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Why boards fail to address risk

March 7, 2018

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Does your board spend as long debating risk as it does strategy? Both are estimates of opportunity and threat in an unknown future environment. Both require sound judgement and a keen appreciation of where the organisation is headed, yet there is ample evidence that many boards see risk only through the lens of business continuity, control rather than uncertainty. Those who do appreciate the concept of uncertainty, often regrettably seek certainty in the wrong places. Misplaced certainty and ignorance of risk have been evident in three recent high profile cases of poor decision making by boards. I shall look at Carillion, Oxfam and KFC.

Carillion collapsed spectacularly because the board failed to fully understand the financial predicament it was in. Finance heads and external auditors claimed the business was technically solvent, when in reality it wasn’t. Institutional investors and hedge funds knew there were problems long before the collapse on 15 January 2018 yet none of the board directors queried this. The board collectively trusted assurances that the business was fine right up to the sudden profit warning of July 2017, at which point the CEO was fired, and the ship began sinking fast. Groupthink was a factor, as was confirmation bias and over-optimism, all of which academics knew 40 years ago can cause systematic bias leading to errors of judgement.

Oxfam has suffered significantly through revelations of unethical behaviour among its field agents over seven years ago in a disaster relief operation. An internal enquiry decided against transparency in order to protect the reputation of the charity, yet this decision, now revealed, has had the opposite effect with an immediate impact on donor trust. The board should have known that secrecy would be a reputational time bomb. Was this down to cognitive dissonance, they just didn’t appreciate the severity? Or was it down to anchoring and adjustment based on familiarity with resolution of previous staff misdemeanours? Was it perhaps an escalation of commitment and a determination to justify a course of action because too much time had passed?

KFC has lost a lot of customers and been forced to close branches due to food shortages. This followed a switch in chicken distributor, a cost saving in logistical overheads. Unfortunately the new distributor (DHL) could not replicate the branch supply schedule of the previous distributor (Bidvest) and hence stores ran out of stock and had to close. Did the board of KFC question the rationale of changing distributor or did the head of logistics reassure them of the upside cost saving rather than the downside supply risk? It turns out that Burger King had previously switched to DHL but quickly reverted to Bidvest when they saw that it wasn’t working. Did the KFC board use this information or were they hypnotised by obedience to authority or attitude polarisation?

What should boards do to make better decisions and protect value? It would be nice to think that codes of governance emphasised the need to guard against cognitive bias, especially as the dangers have been known for over 40 years. A recent report by the Leadership Foundation for Higher Education found that governing bodies of universities do not take sufficient notice of heuristics and biases. This is true in the corporate world where ‘groupthink and polarisation run counter to the predictions of rational choice decision making’. Boards need to appreciate the stewardship risk of misplaced certainty: to consider the personalities and agendas that collide in collective consensus.

Written by Garry Honey, founder of Better Boards, CEO, Chiron Reputation Risk and SAMI Associate. The views expressed are those of the author and not necessarily of SAMI Consulting.

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