The company was in financial difficulties, as changing market conditions had seriously exposed the misplaced strategy. There was however no suggestion that anything improper had gone on. The external auditors were high quality, and there was a competent internal audit team with appropriate risk models.
Yet something didn’t feel right. Whilst the strategy had failings, the execution must also have been wrong, yet none of the KPI’s showed anything wrong. Eventually, management admitted that they had changed an accounting policy to capitalise losses, and then report the lower numbers. The figures that the board had been looking at, and relying on, were in fact useless and misleading.
Fortunately, outright distortion of data for a board is very unusual. However, a board can only work successfully if it knows all the salient information. A board cannot know everything that matters. It just doesn’t have the time. With luck, executive management will know most of what really matters. It will then brief the board on what it thinks the board needs to know. This will be supplemented by knowledge that non-executives glean from other roles and sources.
The prime source of information for non-execs is therefore what the executives choose to pass onto the board. NEDs can of course ask further questions, and this will elicit further information. Non-execs need to spend some time trying to crosscheck information. One way to do this is to look hard at the standard performance indicators (KPI’s) given in board papers.
A new non-exec might be surprised at how often a KPI appears to contradict what management is saying. It is worth challenging this, as the explanation is usually illuminating. It may well be that the KPI is being distorted by a one-off factor. Sometimes, this provokes a useful discussion as the distorting or one-off factor may be being forgotten. It may be that the question is followed by an awkward silence as the CFO starts flicking through his packs to find a reason. This may itself trigger a concern in your mind.
Management is likely to present information in a way that fits with its view of the world. This is perfectly natural. However one of the roles of independent non-executives is to be independently minded, and even to apply a little ‘devil’s advocacy’. The executive team is quite likely to be pulling one way under the CEO, so the NED’s can play a vital counter-balancing role.
If someone in management does decide to distort (or ‘re-present’) the data, it will be very difficult for a non-exec to detect. In my example, neither internal nor external audit spotted a change in an accounting policy, let alone reviewed if it was the right thing to do. Non-execs should not expect auditors to spot such problems. They may do so. They may well see such an event so early that it is corrected before the board even hears about it. But the auditors feel no responsibility for internal management performance data (even if, as here, the data was subsequently published). Internal auditors will only take responsibility if they are directed to review the performance measure itself.
You should expect any material change in accounting policies to be presented to, and approved by, the Audit Committee. This is an important check and balance for non-execs. It is also however worth asking whether any changes in accounting policies, treatments or estimates might have had an effect on important KPI’s.
If you spot an issue through advance reading of the board papers, it is good etiquette to ask the initial question before the meeting. If the answer is easy, then it can be dealt with quickly. If the response suggests to you that there is a real issue, it gives you a chance to raise this in the subsequent board meeting, at which management have had notice of the point you will raise and so will not feel ambushed.
If something doesn’t feel right, especially if the management narrative doesn’t seem to fit with some of the numbers or the KPI’s, it is worth asking questions. You may need to start out by asking apparently dumb questions. You will be surprised at how often an apparently stupid basic question elicits a very revealing reply. You may well find that one question leads to another and so on. It is worth persisting until you have an answer that satisfies you. Of course, it may be better to ask these question outside of a board meeting. Your colleagues will thank you for saying that you will take the issue up after the meeting and report back if anything material arises, rather than elongate a board discussion at the time. It may also be more comfortable for management to research the answers rather than to be put on the spot in the meeting.
Summary
- Boards thrive on good information. Most of it comes from management and from regular board reporting, such as financial statements and KPI’s.
- Most management teams try to provide the best, balanced information that they can.
- Occasionally, information can have a little spin added or even be distorted, and this can be challenging for non-execs to spot.
- Try to cross-refer information with financials and KPI’s. If there are discrepancies, or things just don’t feel right, ask about them.
- Watch how any change in accounting policies might affect KPI’s.
- Keep asking questions to drill down to get the answer you want, but not necessarily at a board meeting itself.
- Look for help from auditors, but do not rely on them. If unsure, ask the internal auditors to do a specific project on the area concerned.
- Use the time between meetings to gain information and establish if there is an issue, but feel free to raise the issue at the meeting for discussion and to alert everyone to the point.