Careful, thoughtful oversight of risk management is a critical duty for boards at a time when the magnitude of both risks and opportunities seems to be rising.
In this interview for FM magazine, which has been edited for clarity, Simon Laffin, FCMA, CGMA, talks about the increasing importance of risk management and the board’s role in it, the practical steps for an acquiring board to achieve a successful M&A, and how diverse boards improve decision-making.
Laffin is a nonexecutive director at Tokyo-based global media company Dentsu Group Inc. and UK property company Watkin Jones plc. Previously, he chaired the boards of three large public UK companies and served as a nonexecutive on several others. He is the author of Behind Closed Doors: The Boardroom — How to Get In, Get On, and Make a Difference, which publishes on 2 September.
Laffin also gives practical advice for management accountants seeking a nonexecutive board role: Study your own board, ask questions, and “get an MBA from real life”.
How has business risk changed over the last few years?
Simon Laffin: The pandemic has reminded us how big some risks are. They’ve also reminded us that “black swan” events — these events that are supposed to happen so rarely that you don’t need to worry about them — actually happen much more frequently than people think. The other thing it’s taught us is that the worst case can be really bad. I’ve seen an awful lot of cases over the years where the outcome was even worse than the worst case that management had put together. If you think back over the last few years, we had the great financial crisis of 2007–2008, the pandemic, and increasingly bouts of exceptional weather. The risks do seem to have got bigger. But to put it in a bit of context, within many of our parents’ lifetimes, we’ve had a world war. World War II followed not very long after World War I. So, big shocks have always been there. The other thing that’s happened is that globalisation has made interconnected risks much bigger. So, for example, the pandemic wouldn’t have been such an issue if people weren’t travelling internationally so much. I think the great financial crisis showed the interconnectivity of all the economies.
How has the management of risk changed?
Laffin: Companies have become much more professional in thinking about managing risk over the last few years. It’s not always obvious because if you read the annual reports, they tend to be still full of, “This is a risk. This might happen, but it’s OK because this is our mitigation.” It’s so superficial it’s of no use. But I hope that the annual report is just the tip of the iceberg of the work that companies are doing and they’re doing much more detailed and high-quality work — it’s just they struggle to show a good representation of it in the annual report.
The biggest challenge we have in risk analysis for corporates is boredom and superficial reassurance. What you get is a tendency for a superficial discussion. Because it’s very difficult as a board director, especially a nonexecutive, to get an idea of what’s really, really happening. I always say to management, “You’ve got committees that look at it. Jolly good, but what do you actually do about it?”
There’s far too much focus on risk registers — an obsession, as if risk management is only filling out a risk register. The best way of controlling risk is every time you have a project or a change, you challenge yourself on what are the risks. That’s because risk is a crucial part of a capitalist economy. One of the ways you make value creation in capitalist economies is by taking a risk. Of course, the trick is, it has to be a measured risk. You have to know what risk you’re taking. To analyse the risk return and the risk cost of every action. Risk needs to be baked into everybody’s jobs. That’s where you take risk management to a new level.
What’s the board’s role in effective risk management?
Laffin: The board oversees the risk management process as a whole. But it’s also got to think the unthinkable. All directors, especially the nonexecs, need to ask the question that the execs don’t dare ask: “What would be the real worst case?” Are you absolutely sure you’ve bottomed that out? They’ve got to challenge the assumptions. Also, importantly, they need to lead the company in saying, “Risk is vitally important.” So there’s a leadership role for boards. Boards have got to say, “This really matters”, and they’ve got to emphasise risks. They are really important.
“Safety critical risk methodology” — from safety-critical industries such as chemical, marine, aviation, nuclear — helps because it becomes more granular and a more rigorous process. In risk, your enemy is complacency and false reassurance. Your weapon is thinking things through, thinking through the worst case, and challenging all the assumptions.
M&A activity has accelerated in recent months. What are the practical steps members of an acquiring board can take to create a successful M&A?
Laffin: There are five key points that I would say acquiring boards need to really think about.
One is, try to keep an acquisition friendly. An acquisition is not a conquest. It’s not a time to be macho. Even if your advisers, who can be quite macho, want to, my experience is you are much, much better doing everything you possibly can to keep an acquisition friendly.
The second point is to respect the other side and its management. Very commonly in an acquisition, people think of it as, “We are the acquiring party; therefore we know much more than you. You’re incompetent,” and treat acquiree management without any respect. It’s a big mistake because the acquiree management often knows an awful lot more than you do.
The third thing is to focus on post-acquisition as much as the bidding process. Everybody gets excited, “Do we bid £2.40? Do we bid £2.45? What’s the tactic?" What you should give equal or more time to saying is, “If we win this, what do we do?” Because the real difference between a good and a bad acquisition is not the price. It’s the quality of the post-acquisition integration.
The fourth point is you should do a thorough risk analysis. And you should think through the worst case. An acquisition proposal should have a well-thought-through risk analysis because there are a number of events and occasions where businesses have been almost brought to their knees by a poor acquisition. So, the risk profile is high.
Then, my final point is to keep asking questions until you’re satisfied. Don’t assume everything is OK and everything has been thought through. Questions are one of the most powerful weapons of boards, particularly in a high-risk activity like M&A.
Moving on to diversity and the board. How can boards improve their decision-making through increasing their diversity?
Laffin: Well, I think it’s the statement of the obvious. If you have a room full of well-qualified, diverse people, you’ll probably get better decisions than a room full of well-qualified homogeneous people. Because of the extra experience and skills, and difference in attitudes that you get from people with different experiences. Of course, don’t forget that the board itself brings diversity into decision-making because, if all decisions were taken by the executive team, they tend to be pulling in one way and they tend to have a common background. One of the purposes of the board is to bring in nonexecutives with lots of different sorts of experience to challenge and oversee those decisions. That, together with well-qualified people, must make your decision-making better.
What you don’t want to do is have a board of people who look exactly like your executive management because then you’re not making the most of diversity.
Finally, what advice would you have for management accountants looking for a nonexecutive board role?
Laffin: The first thing to do is study your own board and your own board directors. If you’re working in a company, or any organisation that has a board of directors, you have the opportunity to look at what they’re doing. Obviously, the closer you are, the more information you can gather. Look at what board directors do, how the board works, and learn from that. As you get more senior and maybe you get invited in to do a presentation, then yes, you’re trying to make a great impression. But also try and sit back and look at the board and think about how that board reacted to your presentation. And afterwards, seek feedback from people so that you get to understand what works and what doesn’t.
Don’t be afraid to ask questions. Ask your CFO, “How did that board meeting go? How did that presentation go? How did people react?”
I think the second suggestion is to try and get experience and knowledge from outside of finance. You know, that can be working on voluntary bodies or reading about business. Take any opportunities you get and talk to people from other functions within your company or other companies. Get an MBA from real life.
In terms of getting onto a board, finance is the best function. That’s because every board needs a CFO. Increasingly now, there are only two directors on a public board: CEO and a CFO. So, the top finance man is guaranteed a board seat. Then, of course, every nonexec team requires a financial expert to be on the audit committee. Finance is particularly privileged when it comes to a board role.
— Oliver Rowe (Oliver.Rowe@aicpa-cima.com) is an FM magazine senior editor.