The Critical Importance of Process in Board Decision Making
21/Oct/19 08:45
When we were researching the relationship between Board Chairs and CEOs we asked our interviewees about the processes they used in the boardroom. Mostly this elicited a response along the lines of “We have an agenda and we take minutes”. It seems most Boards of directors confuse process with procedure. Procedure may be involved but process is a much broader concept; it is a structured method or sequence of steps or activities, but not used for the purpose of administrative consistency or compliance. Process is used for quality of outcome.
There is perhaps a tendency for directors to view the discipline of process as a constraint on the free reign of experienced judgement. If so, this would be a mistake. A very wide body of experience and research has demonstrated that Board decision making is no less subject to the pitfalls of cognitive and behavioural limitations and biases than any other human activity. In certain important respects, in specific cases, Board decision making has been shown to be worse than in other, similarly important contexts. This is especially true of the performance of Boards as regards Strategic Risk.
There are two compelling reasons for Boards to take another look at their decision making processes – the first is the consequences for directors when their processes are absent or poor and the second is the real potential for improved Board effectiveness.
Traditionally, Board decision making has been defended in practice from external legal scrutiny by a convention, sometimes reinforced at common (i.e. judge made) law, that “business judgement” was not judiciable. This assumption has been long established. Yet even if it was ever wholly true, which is debatable, clear political and regulatory trends are moving against it.
In the UK, statute law has been enacted to both clarify and tighten directors’ accountabilities. Consequently, as recent research* (led by Professor Joan Loughrey at the University of Leeds) has highlighted, there has been dramatic growth in directors’ decisions being challenged in the courts. In less than a decade such cases grew by a factor of 10. Moreover, when directors are taken to court the probability is that they will lose. 63% of cases reviewed by Prof. Loughrey’s team were found against the directors, i.e. they were found liable for the consequences of their decisions. The proportion of cases being found against directors is also increasing. “Business Judgement”, at least in the UK, is no longer (if it ever really was) a blanket defence.
Even in the US, the legal environment is moving in the direction of greater director liability, especially in the arena of risk governance. The Supreme Court of Delaware, long a bell-weather for the legal approach to corporate governance in the US due to the large number of corporations domiciled in the state, has tended to err in defence of the “business judgement” principle. Historically the so-called Caremark doctrine held that directors would not be held liable for a failure in risk oversight unless there was “… an utter failure to ensure … [ ] … a reasonable system exists.” Now that seems to be changing too. In a recent judgement** the court found that “… directors must make a good faith effort to implement a [risk] oversight system and monitor it themselves.” This new ruling places the onus of accountability squarely on the Board to demonstrate an effective process is in place.
What does this mean for Board decision making? For a start it means much more than simply recording decisions in minutes. Prof. Loughrey’s team found that when cases were found in favour of directors it was most frequently because the defendants could show that they had followed a clear decision making process, supported by relevant and timely information and advice.
Thus, there is a clear case for Boards to pay greater attention to the appropriateness and rigour of their decision making processes, especially when critical strategic issues and risks are involved. Yet even if self-protection is not sufficient justification there is another good reason for Boards to up their decision making process game. Better processes produce better outcomes.
Nobel prize winner and doyen of the behavioural science underpinning human decision making, Daniel Kahneman recently published*** on why disciplined decision making processes are required. The fruits of his over 30 years of research give Kahneman deep insights into the cognitive and behavioural biases that afflict most human decision making. In the context of high stakes, high impact strategic Board-level decision making, these biases are frequently exacerbated by the individual egos, personalities and group dynamics involved. To counter these conditions Kahneman and his co-authors set out a compelling case for why decision making processes are needed.
In case after case of major corporate failure, the root cause can be found to be poor Board decision making. Yet when Boards get it wrong it is not just the individual directors who may have cause for regret. The consequences and costs fall far more widely than on the directors involved. Indeed, they are most frequently cushioned from financial impacts; employees, suppliers, customers and society at large are not. It can be argued that Boards and directors have a clear moral responsibility to improve their critical decision making processes.
