Blindsided Boards

Board “blindsided” said the FT headline .  Volkswagen’s board is one of an endless stream that did not realise they were sitting on a time bomb with a dodgy fuse.  Others unwittingly presided over the incubation of the LIBOR and PPI scandals, bribery cases, most profit overstatements and countless other crises.  BP’s Deepwater Horizon, G4S’s Olympics problem, Volkswagen's emissions scandal  and the implosions of financial institutions such as Lehman, RBS, HBOS, AIG, Equitable Life and Independent Insurance are tiny sample from my bulging library.  These scandals exposed unrecognised reputational risks and the behavioural and organisational risks that underlay them.

Five days before Carillion’s £845 million write down, its chairman Philip Green was working towards an “upbeat announcement” to the City.  Yet the new new Finance Director had already sounded the alarm.

Two weeks before Tesco’s £250m profit warning, Terry Smith lucidly explained why he refused to invest in Tesco: it had, he wrote, been massaging its results for more than a decade to create growth in earnings per share, whilst return on capital had almost halved.   Even the firm’s auditors had insisted on public warning as to the difficulties in accounting for Tesco’s commercial arrangements. 

Independent Insurance was a stock market darling that reported stunning results.  Its charismatic chief executive, Michael Bright, was the FT’s “Entrepreneur of the Year” for 1998.  Yet the company collapsed two years later and Bright, and two colleagues were jailed for fraud: they had been hiding over £100m of liability claim reserves.  

Boards at Airbus, BAe, Rolls Royce, Glaxo and many more found their companies embroiled in bribery allegations, confirming long-running rumours of corruption in their sectors.

The role of NEDs is to challenge and support executives but why don’t they see trouble coming?  Having studied scores of scandals, it is clear that insufficient intelligence is rarely the problem.  But patterns of board weakness recur time and again. 

There are NEDSs who lack understanding of the business.  None of the NEDs at Tesco had retail experience  so it would not be surprising if they didn’t have enough insight into the Byzantine structure of ‘commercial arrangements’ between supermarkets and large suppliers.  

It was the same at Independent Insurance.  The main fraud was a scam I was taught about on day one of my reinsurance education.  There is always an element of estimation in the kind of liability claims the Independent underwrote, which makes it tempting to cook the books and gull the ignorant.  Months before the collapse, a friend and I, armed with no more than their published regulatory returns, found the hole the board had missed.  Unfortunately it seems the NED team lacked the skill, knowledge and experience to do this even with access to inside information.

Back at VW, renowned for its technical skills, the truth about the emissions scandal seems to have eluded leaders, who appear not to have questioned how their company was achieving results others thought impossible.  Elsewhere, many boards seem to have believed that corruption, rife in their industry, did not encompass their firm.

Competent NEDs worry about how and why their firm is successful, including the relative roles of skill and luck in success.  They know it is hard for unpalatable truths to reach leaders.  Taboos, loyalty to colleagues, and fear fracture frank communication channels to the top.  So do social bubbles, norms and silences.  Chinese whispers can transform messages as they rise up hierarchies.  Incentives and perceptions of leaders’ attitudes can discourage those with unwelcome news or views from bringing them to leaders.  Without curiosity and persistence, dissonances remain unexplored.

One reason for this is NEDs who do not recognise their humanity.  We are all affected by cognitive biases.  As Daniel Kahneman once wrote,

"We're blind to our blindness. We have very little idea of how little we know. We're not designed to." 

The optimistic bias leaves us thinking that bad things are less likely to happen to us.  Confirmation bias leaves us seeking to confirm, rather than disprove what we feel or believe.  Overconfidence leaves us believing we are better than an outsider would conclude.  Hubris overwhelms us.  Groupthink undermines our capacity for independent thought.  We are less rational and more deluded than our overconfidence leads us to suppose.

The greatest delusion is probably that an intelligent, well-meaning board is enough to lead a company to success.  An effective board needs a NED team with the skills, knowledge and experience to understand every aspect of the company’s systems and activities, including its people.  It takes NED self-awareness and courage plus forensic and social skills constructively to challenge charismatic or dominant leaders. 

Being blindsided is bad for your company and its reputation and for your board members and their reputations.  The questions are whether the board wants to remove its blinkers; and who will take the lead.  

Anthony Fitzsimmons

Reputability LLP

London

www.reputability.co.uk

Reputational risks, and the behavioural, organisational risks that underlie them, are discussed in more detail in Rethinking Reputational Risk - How to Manage the Risks that can Ruin Your Business, Your Reputation and You You can get a 20% discount hrough this link by using the code RRRF20