4. Board of directors - Strategic development and risk management.pdf

Module 2 Board of directors Strategic development and risk management Learning objectives After studying this section, you should • Understand a board’s role in the strategic development • Understand a board’s role in the risk management 2 Strategic guidance • One of the primary responsibilitie...

Module 2 Board of directors Strategic development and risk management Learning objectives After studying this section, you should • Understand a board’s role in the strategic development • Understand a board’s role in the risk management 2 Strategic guidance • One of the primary responsibilities of the board is to ensure the strategic guidance of the company • Strategy development and oversight involves four steps: 1. Define the corporate strategy 2. Develop and test business model 3. Identify key performance indicators 4. Identify and develop processes to mitigate risk • Board does not perform these tasks, but management does • Board evaluates and tests the work of management to ensure that it appropriately builds and protects shareholder value 3 Board’s and management’s roles in developing the strategy 4 Board’s and management’s roles in developing the strategy • Strategy development may not be a linear process • Company might refine strategy over time (iterative) or stumble on strategy and articulate it later (random) • Board needs to understand how the specific strategy was selected and when to change approach • Is management anchoring on current activities? ˗ Does the strategy bind the future too closely to the past? ˗ Does management understand the dynamics, pressures and resources ˗ required to achieve company objectives? ˗ Is there proper information sharing across functions? • Develop a causal business model that explains how the corporate strategy translates into shareholder value • A business model links specific financial and nonfinancial measures in a logical chain to delineate how the firm’s activities create value 5 Board’s and management’s roles in developing the strategy • The business model is based on rigorous analysis – not on a management’s intuition • Board relies on business model to test management assumptions and satisfy itself that the strategy is sound • Board evaluates for logical consistency, realism of targets, and evidence that relationships are valid • Board should be aware of challenges ˗ Management might take shortcuts ˗ Management might resist scrutiny ˗ Relevant data might be difficult to obtain • Key performance indicators (KPIs) are the financial and nonfinancial metrics that validly reflect current and future performance. • KPIs should be used to track performance and to award compensation 6 Risks management • Risk represents the likelihood and severity of loss from unexpected or uncontrollable outcomes. • Risk cannot be separated from the corporate strategy - they are intimately related • Each company must decide its risk tolerance, and this decision should involve the active participation of the board • The risks that the firm is willing to accept should be managed in the context of the strategy • The risks that the firm is unwilling to accept should be hedged or transferred to a third party (insurance, derivatives, etc.) • The risks facing an organization are comprehensive and touch all aspects of its activities (operations, finance, reputation and intangibles, legal and regulatory, etc.) • By stress testing key linkages and assumptions, the board and management can determine what might go wrong and the possible consequences • Management can then develop very detailed risk management analyses around each key issue 7 Risks management • The board has four important responsibilities in this area 1. The board determines the risk tolerance of the company, in consultation with management, shareholders, stakeholders. 2. The board evaluates the company’s strategy and business model in the context of the firm’s risk tolerance. 3. The board ensures the company is committed to operating at an appropriate risk level. It relies on risk KPIs to help make this assessment. 4. The board should satisfy itself that management has developed necessary internal controls and that procedures remain effective 8