The evolution of organizational governance and board of directors’ responsibilities continues. In recent years, the actions of shareholder activists’ groups, securities regulators, and courts, as well as shareholder votes in corporate annual meetings, have confirmed the ongoing growth of expectations for the roles and performance of boards of directors.
The existence and responsibilities of specialized committees also continue to evolve. In addition to long-established types of board committees such as audit, finance, compensation, risk management, and nominating/governance committees, we now see committees formed to address issues such as technology, cybersecurity, personnel, safety, security, environment, and sustainability. While these topics are all valid considerations, one wonders how many committees one board of directors can administer and support effectively. How can numerous board committees successfully monitor issues and developments and then report on these matters in periodic board meetings?
With these growing expectations, further questions arise regarding whether boards today are receiving and utilizing adequate information and support to address governance and oversight responsibilities, and ensure operable checks and balances are in place. Far too frequently, it seems there is a news report about a breakdown in organization ethics and control, as well as performance failures across a wide range of industries and organization types.
How could the directors in these organizations not have been aware of serious problems? Did something go wrong in communications and information flow that let this happen? The recent termination of BP’s Chair (S. Reed, “BP Takes Tough Line with Former CEO over Relationship with Colleagues,” New York Times, Dec. 13, 2023, https://www.nytimes.com/2023/12/13/business/bp-bernard-looney.html), the removal of Boeing’s CEO (S. Ember and N. Chokshi, “Boeing CEO to Step Down in Major Reshuffle at Embattled Plane Maker,” New York Times, March 25, 2024, https://www.nytimes.com/2024/03/25/business/boeing-ceo-steps-down.html), and the Federal Reserve publicly criticizing the job performance of the Wells Fargo board members and the Chair/CEO (E. Herilihy et al., “Federal Reserve Takes Severe and Unprecedented Action Against Wells Fargo: Implications for Directors of All Public Companies,” Harvard Law School Forum on Corporate Governance, Feb. 5, 2018,https://tinyurl.com/2r5k8z2u) are examples.
Quantity of Information
Regarding the quantity of information, one must ask the following questions:
- How much information is needed for a body with oversight and increasingly recognized governance responsibilities to perform its functions?
- How much information is it realistic to expect a part-time body, oftentimes composed of people from a range of industries, institutions, and professions, to absorb and act upon?
- Who decides what data elements will be in the directors’ regular information package supplied for the board’s periodic meetings? And who decides when special circumstances warrant additional information, and what that information should be?
- How involved are board members in determining and specifying how much information they will receive for various purposes, when, and in what form?
Initially, the company’s founders and sponsors work with management to develop a structure for periodic board operations and meetings. As time progresses, the board members and board committees may request additional information they need to address their governance and oversight responsibilities. Changing circumstances, special events, and unexpected conditions may create a change in the quantity of and formats for information required. Additionally, third parties such as the firm’s external auditors, outside legal counsel, and other stakeholders may recommend matters to be brought to the attention of the board and its committees.
Types of Information Supplied to the Board
When considering the types of information to be supplied to the board, the following are the basic questions to ask:
- What types of information are needed to fulfill the board’s governance and oversight responsibilities?
- What matters are covered?
- How understandable is the information?
- Is the information timely?
Common components of board information include information about an organization’s market and business strategy, risk management, measures of financial and operational performance, control structures, management processes, and human resource issues. All of these components are important. Providing the right kind of information is an essential element of overseeing a company’s performance and prospects.
Although GAAP financial statements are necessary, important, and widely used, they are not sufficient to understand and run a business at a particular point in time. Organizational governance structures and processes, and operational needs and priorities, are specific to a firm at a point in time. The responsibilities of the board of directors, be they governance, oversight, or even management, constitute important checks and balances in an organization’s structure and ongoing operation, and they must consider more than GAAP financial statements. Boards require relevant, clear, and understandable information to address their responsibilities and, increasingly, bear a responsibility for obtaining the necessary information.
In today’s environment, it is imperative that a director have an in-depth understanding of the organization, its information flows, and its directors’ governance oversight and management responsibilities when they become a director. Understanding the organization’s operations and flows are situation-specific but are a burden a director assumes and can expect to be held responsible for understanding.
Non-GAAP Measures in External Reporting
Non-GAAP measures can be illuminating and useful to management and directors, and some non-GAAP measures may be reported externally to the shareholders and other stakeholders. A common example of a non-GAAP result is Earnings Before a Non-Recurring Loss, which may help readers better understand recurring profitability. Non-GAAP measures used in external reporting have, at times, however, been challenged by regulators as misleading to investors and other stakeholders.
This article will not attempt to cover the subject beyond making these two statements:
- Non-GAAP measures have a useful and legitimate place in reporting about a business, both internally and externally.
- An organization’s board of directors would be well-advised to understand how an organization’s non-GAAP measures are developed and used, and why they are viewed as meaningful.
Cash Flow Monitoring
An important part of performance measurement that doesn’t always receive enough attention in internal reporting to a company’s board of directors is cash flow monitoring. Cash flow is the lifeblood of a business. Understanding how to interpret cash flows, including capital expenditures, and monitoring cash closely is essential for overseeing and managing a business. Irrespective of the size of a business, the failure to track and manage cash flows effectively and promptly can disrupt or even bankrupt a business.
The complexity is magnified when analyzing long-term cash implications of performance results due to changes in the economic environment, implementation of strategic business changes, or unanticipated variances from business plans on future cash flows and the capital structure. A more detailed discussion on cash flow monitoring by the board, the CEO, the CFO, and the CLO will be presented in a future column.
Designing the Ideal Internal Reporting System
An organization’s internal reporting should aim to identify and illuminate the relevant elements of financial and operational performance that are important to the company’s success. A good design for internal reporting can also be used to encourage the behaviors and actions that contribute to a company’s success.
The design of a company’s internal reporting system is inherently unique to each company. While guidance can be gleaned from benchmarking and understanding the approaches used in peer and other companies, each company must ultimately find its own design to assess and understand performance. Revisions over time are almost a certainty, considering changing needs and circumstances.
