Avoiding the timebomb of corporate failures
By GERARD TAN
The Business Times, 8 September 2023
THE abrupt and dramatic collapses of FTX, Silicon Valley Bank, Signature Bank and Credit Suisse have provoked questions of why they happened and whether they were foreseeable. Could investors, boards and regulators have detected signs of brewing trouble?
While business failures are a fact of corporate life, there were common threads and red flags evident in many of these downfalls. Drawing upon these major collapses, we can distill three lessons:
- Manage the risks inherent in spectacular business success.
- Ensure accurate financial reporting.
- Maintain an effective board.
Balancing business and risk
The right business model in the right market at the right time can culminate in spectacular business success. Several companies aiming for the stars have made history with their novel approaches and outstanding growth. However, when these ventures stumble, the scale of their downfall can be equally staggering.
In retrospect, the extremely high leverage to buy and sell cryptocurrencies at FTX should have set alarm bells ringing. The failed crypto exchange was valued at US$32 billion (S$42 billion) at its peak.
John Ray, the restructuring expert appointed to replace Sam Bankman-Fried as CEO of FTX, said in his court filings: “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information,” in part because Bankman-Fried instituted a corporate culture of not keeping communications records.
Boards have the dual role of performance and conformance. Thus, strategic planning and risk management should be integral to every board’s agenda.
While corporate ambition should be nurtured, it must align with the practical aspects of attaining business outcomes via innovation, customer centricity, employee engagement, supply chain management and more.
The board must objectively assess the company’s and the industry’s short-term, medium-term and long-term outlooks. This involves posing challenging questions to management and initiating changes in key areas, if necessary. Companies should prepare for the “when, not if,” to avert surprises from unforeseen events.
One of the fiduciary responsibilities of a director is the oversight of business risk management. A failure to uphold these duties can result in legal liability for breaching the fiduciary duty of risk oversight. Given the shifting legal landscape of risk oversight liability, directors and officers should expect oversight claims if their corporation incurs substantial losses due to any failure to properly exercise their oversight responsibilities.
Accurate financial reporting
The board’s accountability to investors extends beyond showcasing impressive figures to ensuring the accuracy of those numbers.
In this respect, financial reporting cannot be solely delegated to management. It is more than the responsibility of the chief financial officer and auditors to get it right. The board has the primary responsibility under the law.
Given the complexities of accounting, boards should not unquestioningly accept financial statements. The annals of creative accounting are replete with instances where these intricate accounting standards were misused or misunderstood, either unintentionally or intentionally.
Financial statements offer a snapshot of the corporation’s health at a particular moment, usually months prior. Although auditors must consider post-balance sheet events and assess the entity’s ongoing viability, market volatility complicates this task. This means that boards should always be aware of the inherent limitations in relying solely on audited financial statements.
An effective board
High-profile collapses such as Enron, Theranos and FTX involved “trophy boards” populated by prominent individuals known for their prestige, reputation and connections. However, in the wake of the scandals that erupted in each of these cases, these boards have faced criticism for their inability to prevent or detect misconduct.
An effective board comprises the “right” individuals whose financial, industry and technical expertise are invaluable. It should be a diverse board, not only in terms of gender and age, but a truly balanced mix of people who can guide management and the CEO to look beyond the horizon, manage the company’s risks effectively and assemble a team capable of successfully executing the strategy.
As much as boards, the right or wrong CEO can make or break a company, as witnessed in many scandal-hit companies. A good board hires the right CEO with the right balance of vision and drive to get the job done.
Interestingly, Steve Jobs was fired by the Apple board in 1985 over a purported clash with then-CEO John Sculley. If Jobs had not been rehired in 1997, the company’s trajectory might have been starkly different.
When asked about Apple’s place in a world then 97 per cent dominated by Microsoft, Jobs asserted the need for Apple to connect people to their passions – their photos, their music and each other. This distinctive vision propelled Apple from the brink of bankruptcy to one of the world’s most valuable companies.
In summary, directors can help avoid corporate failures by establishing clear structures and policies. Robust financial planning is crucial, as is the need for strategic vision and planning. Ultimately, good governance is key to any business’s long-term sustainability and effective communication of these policies and processes is equally important.
The writer is a member of the Boardroom Matters committee of the Singapore Institute of Directors.