IMHO: The risk of risk aversion

On the same day this past week my normally calm and soft demeanour was disturbed by learning that Judith Collins was to become President of the Law Commission and almost simultaneously by a reminder that the Law Commission is reviewing the role of company directors.

Visions of BMWs and Mercedes being crushed in retaliation for governance mistakes flashed through my brain. I had to reach for my union card from the Institute of Directors to reassure myself, paid my late dues and made a mental note to be careful.

A leading law firm in a newsletter identified a “heightened director risk” of litigation, noting: “All eyes on the boardroom: Personal liability for directors is expanding beyond traditional boundaries and the Law Commission’s review of directors signals potential legislative change.”

And:

“Escalating class actions and shareholder activism . . . heightened risk for boards and directors . . . a new era of active regulatory enforcement including Fair Trading penalties up to $1 million” and “new types of risks such as inaccurate AI decisions and representations”.

You may well add various compliance issues around climate change to the challenging list of impending liabilities.

And these are potential personal liabilities for directors who transgress. Gone are the days of my governance youth, when a colleague could observe at an Institute meeting that “a good board is one with a short agenda and a long lunch”.  Now a good board may be one that is careful and successful in avoiding regulator, shareholder or other litigation.

Some of this direction of change is fair and good. We should not tolerate dishonest or careless corporate behaviour. The whole point of corporate governance is to ensure managers adhere to the legitimate expectations of shareholders, lenders, staff, customers, suppliers and the wider community.

To fulfil this role, directors must have information systems and reporting that make this possible. This is not always the case, and formal audit systems will not always pick up the deficiencies.

Individual directors rely on their skills and experience to reassure themselves about this, but any real reflection will tell us that we very often do not have reason for complete confidence. A good mix of skills at the table will help if marshalled effectively by a chair. It’s one thing for the necessary information to exist, quite another for it to be in a readily available, timely and comprehensible form. This “information space” is one where various forms of artificial intelligence show promise in creating stronger visibility and rectifying the gaps. 

Typically, the stream of information available to a board is curated by management and presentation, even when diligently prepared to meet board requirements, inevitably reflects its source. Good risk management requires options well analysed, often including those from outside. Again, there is good scope for AI to scan wider and test assumptions effectively to assist governance. 

The Institute of Directors training and other educational and informational sources offer plentiful support and resources to keep directors up to date with current governance matters. So, there is no excuse for directors not being informed to a level comparable to other professions. In my experience, many directors (far from all) do maintain that learning, though such diligence and the initial qualifications for governance are not required legally.

 My guess is that as obligations on directors increase and insurance coverage becomes more testing, some form of initial required qualification will be adopted for at least larger corporates. There are disadvantages in this in terms of diversity and lived experience, but it is not hard to see the direction of change. 

In my experience, difficult governance decisions of the type that may give rise to a litigable failure by directors are not common; indeed their difficulty arises precisely from their unusual nature. They are often about risk and its allocation and therefore about judgement rather than numerical certainty. There are those who argue that risk judgements are best made by those with “skin in the game”, which may suggest that directors facing more personal responsibility may create that “skin” even for otherwise “independent” directors. 

Unfortunately, I think it is more likely that the impact will be to increase how risk averse many boards will be. When difficult choices are to be made, self interest may prevail over taking the best option, reinforced by what insurance protection is available. This will affect many of the most important judgements made by a corporate board. 

In a testing world, reducing risk appetite may reduce the best options effectively available. If ever we were in a time when “better” beats “bigger”, this is it. Good risk judgement is not about avoiding risk but taking it. 
The option of increasing director personal liability is no panacea to better corporate outcomes. Tough decisions about issues with big impact internally and externally are what boards should be taking on. Process improvement can manage many of the more straightforward monitoring and compliance aspects of a board and should be pursued, recognising the diverse needs of diverse organisations. One size fits none – as I have been telling an MBA class this morning. 

The big answers for current and future directors will not lie in technology or in qualifications – important as they are – but in integrity and sound judgement, ability to think and articulate critically and constructively, and capability to consider complex systems. 

The big danger of legalistic testing of their judgements may be the degree to which such characteristics are found in the legal profession as much as in governance. From the President of the Law Commission to judges to litigators. 

I have my doubts on both sides. It pays to be careful before you crush. 

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This opinion piece was first published in Newsroom and is republished with permission. The views expressed are those of the author and do not necessarily reflect the position of the Institute of Directors.