Whether your organisation is a not-for-profit, SME or a large public company, it will benefit from the multiplier effect of better governance.
Getting governance right makes for a healthy, effective and responsible Board. It ensures that a clear message is delivered to all stakeholders, and that employees are engaged, which leads to higher productivity and lower employee turnover. This article will outline the attributes of good governance and how they can lead to benefits for an organisation, as well as explain how you can test your governance system.
Governance starts at the board of directors. For most for-profit organisations, the board will comprise executive directors, who work in the business, and non-executive directors. Not-for-profit boards typically comprise non-executive directors, who appoint a chief executive officer to manage the organisation. Executive directors are responsible for managing the organisation appropriately and achieving the organisation’s stated objectives. Non-executive directors provide objectivity and oversight of management, to provide accountability to the relevant stakeholders of the corporation and to assist in the delivery of corporate performance consistent with the law and the organisation’s stated objectives. As a board, the executive and non-executive directors accept equal responsibility for achieving the organisation’s stated objectives. When the board provides the organisation with clear direction, and develops a positive culture, good governance flows through the organisation.
Getting governance right starts with the board composition; finding the right people to provide the required mix of skills, expertise and experience. The right board will have expertise in all key areas, be a good cultural fit, and work well together. The directors need to be cohesive, which means they can trust each other. Patrick Lencioni refers to this trust as vulnerability-based trust, which is when the directors are comfortable being transparent and honest, even if that reveals their own weaknesses. The directors need to commit to the organisation’s stated objectives, and put those objectives ahead of their team’s results. As a board, constructive conflict is important to reach better decisions. Directors need to advocate strongly for their opinions to ensure there is robust discussion on critical issues. The chairman should encourage all directors to participate in decisions. Ultimately though, the board needs to make a decision, and the directors must commit to the decision reached, even if they personally disagree.
In practical terms, the following factors affect Board effectiveness:
- Chairman’s leadership
- Relationship between the chairman, directors, chief executive officer, company secretary and senior management
- Cohesiveness of the board and leadership team
- Clarity of the organisation’s stated objectives
- Internal processes
- External environment
- Evaluation, measurement and continuous improvement
The following checklist may be useful for directors to help the boards on which they sit to become more effective:
- Understand the role of the board and management
- Understand the organisation’s:
- vision, mission, or purpose
- value proposition and business model
- strategy and strategic imperatives
- Seek to clarify the organisation’s stated objectives, and clearly articulate them to management
- Read board papers to become conversant with key issues that will be discussed
- Attend board meetings
- Ask questions to understand basis for recommendations
- Challenge assumptions and decisions constructively
- Participate in decisions
- Mentor management within your own skill set and experience, and as required
This checklist is consistent with the Australian Institute of Directors’ guidance on board effectiveness and the Australian Securities Exchange principles of governance.
What are the benefits of improved governance?
From a business valuation perspective, good governance creates enterprise value by increasing earnings and increasing the multiple applied to future maintainable earnings to determine enterprise value. Earnings are increased, because good governance leads to higher employee engagement, which increases productivity and reduces employee turnover, absenteeism, and safety issues. Good governance makes the organisation more attractive to all external stakeholders, such as potential donors, supporters and even future board members or staff.
Stress testing to avoid business failure
To protect themselves and their businesses, directors must ensure their management teams conduct thorough stress testing, through detailed financial modelling and ‘what if’ scenario testing. This can be done in-house and/or reviewed by a non-executive director or an external advisor. Stress testing helps avoid business failure. Directors should ensure their management teams put initiatives in place to bulletproof their businesses from a range of risk impacts. Stress testing puts businesses in a stronger position, if they need to negotiate with their financiers, by showing they are prepared for change and able to handle challenges. It also enables directors to act swiftly in response to change, and make wise decisions quickly.
So what is stress testing?
Stress testing focuses on analysing base case and worst case scenarios, which provides a number of benefits. These include enabling businesses to react quickly when conditions change suddenly, and clarifying short to medium term capital requirements. Stress testing forces directors to ask ‘what if’, and create strategies to deal with potential scenarios to minimise risk and maximise opportunity.
Effective stress testing
When our team works with clients on stress testing, we ask them to consider these key questions:
- How is the new break-even sales level for the business affected by changes in demand for product/services and altered supply conditions?
- How would lower demand for products/services affect revenue and earnings?
- Would this translate to lower staffing demand, and what effect would this have?
- Does the business have sufficient cash flow to fund redundancies?
- How low is the board prepared to reduce prices before it becomes unviable to sell the product or service? What changes will need to be made to the cost base to match a lower revenue base?
- How is cash flow affected, if debtors take an extra 10 days to settle accounts?
- Is the business at risk of breaching financier covenants? If so, how will the board respond to financier concerns?
- What changes will be required to finance facilities, and how would financiers react to a request for increased lending?
- Which overheads can be reduced and what capital expenditure plans can be put on hold to preserve cash?
- What non-core assets could be sold to reduce debt or provide extra cash flow?
- At what point are sales/production levels too low for the business to remain viable? Is a merger/strategic partnership an option? Who would you approach?
Stress testing forces directors to ask ‘what if’, and create strategies to deal with potential scenarios to minimise risk and maximise opportunity. This is an important component of good governance.