costly. It is a process that begins with tracking actual and projected cash receipts and disbursements at the business unit level, that identifies key value drivers, and that establishes basic processes and procedures for getting the right information to the right individuals at the right time. It is a process that, as the Business Roundtable thoughtfully said in their recently issued Principles of Corporate Governance, requires directors to understand the corporation’s business and risk profile, and to critically apply their business experience and judgment to the issues for which the board and its committees are responsible.

A business leader recently stated that effective business oversight is a process that requires a degree of cynicism, beginning with the board. Such an approach may seem adversarial; yet, as Welch and others have pointed out, this approach can lead to real trust between the board and senior management, trust based on in-depth knowledge and open communication.


H. Stephen Grace, Jr., PhD, is president of Grace & Co. Consultancy, Inc., Houston, Texas.

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