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Best Practice is one part of Governance


Best Practice is one part of Governance

Over past years boards have improved their structures and processes by adopting best practice. But to become truly effective, boards must build strong boardroom dynamics and risk management capabilities.

Despite all the governance reforms that have been undertaken over the past two decades, how many boards could be said to having pasted the 'financial crisis' test? So what are we referring to about when we talk about the 'financial crisis' test. One of a board's fiduciary duties is to manage and where possible mitigate risk as part of its stakeholder responsibility. This stewardship task, being bound up in the need to take a prudent and conservative approach to business propositions presented, seeks board members to consider how environment forces may impact on decisions made; both now and in the future and not to take risks.

It has become clear that the recent financial crisis accelerated as boards of US financial institutions failed to reflect the short, medium and long term possible impacts on management's aggressive forays into US subprime mortgages. As a result their organisations fell apart like a well arranged set of dominos during the 2008–09 economic melt-down. In a similar way the financial institutions in this country tumbled.

It's a sure bet that many of these organisations' boards, established before the recession hit home, would argue and be able to demonstrate that they had best-practice structures and processes in place. So why then did so many shareholders lose so much, so quickly and so many financial institutions failed?

We know that considerable effort and energy worldwide has been directed towards developing and seeking acceptance of so called 'best practice' ever since the Cadbury Report in 1992. Since that time we have seen 'best practice' principles being developed and extended throughout the world of governance. This alone could be viewed as a concern – if you view practice always as being 'the best' then you may not take time to improve that practice. Lets for the moment accept such practice as 'sound practice' or 'acceptable practice', practice that can make a positive difference. Then we can ask the real question: Why did the financial institutions fail despite the effort and energy directed to ensuring such organisations adopted the much publicised best practice principles.

Even when a board is stacked with highly qualified members, has a good mix of skill-sets it still needs a sound decision-making culture. It needs board members who continuously consider what risks may emerge and what impact these may have. When the boards of US financial institutions supported management decisions to aggressively enter into US subprime mortgages did board members really test the proposition, consider the risks and did they take a conservative approach before risking shareholder funds? As investigations continue we will gain a better insight.

In the meantime without the right human dynamics and decision-making environment; a collaborative between the Chair, Chief Executive and board members who work to deliver on their fiduciary duty, good board process does not really have much impact other than to shape the form of the governance activities. As a result, the board's decision-making and risk management contribution is likely to continue to fall short of what it could and should be.