* Business Judgement and the Courts; Centre for Business Law and Practice, University of Leeds; University of Liverpool Management School
** Marchand v. Barnhill, No. 533, 2018 (Del. June 19, 2019)
*** A Structured Approach to Strategic Decisions; Daniel Kahneman, Dan Lovallo, Olivier Sibony; MIT Sloan Management Review, March 04, 2019
There is perhaps a tendency for directors to view the discipline of process as a constraint on the free reign of experienced judgement. If so, this would be a mistake. A very wide body of experience and research has demonstrated that Board decision making is no less subject to the pitfalls of cognitive and behavioural limitations and biases than any other human activity. In certain important respects, in specific cases, Board decision making has been shown to be worse than in other, similarly important contexts. This is especially true of the performance of Boards as regards Strategic Risk.
There are two compelling reasons for Boards to take another look at their decision making processes – the first is the consequences for directors when their processes are absent or poor and the second is the real potential for improved Board effectiveness.
Traditionally, Board decision making has been defended in practice from external legal scrutiny by a convention, sometimes reinforced at common (i.e. judge made) law, that “business judgement” was not judiciable. This assumption has been long established. Yet even if it was ever wholly true, which is debatable, clear political and regulatory trends are moving against it.
In the UK, statute law has been enacted to both clarify and tighten directors’ accountabilities. Consequently, as recent research* (led by Professor Joan Loughrey at the University of Leeds) has highlighted, there has been dramatic growth in directors’ decisions being challenged in the courts. In less than a decade such cases grew by a factor of 10. Moreover, when directors are taken to court the probability is that they will lose. 63% of cases reviewed by Prof. Loughrey’s team were found against the directors, i.e. they were found liable for the consequences of their decisions. The proportion of cases being found against directors is also increasing. “Business Judgement”, at least in the UK, is no longer (if it ever really was) a blanket defence.
Even in the US, the legal environment is moving in the direction of greater director liability, especially in the arena of risk governance. The Supreme Court of Delaware, long a bell-weather for the legal approach to corporate governance in the US due to the large number of corporations domiciled in the state, has tended to err in defence of the “business judgement” principle. Historically the so-called Caremark doctrine held that directors would not be held liable for a failure in risk oversight unless there was “… an utter failure to ensure … [ ] … a reasonable system exists.” Now that seems to be changing too. In a recent judgement** the court found that “… directors must make a good faith effort to implement a [risk] oversight system and monitor it themselves.” This new ruling places the onus of accountability squarely on the Board to demonstrate an effective process is in place.
What does this mean for Board decision making? For a start it means much more than simply recording decisions in minutes. Prof. Loughrey’s team found that when cases were found in favour of directors it was most frequently because the defendants could show that they had followed a clear decision making process, supported by relevant and timely information and advice.
Thus, there is a clear case for Boards to pay greater attention to the appropriateness and rigour of their decision making processes, especially when critical strategic issues and risks are involved. Yet even if self-protection is not sufficient justification there is another good reason for Boards to up their decision making process game. Better processes produce better outcomes.
Nobel prize winner and doyen of the behavioural science underpinning human decision making, Daniel Kahneman recently published*** on why disciplined decision making processes are required. The fruits of his over 30 years of research give Kahneman deep insights into the cognitive and behavioural biases that afflict most human decision making. In the context of high stakes, high impact strategic Board-level decision making, these biases are frequently exacerbated by the individual egos, personalities and group dynamics involved. To counter these conditions Kahneman and his co-authors set out a compelling case for why decision making processes are needed.
In case after case of major corporate failure, the root cause can be found to be poor Board decision making. Yet when Boards get it wrong it is not just the individual directors who may have cause for regret. The consequences and costs fall far more widely than on the directors involved. Indeed, they are most frequently cushioned from financial impacts; employees, suppliers, customers and society at large are not. It can be argued that Boards and directors have a clear moral responsibility to improve their critical decision making processes.
* Business Judgement and the Courts; Centre for Business Law and Practice, University of Leeds; University of Liverpool Management School
** Marchand v. Barnhill, No. 533, 2018 (Del. June 19, 2019)
*** A Structured Approach to Strategic Decisions; Daniel Kahneman, Dan Lovallo, Olivier Sibony; MIT Sloan Management Review, March 04, 2019
blog comments powered by Disqus