‘Healthy scepticism’ is crucial for company directors

A previous article highlighted the most important attribute required for a company director — wisdom. Listening to the conversations at any gathering of these privileged individuals, it is apparent that only a few of them possess it. What does become apparent while eavesdropping is how transactional their interests are: they know the latest about which CEO is moving to which company and at what compensation, which global fund has what criteria for investing in India, which company has purchased what business, how much debt has just been signed-up by which corporation, and more of the like. It is apparent that they all read the pink papers every morning and that they are well networked with more of their own kind. However, rarely will you see directors whose interests include philosophy, history or authors such as Yuval Noah Harari.

This is not to downplay the value the “transactional” directors provide; knowledge of what is happening in the marketplace is essential. And not all directors need to be wise, a few owls will suffice in any one board.

Many directors are uncomfortable displaying any doubts about what managers propose. They believe that that can demoralise them.

But how are directors supposed to make use of the transactional approach? Basically, to challenge management — not in an aggressive fashion or to score brownie points; but to ensure that a proposal to the board by the management is thoroughly understood before it is agreed to. Many directors are uncomfortable displaying any doubts about what managers propose. They believe that that can demoralise them. As one said recently, “I will not join a board if I do not trust the top management and the controlling shareholder. But, having done so, it would be wrong to then question their proposals. I should not join if I do not have faith in their business sense and their intentions.” One was left wondering what purpose this director served.

Many directors believe that they must show confidence in management by cheerleading their proposals. Sadly, the long and wide trail of failed companies shows that this is a common belief in company boards reinforced by the prevalence of group-think and confirmatory bias.

Question the management

The reluctance to “challenge” management is more common in directors who were, themselves, managers in the recent past. Perhaps they have been through similar experiences when they proposed to their boards ideas which were passed muster without demur. Or maybe they are sympathetic towards their own kind, aware that it is difficult to say with confidence that a proposal will be successful if implemented. In this respect, former auditors demonstrate the correct attitude of respectful questioning, because that is a skill they should have honed over their professional lives. Auditors are taught to always demonstrate a “healthy scepticism”. What does that mean?

To be sceptical of any idea not because one suspects a concealed motive, but because it is necessary to verify before trusting. If one does not do that, a manager’s blind side to an issue will expose the company to a risk. The scepticism is to ensure that if the manger has missed a risk or, for that matter, an opportunity or advantage in a proposal, that is brought out before the decision to accept or reject is reached.

A board colleague, who had himself been a manager all his life, pointed to the correct way to demonstrate scepticism or even disagreement. If he wanted to convey disagreement with a proposal, he rarely did so by stating so. He employed the Socratic method. By a set of carefully thought-out questions, he got the manger championing a proposal to realise that there were risks or aspects of the proposal that the manager had missed and that required rethinking. Not all of us possess the patience to go through such a procedure; besides, many of us would rather demonstrate our brilliance to our board colleagues than to conceal it in the interest of manager morale.

Understand the risks

Why is scepticism important? As already seen, it brings out the risks that a manager might be blind to. There is also the possibility that managers, once they have convinced themselves of an idea, are keen for the board to approve it. Therefore, the presentation to the board and the discussion that follows has a “selling” air about it. The positives and advantages of the idea are stressed and repeated whilst the negatives are underplayed. Even when the board has mandated that proposals must also contain the risks, it is not uncommon for those to be relegated to a slide at the end whilst many slides filled with advantages precede it.

The slide with the risks will always downplay them by stating that they are low or, at the worst, moderate. The board will be assured that management has a plan should any of the risks manifest at any time. Sometimes such assurances are glib. Directors must carefully examine a proposal to identify hidden pitfalls. Fortunately, Internet search engines come in handy to discover risks that have not been brought out adequately, either on purpose or because of ignorance.

These extracts from the fourth schedule of the Companies Act, 2013, which lays out the code for independent directors, adds legal support to the need for boards to be diligent: “informed and balanced decision-making”; “seek appropriate clarification and amplification of information”; “participate constructively and actively”; “take …. opinion of outside experts”; and “pay sufficient attention and ensure adequate deliberations are held”.

Directors who believe that display of diligence demonstrates distrust of management would be well advised to read section 149(12) of the above act. It protects from action any director who acted without malice and who acted diligently. Demonstrations of good faith and trust in those who control the company are no protection if things go awry. This is a lesson many directors are now learning the hard way, with bank accounts frozen, passports seized and threatened with incarceration.

(The writer serves on the governing council of TERI and as an independent director on the boards of Thermax and Exide Industries)

Published online by Business Line here