Making Sense of Disruption Public Company Board Projections for 2019

Making Sense of Disruption Public Company Board Projections for 2019

By Friso van der Oord, NACD

No company is immune to disruption, and change, especially in technology, is now exponential. At least so goes the conventional wisdom about today’s business landscape that dominates media headlines, business conference themes, and very often board agendas. Many directors now express fear that their companies will be disrupted, rather than becoming the disruptors.

It’s therefore no surprise that for the second year in a row, according to results from the 2018–2019 NACD Public Company Governance Survey, a large majority of directors, almost 70 percent, report that their boards need to strengthen their understanding of the risks and opportunities affecting company performance. They believe that their boards struggle to keep pace with fast-moving developments that can create or destroy business value. In a 2018 NACD poll, 62 percent of board members said that they view atypical, disruptive risks as much more important to the business environment today as compared to five years ago (and none said that they were less important).1 In the same poll, only 19 percent of board members reported that they are either extremely or very confident in management’s preparedness to address atypical, disruptive risks, while an overwhelming 82 percent of them indicated that they were either extremely or very confident in management’s ability to address known risks.

In this short outlook piece, we will explore key board projections for 2019 about the most disruptive trends affecting businesses. We will offer nuance around these projections, recognizing that change is not uniform across industries, that disruption offers both risks and opportunities, and that directors should not expect to become experts in each new disruptive trend. Rather, we believe that boards can successfully adapt their oversight practices to help management better anticipate and respond to disruption.

Key 2019 Projections

  1. Boards have concerns about less controllable, exogenous risks.

    Public company directors rate shifting economic and political developments as major trends that will affect their companies next year. In the 2018-2019 NACD Public Company Governance Survey, almost 50 percent of them rank changes in the regulatory environment and the threat of an economic slowdown in 2019 as the top issues which have the greatest potential for impacting their organization. Regulatory change itself may not invariably be negative, as some industries have benefited from deregulation over the last year. Yet companies are bracing for the effects of proliferating cybersecurity and data-privacy rules as regulators play catch-up in overseeing the digital economy and executives are anxious about the costly compliance impact of a still-pending Brexit deal. See page 6 for projected 2019 regulatory developments.

    A looming economic slowdown in the United States after a long period of expansion is also raising uncertainty. Inflation and interest rates are rising, and stock market volatility is up, triggering questions about whether major market corrections might be near term. Moreover, the recent economic gains have not addressed fundamental concerns about growing income inequality in the United States and other countries. And there is a risk that these economic divisions, both within and between countries, may worsen when the technology revolution accelerates and more jobs are displaced due to automation.

    Geopolitical volatility is also projected to be a top-five trend over the next 12 months for almost 40 percent of corporate directors. A more detailed look at director views of geopolitical issues reveals significant concern about the repercussions of escalating global trade conflicts and domestic political volatility in the United States—issues with which many management teams generally lack deep, operational experience.

    These macro trends affect many different markets and industries and are amorphous, creating more business uncertainty than many more-traditional corporate risks. Companies may find the combined impact of these forces harder to control than other risk areas. These forces are also more likely to have unforeseen, far-flung consequences.

  2. Key talent deficit and technology disruptions are seen as major management challenges.

    There are a number of disruptors that concern boards greatly, but where their confidence in management’s ability to address them is relatively low. Key talent deficits and the pace of technological disruption are both ranked in the 2018–2019 NACD Public Company Governance Survey in the top half of trends likely to have the greatest impact on organizations, but they rank in the bottom half of board confidence in management’s ability to address them. These issues may be particularly challenging for companies to address because they often materialize quickly and unexpectedly, are largely outside of management’s control, and may not fit historical patterns. And in the case of technology disruption and key talent deficits, the risks are interconnected, with the growing adoption of emerging technologies amplifying the shortage of skills for critical positions. As a result, boards must evaluate how well management is adapting the company’s existing enterprise risk management (ERM) capabilities to anticipate and respond to interdependent risks.

  3. Artificial intelligence is seen as both the biggest technology disruptor and the biggest business enabler.

    In the 2018–2019 NACD Public Company Governance Survey, 47 percent of directors rate artificial intelligence (AI) as

    the biggest technology disruptor, but 49 percent also regard it as the biggest business enabler most likely to benefit their organizations. And this top ranking of AI is remarkably consistent across respondents from different industries. Boards recognize the transformative power of AI for many dimensions of business, but fear that their organizations, often incumbent companies that struggle to embrace technological innovation, will fail to reap the benefits of AI. Recognizing what’s at stake, 50 percent of boards plan to improve their oversight of digital transformation in 2019.

  4. Climate change is not a critical issue for the next 12 months.

    Similar to the results we have seen in our surveys over the last two years, very few boards consider social and environmental issues to be top trends that will impact business performance over the next 12 months. Despite the growing investor and regulatory focus on climate risk, just 6 percent of respondents in the 2018–2019 NACD Public Company Governance Survey selected climate change as a top-five trend for the next 12 months. And only 5 percent indicated that growing antibusiness sentiment will have a major impact in 2019. These results suggest that sustainability concerns are crowded out by short-term priorities. However, directors are certainly not blind to the growing importance of environmental, social, and governance (ESG) related risks and opportunities. In our same 2018–2019 NACD Public Company Governance Survey, a majority of respondents would like their boards to take action next year: 54 percent want their boards to improve their understanding of their company’s current ESG performance levels and 50 percent would like their boards to link ESG to corporate strategy.

Adapting Board Oversight in Disruptive Times

No business process can be static in an ever-changing world, and board risk oversight is no exception. In 2018, NACD offered new guidance, a Blue Ribbon Commission report on board oversight of disruptive risk, and a joint white paper with Protiviti on Strategies for Addressing the New Risk Landscape to help boards adapt their governance approaches. To prepare directors to deliver effective disruption oversight in 2019, we have selected the most relevant recommended practices from these reports:

  • Ensure management integrates disruption considerations into strategy, performance, and decision making.

