CEOs and sentinels

John M Green suggests boards do not always talk to management as effectively as they might.

Corporations can be like hospitals. Say you are wheeled into an operating theatre for a knee replacement but when you shake off your anesthesia you discover they have amputated your leg. What would the hospital do?

Way back, the medical profession’s DNA was to deny everything. They would even deny you had ever had a leg.

Then hospitals learned that quickly identifying whom to blame, then firing them and saying sorry could limit their patients’ anger, and the legal claims.

But today, zealous hospitals do not stop there. They genuinely want to know how the culprit could have possibly put you on the wrong operating table in the first place. While they are hoping the incident was a one-in-a-million, they are worrying it might actually be a sentinel, an alarm bell that is warning there is a serious systemic flaw buried in their systems that had not burbled to the surface before.

So what happens if a company takes a hit but the CEO assures the board that it is a one-off? Does a board accept the CEO’s word?
Being a director is easy, but being a good one is not. Pressing the CEO further might endanger the board’s relationship with him or her, especially if it turns out the CEO was right.

Yet investors — especially institutional ones — reflect how boards often do not have a clue about what is really going on inside their company and, perhaps worse, that when things do go haywire, it was over something the investor already suspected.

Similarly, some directors have grumbled after a crisis how, “apparently the management knew, but they never breathed a word of it to us.”

So is it fair to suggest that diligently reading board papers and asking probing questions in the boardroom might not be sufficient? If yes, what else should we directors be doing?

We could start by seeing so-called one-off events more like a hospital would, by hoping they are truly one-offs yet encouraging and overseeing a process that is checking for whether they might be sentinel events.

The language of risk management helps. Risk experts warn that relying on single sources of information is a bad idea, that a better way to elicit the truth is to triangulate from multiple sources, and so adjust for biases, frauds and mistakes, getting earlier warning that things may not be what they seem.

Take a really simple but common example of a respected senior executive quitting. The CEO tells you it was all because he or she received an offer that was too good to refuse. While that might be perfectly true, what if the former executive resigned because he or she felt the company had become a sinking ship? You would want to know that, wouldn’t you? But you would hardly expect the CEO to fess up to it since it is a direct reflection on his or her leadership. This is precisely why many chairmen will do an exit interview in such cases. Depending on the outcome, the chairman might go even further and take the temperature of remaining members of management.

Here is another example. A company suffered a major crisis. Afterwards, one senior executive confessed to a director that he had been worried about the underlying issues for a long time. Understandably, the director asked, “Then why did you not ever tell the board?” The executive’s feeble reply was, “You never asked.”

Maybe that was code for, “If I had, the CEO would have fired me.” But maybe it is a reminder of human nature: that keeping your mouth shut is easy even when you do not like what is happening, but lying in response to a direct question is very hard.

This “you never asked me” problem might be more common than we think. So we need to find acceptable ways to do the asking.

Boards meet with the auditors at least twice a year without any management at all in the room. Most boards meet quite frequently with their CEO alone, for a heads up on the issues simmering under the surface, for insights into the executive team and for what is keeping him or her awake at night.

But boards are less focused on probing executives in the absence of their CEO. Some CEOs have the confidence, and sense, to encourage directors to chat to management and employees, but others will grit their teeth or even slam the table. If your CEO is one of the latter two, it might well be a sentinel for getting yourself a new one.

Of course, a director spending time with executives other than the CEO needs quite a bit of discretion to ensure that the director does not overstep. Going too far might risk you interfering with management, or even giving a mistaken (and dangerous) signal that the board lacks confidence in the CEO.

But meeting with executives even informally can be productive. Over a coffee once, one director asked a CFO, “If you had a magic wand, what would you change in the company?” The unexpected answer he got was, “The CEO.”

In a few short days, after the chairman took some other soundings, that CEO became “the former CEO”.
(Twitter: @john_m_green)