Boards are responsible for risk management. But the way they exercise that role is mostly invisible to shareholders. Clues over the risk appetite of a board and the way they are prepared to challenge can be found in its size and the relationship between execs and non-execs.
Financial risk-taking is lower in boards which have fewer than eight directors.
However, the proportion of non-executive directors on the board and the existence of risk committees does not have a significant effect on corporate risk.
How to lower financial risk taking
Financial risk-taking is lower where executive directors have served for much longer than non-executives.
Some evidence suggests that companies take higher financial risks where executive director pay is significantly greater than non-executives.
Companies take lower financial risk where non-executives were active in board meetings and prepared for those meetings. Financial risk taking is also lower when there is frequent dialogue between executives and non-executives.
Directors who have healthy differences of opinion over key company issues and the tasks facing the board also take lower financial risks.
Who takes the business risk?
Business risk management is primarily an executive function or task. Business risk management seems to takes place away from main board processes. If this is the case it suggests that that the corporate governance of business risk management is poor.
A board’s process of strategic decision making for financial and business are closely related. They fuse together within the processes of reaching board decisions. This is particularly true when economic conditions where liquidity is a significant restraint in strategic decision making.
Non-executives and boards need to be able to use these opportunities to convert their understanding of the business and contact with executives into effective influence.
Board effectiveness draws on qualities of both sides of the executive and non-executive director relationships.
On the one hand, it is important that executives enable, and see the value in, as challenging an environment as an effective board can provide. On the other hand, the non-executives need to exercise their influence by behaving in ways that combine host company understanding, insight and skill.
"At board level risk management is, in large part, a social and subjective process, rather than a purely technical or procedural matter. This risk management is characterised by challenging yet constructive interactions between board members geared towards developing a collective and informed sense of risk."
The board’s role in risk decisions
Interviews for the study suggest that in real-life strategic decision making, financial and business risk are intertwined.
The board must be prepared to ask challenging questions such as:
1) What is the impact of a potential acquisition on shareholder value?
2) What are the downside risks, such as loss of revenue or failure of proposed synergy benefits?
By asking such questions the board understands the acquisition risk, the valuation and the proposed way to finance the deal. The board should challenge executives over why a particular deal at a particular price makes sense.