Boards Fail -- Again

Directors are ultimately responsible for the decline of their companies. At teetering financial institutions, they have a lot to answer for

by Ben W. Heineman Jr.

The battlefield of the credit crisis—indeed, the crisis of capitalism—is strewn with the dead and wounded.

One casualty is the role of directors at a broad range of dead and maimed financial institutions. These board failures represent, in turn, a signal failure of the broad governance movement that gained momentum at the beginning of this decade.

This issue is of profound importance because the board of directors stands between government regulation and corporate freedom. The board's duty is to provide a balance among wealth creation, financial discipline, and risk management; to make the fusion of high performance with high integrity the firm's foundation; and to choose and reward a CEO who has the vision, motivation, and skills to affect that essential balance and critical fusion. When boards don't succeed but fail, as so many have, the terms of debate shift from how companies can best govern themselves to how regulators should govern them.

A Board's Responsibility

Since the Enron scandal, regulators, academics, commentators, and the media have all focused on the importance of an independent board in providing meaningful checks and balances on chief executives and top management. Centers have been established by nonprofits and professional schools; conferences are held every week somewhere around the nation; enough earnest papers have been written to fill a library.

Yet, despite the enormous time, energy, and focus generally devoted to governance in the past decade, the boards of directors at Bear Stearns, Merrill (MER), Citi (C), Countrywide, Fannie Mae, Freddie Mac, Lehman Brothers, and Washington Mutual (WM) are ultimately responsible for the sharp decline or disappearance of their companies. Although the sad sagas of institutions will vary due to their cultures, the personalities involved, and their particular mistakes, I believe it is safe to say that the boards at all adversely affected financial service companies have failed in their most basic tasks.

Properly defined, a corporation's strategy is not just its business plan but also the major short-, medium-, and long-term opportunities and risks it faces: commercial, societal, reputational, and legal/ethical. Oversight of these risks and opportunities is a fundamental board function. A clear process for identifying these priority issues and addressing them in detail at the board level (and perhaps at more than one meeting) is the essence of board oversight. The board must assure itself that the process for making and implementing decisions, as well as the decisions themselves, are carefully considered and reasonable.

Paying Attention to Risks

Sadly, it is clear that the boards of our major financial institutions did not understand the risks the entities were taking. It may be that the CEOs and top management didn't understand, either, but it is the board's job to press management. The board should ensure that the risk function report directly to the board as a whole or to the audit committee. The board should cut through complexity and require that the reasons for committing capital are explained in plain English. Directors must assure that risks are sufficiently spread so no one activity can threaten the enterprise. As experienced individuals, it is board members' duty to ask hard questions when things are going extremely well as well as when they are going badly.