At a board meeting of a top ten multinational corporation, the question of whether to invest $80 million in a project in an African country was discussed. The President of the company subsidiary seeking approval to make the investment suggested that the country was a safe place to invest because of its recent history of economic and political stability. Unknown to the Board or the President at the time was that the information they were given was inaccurate, because the company’s risk management function was faulty. The Board approved the investment, and later regretted it.
Too many decision makers pay too little attention to country risk and other subjects of crucial importance when making cross-border trade and investment decisions. There are a number of reasons for this, but the most common are a lack of education at the Board level (which leads to an inability to discern fact from fiction) and not knowing the right questions to ask of corporate management. Companies also tend to rely on risk management processes they believe are bullet proof, which may instead be riddled with gaps, inconsistencies, and contradictions.
If the Board had been better educated about the economic and political situation in the country, the flaw in the vetting system might have been uncovered. But the truth is that candor often gets lost in the politeness of Board proceedings; too many Board members believe they exist to address emergencies, rather than to prevent problems from occurring. Too often, Boards are focused on building consensus, which inhibits due diligence and proper risk management. In addition, many Board members are appointed because of their accomplishments, prestige, or connections rather than their knowledge, and tend not to want to demonstrate their ignorance -- preferring instead to remain silent when complex or controversial issues are discussed.
The irony is that by remaining polite, uneducated, and silent, Boards can do more than contribute to monetary losses -- they may unwittingly contribute to reputational risk, often with long lasting and severe consequences. That Board members may be independent does not necessarily imply a more favorable outcome. Board members almost never suffer personal liability as a result of poor decisions they may make. As long as they follow due process (by attending meetings and doing what they are asked to do), they will likely never be held personally liable.
What should companies do to raise the bar on the level of competence among board members? A good start would be to change the way Board members are appointed. Rather than selecting members based on past achievements or current connections, select them based on knowledge, talent, and performance, as any other employee would be hired. It is mystifying that the ultimate decision-makers in a company should be held to a less rigorous standard than every other employee.
The above example also occurred because the corporate underwriters of the transaction were incentivized to promote the deal internally so they would meet their production targets and receive a bonus at the end of the year. There were personnel in place in the risk management department to properly vet the transaction, but a procedural hole existed. The underwriters sought the views of the person given the responsibility to approve the transaction from a country risk perspective, but a large portion of the analysis produced by the country risk manager was deleted from the version that went to the risk manager for final approval before being given to the president, and the remainder of the analysis was watered down. Neither the risk manager nor the president knew this had happened, and believed all necessary approvals had been obtained.
What should companies do to plug the inevitable holes in their risk management processes? Hire the right people, put the right practices in place, and add checks and balances, so self-serving individuals cannot circumvent the system. Beyond that, hire a third party to conduct regular risk management audits that test and stress the system. It will nearly always be the case the cracks in the system will be identified. Listen to the recommendations of the qualified independent assessor and implement his or her recommendations. Then test the system again.
Country risk management should no longer be considered some ‘luxury’ that could be useful to have around when times get really bad. It is, rather, an absolute necessity for any business that trades or invests abroad and should become an integral part of the decision-making process. The C-Suite should become better educated about the right types of questions to ask, and become knowledgeable and sophisticated enough on the subject to be able to tell the difference between bogus information delivered by a bonus-seeking sales force and corporate foot soldiers who have done the hard work of deciphering fact from fiction in the global business landscape. Managing country risk is everyone’s responsibility, from middle management right up to the top of the corporate food chain.
*Daniel Wagner is Managing Director of Risk Cooperative. His latest book, on cyber terrorism, will be out later this month.