    Company exposure to disruptive change presents a choice: on which side of the change curve do organizations want to be? For example, organizations need to make a conscious decision about whether they are going to be the disrupter and try to lead as a transformer of the industry or, alternatively, whether they are going to play a waiting game, monitor the competitive landscape, and react appropriately—and in a timely manner—to defend their market share. It is important that the board ground its disruptive-risk oversight with a solid understanding of the company’s key strategic drivers and of the significant assumptions made by management that underpin the strategy. Boards should ask management whether they

    • monitor significant risks related to the execution of the strategy and business model and consider the enterprise’s risk appetite and risk tolerances in meeting key objectives;

    • evaluate the risk-reward balance associated with different strategic alternatives to understand the risks the enterprise is taking on as a result of each alternative for creating enterprise value;

    • track the external environment and macroeconomic trends for changes in significant assumptions underlying the strategy and continued relevance of the business model, and evaluate whether disruptive trends exacerbate risk or create market opportunities;

    • integrate lead indicators and advanced data analytics into performance monitoring so that it becomes more anticipatory and forward-looking and supports risk-informed decision making and increased accountability; and

    • involve the board in key decisions—e.g., acquisitions of new businesses that could offer access to disruptive technologies, entry into new markets, digital transformation initiatives, or alterations of key assumptions underlying the strategy—and invite challenge and open discussion regarding those decisions.

  • Assess the continued effectiveness of the risk-management program.

    Given the pace of change experienced in the industry and the nature and relative riskiness of the organization’s operations, does the board understand the quality of the ERM process informing its risk oversight? How actionable is management’s risk information for decision making? Does ERM effectively capture and assess early warning signals that indicate more unusual or disruptive risks on the horizon? These and other questions focus on the robustness and maturity of the risk-management process. Directors should ensure that the critical attributes of risk-oversight excellence are present:

    • Critical and potentially disruptive enterprise risks are differentiated from the day-to-day risks of managing the business so as to focus the dialogue on the risks that matter to the C-suite and the board.

    • Accountability is established for both traditional and disruptive risks and clearly embedded in the lines of business and core processes.

    • Actionable new risk information is not only reported up but also widely shared to enable more informed decision making.

    • An open, positive dialogue for identifying and evaluating opportunities and risks is encouraged. Consideration should be given to reducing the risk of undue bias and groupthink so that adequate attention is paid to differences in viewpoints that may exist among different executives.

    • Advancements in the application of new technologies—including AI, machine learning, mobile technologies, advanced data analytics, and visualization techniques—are used by the organization to strengthen risk prevention, detection, and mitigation

  • Improve the visibility of disruptive risks in board-management discussions.

    In an NACD poll earlier this year, 53 percent of directors cited the lack of information from management as a key barrier that either somewhat or to a great extent hindered effective oversight of atypical, disruptive risks.4 The 2018 Blue Ribbon Commission report highlights the fact that lots of valuable information about exposure to disruptive risks already exists within companies, but doesn’t always reach senior management and the board on time. The report recommends a number of concrete steps to improve management’s reporting to the board:

    • Better leverage the internal audit team to share insights about potentially disruptive risks. They possess a wealth of independent information about possible exposures and red flags.

    • Periodically review the format and content of risk reports to ensure they provide sufficiently forward-looking views of potential risks, including new patterns and linkages between different types of risks.

    • Ensure management reporting considers independent, external data about the company’s risk profile and evolving environment.

    • Frequently evaluate the current protocols for escalating information to the board. Do processes established to ensure the proper and timely flow of information to the board keep pace with changes in the business and risk environment? Are reporting thresholds clearly established and well understood?

  • Invest in the skills

    within the organization and on the board itself—necessary to successfully navigate disruptive risks. Directors express doubts about the readiness of their own boards to provide effective oversight of disruptive risks: 74 percent of respondents to NACD’s online poll held in 2018 reported that lack of board knowledge hinders oversight of disruptive risk to at least some extent.

The 2018 Blue Ribbon Commission report outlines a number of action steps:

  • Ensure that the selection and evaluation criteria for the CEO and other senior leaders focus on disruption and resiliency, including success in the following areas:

    • Leading the development of ideas and insights about future trends and opportunities

    • Problem-solving and executing successfully in uncertain situations

    • Openness to alternative points of view and early-stage ideas aswell as willingness to question assumptions (one’s own, and those of others)

  • Strengthen board oversight of the talent strategy by discussing how disruptive risks factor into the organization’s human capital plans and whether leadership development, compensation, and reward systems reflect the realities of a rapidly changing operating environment.

  • Establish requirements for ongoing learning by all directors and incorporate them into the board-evaluation process. Directors need to invest in continuous learning and development in order to grasp the company-specific impact of disruptive new risks and opportunities and to maintain an independent, well-informed point of view about the business and industry. Nominating and governance committees should ask directors to provide updates about how they are taking a proactive approach to ongoing learning.

In sum, boards have a major opportunity to become better sense makers to management in this disruptive environment. Their diverse experiences and distance from day-to-day operations can be a significant aid in helping management to see around corners and recognize new linkages between risks when considering them in the context of the organization’s specific circumstances, strategic assumptions, and objectives.

Friso van der Oord is director of research, responsible for all NACD content development. He is an experienced governance advisor and business line manager, who has worked over the past 15 years with Fortune 500 and global executives on major risk, compliance, and integrity challenges, including serving in leadership roles at CEB and LRN. He holds an MA in international relations from Johns Hopkins University’s SAIS Program.