One of the most frequently asked questions during director education programs is: “What questions should we as a board members be asking, especially in light of the current economic environment?” Board members should be guided by some basic tenets of corporate governance as well as their duties and role as directors not only in considering, “What questions should be asked,” but also, “How questions should be asked,” and, perhaps most importantly, “When can we stop asking questions?”
What questions should be asked
Although all of a corporation’s power and authority are vested in its governing board, a basic tenet of corporate governance is that a board does not directly exercise all of that power and authority, but it is exercised “under the direction” of the board. Boards are expected to rely principally upon management in recommending, and especially executing, that direction, and each board member is protected from liability if the board member has a reasonable belief that management is reliable and competent in recommending such direction.
Courts generally require that, in order to have such a reasonable belief for a matter, board members must ask questions verifying the reliability and competence of management for the matter.
Your role as a board member is to oversee that direction is provided, but not to execute that direction or mange the organization unless you believe that the CEO and management are not reliable and competent to do so. As a board member, you do this by asking sufficient questions, so you have a reasonable belief that the CEO and management are reliable and competent in what they are authorized or directed to do.
Your questions should not generally be “how are you going to do this.” Management should have the authority to determine “how.” Your questions are to verify or confirm their reliability and competence in making the “how” determination: “How does this benefit the best interests of the business?” “Is it consistent with our business model and strategy for the future?” “What financial, legal, ethical, strategic and reputational issues have been considered?”
Based upon the commonly recognized duties and roles of a director, here are some guideless for what you, as a board member, may consider asking:
How does this action further the corporation’s best interest? Both you and management have a duty of loyalty to act in the best interests of the corporation. If you are not clear from management’s presentation on a matter, appropriate questions for your protection and to assure management’s reliability include, “How does this further the best interests of the organization.” More specifically, “How does this action benefit shareholders as a whole?” for stock corporations; or “members,” for a membership organization; or “stakeholders of the organization’s mission,” for non-member charitable organizations.
Who else benefits from the action? Directors are held to higher scrutiny of transactions in which another director or an officer or other insider may have a personal or economic interest. Accordingly, appropriate questions could include, “Who other than the corporation benefits from this transaction?” Also, “Is the transaction fair from an economic point of view to the corporation despite any interest of such insiders?”
How does this further the organization’s strategic direction? A corporation’s board as the highest corporate authority is ultimately responsible for the strategic direction of the corporation. Accordingly, appropriate questions could include, “Is the action consistent with the overall strategic direction of the business of the organization?” If not, “Is the strategic direction being changed as a result of the action.”
What is being asked of us as the board? Directors, as well as management, have a duty of care to act as an ordinarily prudent person in a like position would act under similar circumstance. Accordingly, appropriate questions could include, “What is the nature of the action we are being asked to take?” “What is our role going forward?” Equally important is the extent that continued board oversight is necessary or appropriate.
What is to be expected of management? Management also has the same duty of care with respect to matters delegated to them. Accordingly, appropriate questions could include, “What discretion does management have to execute or not execute the action?” “What additional authority does management need from directors in the future and when?” and, “What is expected of management in terms of reporting back to the board?”
What if things don’t go as expected? As a director, you should take into account the premise of Nassim Nicholas Taleb’s book, “Black Swan, The Impact of the Highly Improbable,” that policy makers such as board members must consider all of the possibilities, especially those that could have a high impact, albeit remotely probable, and not just the normal. The current “Great Recession” is the likely result of a failure to take into account the highly improbable, but high impact, occurrence: “What happens if real estate prices fall?”
Accordingly, the most important questions that a board should ask are “what if,” most importantly, “What happens if things don’t go as expected?” and, “What financial, legal, ethical, strategic, and reputational issues are involved?”
How should questions be asked?
Both you, as a board member, and management have the same duty of care and nearly the same duty of loyalty. Therefore, unless you believe that the CEO and management are not reliable and competent for a matter, your questions should be non-confrontational and judgmental.
For any action upon which you as a board member are relying upon more than the CEO or a single member of management, a good practice is to ask your questions separately of each management member upon whom you believe you will be relying. The same questions should be asked separately of each management member.
In addition, you are entitled to rely upon professionals or other experts for matters which you reasonably believe are within their professional or expert competence. Such professionals or experts could include the person serving the internal auditor function, representatives of the external auditor, outside legal counsel and outside experts with experience in the matters under consideration.
The consistency of the different answers should be compared. The answers among different constituencies will unlikely be the same. For example, management is more likely to view certain business issues more positively than the external auditor or chief legal officer. On the other hand, the external auditor and chief legal officer are more likely to view risks of liability as more material than management. Often a chief financial officer views a matter from a different perspective than the chief executive or chief operating officer. Accordingly, answers will differ, but there should be a consistency.
When to stop asking questions?
The skill is to learn when to stop asking questions. Nothing is more bothersome to management than irrelevant, unnecessary questions. As a general rule, you should stop asking questions and accept the answers when those answers are consistent. On the other hand, you should delve deeper when the answers to the questions are inconsistent.
Directors and management should expect that there will be some tension between them during this process. Management needs to understand that board members must ask questions to determine whether management is reliable and competent for the matters delegated to them. The board should understand that management will fear “being micro-managed” or “not being trusted.” For this reason, the chair or lead director of the board should from time to time remind management that directors are required to ask such questions to fulfill their duties and that management should not necessarily view this as an adversarial process.
An additional way to relieve this tension is for the board to have regular executive sessions separately with different members of management so that it becomes part of the routine operation of the board. A board should consider meeting regularly with the CEO, CFO, chief legal officer, internal auditor and representatives of the external auditor. Doing so will not only increase the familiarity of the board with management other than the CEO, but also the familiarity of those members of management with the board, which is probably the best defense against mismanagement and fraud.