Ethical Dilemmas at the Heart of Risk Management and Governance

Chief Financial Officers (and in some cases, Chief Risk Officers) are unique, in that apart from the Chief Executive Officer they are the only corporate officers who have a direct reporting relationship to the Board of Directors (usually via the board’s audit and risk committee).

Over a long career, I have repeatedly seen how this reporting relationship creates a recurring ethical dilemma for CFOs and CROs.

In today’s rapidly changing world, corporate failure rates are high, CEOs' average tenure is shrinking, and many of them are powerfully incentivized (via their compensation package and the threat posed by activist investors) to deliver rising returns to investors over short time horizons.

At the individual level, this combination of factors increases the likelihood that they will fall into any number of cognitive traps, including wishful thinking, overconfidence, and reduced tolerance for doubt and dissent.

At the group level, research has shown that heightened uncertainty increases human beings’ desire to conform to the views of the group, and to give greater weight to others’ views than their own private information. In other words, the situation many companies find themselves in today militate against CEOs hearing dissenting views from many, if not most, members of their team.

Under such circumstances, CFOs and CROs can easily find themselves caught between their duties to honestly assess the risks facing a company, and to report them to the board, and the painful realization that doing so may not be in the best interest of their relationship with the CEO and career prospects.

Given these factors, the risk governance role of a board’s non-executive directors is critical. However, to play it effectively they also must overcome two challenges.

The first is human beings’ natural cognitive difficulty when it comes to recognizing the importance of evidence that is absent – i.e., Sherlock Holmes’ dog that didn’t bark. Sometimes the most important red flags should be raised by what isn’t said in the CFO or CRO’s risk report to the board.

The second is perhaps even more difficult. Many non-executive directors have been corporate officers themselves, and appreciate what it feels like to be challenged by a board. Seeking to avoid conflict with a management team is natural desire for directors, until it becomes unavoidable (by which time it often comes too late). A director may also wish to avoid being seen by other directors as causing conflict on the board. And when uncertainty is high, the same group level pressures towards conformity operate on boards just as they do on management teams.

Thus the success or failure of risk management and governance processes often comes down to how CFOs, CROs, and non-executive directors resolve the ethical dilemmas they encounter at critical junctures in corporate history.
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