Why Board Skepticism Needs to Extend Beyond Financial Statements

The cover feature of NACD Directorship magazine is on “Honing Skepticism – Trust, but verify is the skeptics mantra.  Why professional skepticism is one of the most important skills for directors – and how to develop a questioning mind-set.”

Constructive skepticism as a questioning mind-set

Constructive skepticism as a questioning mind-set

The article’s focus is primarily centered on the economic aspect – avoiding financial statement fraud. And while this is certainly critical given the well-publicized failures of fiduciary oversight in the past decade, I’d like to suggest that the scope of board skepticism should also include a company’s social and environmental performance.

The Business Roundtable notes in its 2012 Principles of Corporate Governance that “effective directors maintain an attitude of constructive skepticism; they ask incisive, probing questions and require accurate, honest answers.”  This attitude should not only apply to financial statements, it should also apply to advertising, public relations, sustainability and corporate responsibility reports with the company’s mission and values used as touchstones.

A Case in Point:  The U.S. Health Care Industry

TIME magazine’s recent cover story “Bitter Pill: Why Medical Bills Are Killing Us” by Stephen Brill illustrates this point in his excellent reporting on the health care industry.  Using actual hospital bills, Brill follows the money to expose how hospitals, pharmaceutical companies, and medical device manufacturers systematically exploit “powerless buyers in a seller’s market” by setting prices that result in exorbitant profit margins for their companies and financial ruin for many patients and their families.

brill.pill9.inddNone of the companies mentioned in Brill’s article state on their web sites that their primary mission is to leverage their superior market positioning to maximize short term profits.  They don’t publicize the fact that their industry spends three times the amount that energy companies spend on lobbying and campaign financing to bend policy to their advantage.

Medtronic’s mission “articulates the company’s call to alleviate pain, restore health and extend life and to maintain good citizenship as a company.”  Sanofi believes “that CSR (corporate social responsibility) is an integral part of the process to bring novel healthcare solutions to patients, including making ethical, social, and environmentally responsible decisions that serve patients and the community”

And even the not for profit Mercy Hospital owned by an organization under the umbrella of the Catholic Church called Sisters of Mercy brings in surplus revenue (profit) that would be the envy of any for profit company.  Its mission is “to carry out the healing ministry of Jesus by promoting health and wellness.”

There is no doubt that these companies do a lot of good, and that their products and services have saved many lives.  But skepticism means being wary of confirmation bias; of seeking out evidence that confirms what you want to believe while ignoring or explaining away any evidence to the contrary.  And Brill’s reporting uncovers evidence of behavior that clearly runs contrary to these company’s stated missions and values.

Is it possible that a company whose products and services do much to alleviate suffering also inflicts or contributes to suffering through some of its business practices?  And what if these business practices are common to the point of having become systemic throughout the entire industry, thus amplifying the impact of the suffering they cause on a societal level?  Directors with a skeptical mind-set don’t shirk from the responsibility of asking these types of difficult questions.

Martin M. Coyne II states in the NACD article that “deviation from revenue recognition policy is frequently the most common example of financial statement fraud in a company.”  What, then, should we call it when a company’s business practices deviate from its mission and values causing negative externalities to be imposed on the society it professes to serve?

And if “Doing the Right Thing” is Not Reason Enough

At last week’s GreenBiz Forum in New York, the Vice Chairman of NASDAQ OMX Group, Meyer Frucher, talked about how sustainability and social responsibility should be governance priorities because sometimes it comes down to “just doing the right thing.” I interpreted his comment to imply that moral and ethical considerations that can’t always be directly linked to financial performance still have a place in corporate governance.

There is also a solid business case, though, for doing the right thing.  Just as financial fraud presents a potential business risk, so does not living up to the company’s mission, values and social and environmental commitments.  Journalists, shareholders, social and environmental activists are making increased use of social media to broadcast inconsistencies and contradictions in actual company behavior versus the images they project of themselves.  Reputational risk and financial risk are intertwined.  Both fall within a board’s risk oversight responsibilities; both require the application of skepticism and a questioning mind-set.

The NACD article points out that “The term skepticism is often associated with doubt, but it actually describes a search for the truth. The word comes from the Greek skeptikos, used some 2,300 years ago by disciples of the philosopher Pyrrhus. The verb skeptesthai means “to reflect, look, view.”

Board skepticism and searching for the truth must extend beyond financial statements to include social and environmental claims and statements as well.

 

 

 

7 Responses to Why Board Skepticism Needs to Extend Beyond Financial Statements

  1. While this commentary may include some unnecessarily harsh allegations against well meaning companies, its basic point is true: Indeed, directors and others do need to apply skepticism to all aspects of corporate life, not just to financial statements. In this respect, the core of this commentary accords well with NACD’s upcoming March-April 2013cover story, “Sustainability Rising.” We hope that TE will weigh in on this article as well. Attention appreciated!

    • Richard says:

      Thank you for your comment, Alexandra. My intention in these posts is to use words and phrases that serve to underscore my main point, not overshadow or draw attention from it. After reflecting on your feedback, I decided to edit my original post to make the language less harsh in order to hopefully come closer to realizing that intention. I don’t know if you read the TIME article, but I hope that the directors of those companies mentioned in the article do, and that they honestly inquire into whether the pricing practices documented in the article reflect their company’s values.

      I’m glad to hear about NACD’s upcoming cover story on sustainability and look forward to reading it. While attending NACD’s national conference last October, I was especially happy that NACD’s Chair Barbara Hackman Franklin listed “push for socially responsible actions to be embedded in company strategy” in her list of five suggestions for directors.

      The collective impact of businesses on society and the Earth systems and services on which we depend is greater now than ever. Corporate governance plays a critical role in determining whether their organizations operate in ways that foster an economic system that contributes to overall well-being or one that is based on extracting natural and social capital for the short-term financial benefit of shareholders and senior management based on its compensation incentive structure.

      As a result, NACD’s leadership in helping to create “a world where businesses are sustainable, prosperous and trusted” by advancing “exemplary board leadership” is critically important and needed. Thank you for your comments and for helping to advance NACD’s mission and vision.

      • Thank you for your diligence in the worthy cause of corporate sustainability. Also thanks for going above and beyond in rephrasing the above … Not sure if most would agree with my approach (this is not NACD language, but my own),but when it comes to missteps and shortfalls individual companies I think of companies like people. I can “hate the sin” (the practice the company needs to improve) but “love the sinner” (treat the company with respect for the good that it does). Hope to see you at this year’s Conference as well! 🙂

  2. Larry Smith says:

    Richard, I agree completely with what you wrote above. We are focused on a similar mission for board members and others in business. More specifically, providing stakeholder decision frameworks (along with other frameworks) to help people make better decisions with transparency. One would hope if others had “transparency” as you have described above that people would either do the right thing on their own or have others guide them toward more ethical and moral business behaviors.

    If you would like to talk further I can be reached at Lsmith@equitymetrics.com.

    Regards,

    Larry

    • Richard says:

      Thank you, Larry….I appreciate your supportive comments.
      I’m interested in learning more about your work, so will be in touch.

  3. Skepticism seems to be the loaded word here.
    I don’t hear people disagreeing with what you’ve written; in fact I hear boards discussing this precautionary approach quite regularly. I think we tend to “soften” the language to make harder messages easy to swallow. Perhaps, if we can encourage boards to be more transparent and fearless in their approach when evaluating options and strategy then organizations and corporations will be come more resilient over time.

    • Richard says:

      Thank you, Polly. Transparency does call for fearlessness or courage, doesn’t it? While it may also involve a level of risk, a lack of transparency also carries it’s own set of risks.

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